Why Mexico’s global trade sweet spot may turn sour

The last time Donald Trump was in the White House, Mexico's economy did surprisingly well. The Spanish-speaking country, and global CEOs who have rebuilt their supply chains around it, will be hoping that the US president-elect's initial hostility once again amounts to nothing. That looks too optimistic.

As in 2016, Trump's 2024 election campaign was full of alarming pledges from the perspective of the United States' southern neighbour, whose $1.9 trillion economy is the world's 13th largest, according to the International Monetary Fund. Last week, he promised to impose a 25 percent tariff on Mexican goods on his first day in office until the country clamped down on drugs and migrants crossing the border.

Perhaps surprisingly, the government of new President Claudia Sheinbaum seems relatively sanguine, touting a friendly phone call with Trump later in the week. Economy Minister Marcelo Ebrard, who was Mexico's foreign secretary during Trump's first term, has talked up his country's negotiating power, stating that tariffs would cost US jobs and hurt growth, since firms from General Motors to Stellantis have sites in the Latin American economy.

History supports a relaxed attitude. Trump entered the White House in 2017 promising to radically reshape the North American Free Trade Agreement (NAFTA) to US workers' advantage and build a border wall at Mexico's expense.

Mexico has climbed through the ranks, from 12 percent in 1993 to 43 percent now, and now only trails German and South Korea

In reality, the 2018 United States-Mexico-Canada Agreement (USMCA) contained relatively little to worry its southernmost signatory. Multinational companies, particularly carmakers, subsequently rejigged their supply chains to send more wares through Mexico or make them there – a process known as nearshoring. In early 2023, for example, Germany's BMW said it would invest $870 million to extend its site in the central state of San Luis Potosí.

Trade has boomed. Last year, Mexico sent $475 billion of goods exports to the United States, surpassing China. A Brookings Institution analysis concluded that the number of Mexican jobs supported by intra-North American trade rose by about 2 million between 2017 and 2022. In short, Trump's combative rhetoric from eight years ago turned out to be bluster.

It would be unwise for Sheinbaum to bet on a repeat, however. Trump's choices for his cabinet suggest he is shunning some of the moderating influences that characterised parts of his first term. Howard Lutnick, Trump's nominee to lead the Commerce Department and trade policy, has criticised the USMCA for hurting auto manufacturing jobs.

Mexico's success under the agreement, meanwhile, makes it a more conspicuous target. The country's trade surplus with the United States rose 140 percent between 2016 and 2023 to $152 billion, using US Census Bureau data, while China's fell by a fifth to $279 billion. If trends continue at the same rate, the US trade deficit with Mexico would exceed its shortfall with China in absolute terms by 2027, according to Breakingviews calculations.

The Latin American country also seems entangled with the People's Republic. Economy Minister Ebrard has tried to defuse this point, claiming recently that just 0.4 percent of Chinese investment into North America goes to Mexico. But those numbers reflect the economies' vastly different sizes and levels of financial-market sophistication. The trade figures are more nuanced.

China accounts for a fifth of goods shipped into Mexico, UN Comtrade data shows, up from 15 percent in 2012. It's difficult to tell from the statistics what proportion of those goods head onwards into the United States. The Bank of Mexico argued in a recent analysis that it was tiny. The danger for Sheinbaum is that Trump and Lutnick don't bother to try and find out, and instead jump to the conclusion that Chinese manufacturers are using Mexico to gain cheap access to the US market.
There's circumstantial evidence to support this conclusion. Researchers at Rhodium Group claim to have identified a $13 billion stock of announced foreign direct investment from the People's Republic. This dwarfs the official tally, which the analysts say misses investments through offshore entities in Hong Kong and elsewhere.

Another red flag is that USMCA provisions designed to induce high-wage production in North America seem full of loopholes. To stop foreign carmakers sending finished vehicles into the United States via Mexico, the agreement stated that 75 percent of the content of a car, measured by value, must come from North America, and that 40 percent must come from manufacturing sites that pay workers $16 an hour or more.

The penalty for missing these thresholds, however, is just 2.5 percent, which some manufacturers seem happy to pay instead of overhauling their operations. More than 8 percent of USMCA car imports by value last year paid the duty, compared with 0.5 percent in 2019, according to a July report from the US Trade Representative. For automotive parts, the figure rose to 20.5 percent in 2023 from 9.3 percent four years earlier. One possible takeaway is that the USMCA's penalties are too puny to work.

Add it all together, and it's hard to see Trump letting the status quo persist when the USMCA comes up for review in 2026. Currency investors appear to have factored in some pain: one U.S. dollar now buys more than 20 Mexican pesos, compared with about 19 in mid-October. The question is what Sheinbaum can do to soften the possible blow. Pouring extra resources into policing the border would help, given Trump's hostility to immigration. But Mexico's recent efforts to apprehend US-bound migrants appear to have won little goodwill from Trump's Republican Party.

Another option is to appease the White House by shutting China out of Mexico, either through tariffs or by refusing to approve new investments by carmakers like Shenzhen-based BYD. That will hurt. The Rhodium figures suggest China's $3.8 billion of announced foreign direct investments into Mexico last year was dominated by greenfield sites, which typically bring new jobs.

The only good news for Sheinbaum is that European carmakers and other global manufacturers still have few better options, given that wages in Canada and the United States are high and factory workers are scarce. That means CEOs are unlikely to start pulling out of Mexico. But the country's role as a backdoor beneficiary of US trade tensions looks vulnerable.