By Rosa Ana Aranda López, Tax Partner, RSM Mexico
Tesla is the latest and most high-profile company to commit to investing in Mexico, with a new plant in the country just announced. With challenges for Chinese manufacturing looking set to continue, it won’t be the last.
In a little under two decades, China has transformed from a minor player in a burgeoning market for offshoring to become “the world’s factory”. By the start of this decade, it accounted for about 30% of the world's manufacturing output. As The Economist points out, it produces nearly as much as America, Japan and Germany combined.
However, its dominance may be coming to an end – or at least have reached the high-water mark. A combination of factors has led companies in the US and elsewhere to reconsider their overseas operations and look at options closer to home, including Mexico, with its maquila model as an attractive alternative for manufacturers.
In a sign of the times, perhaps, at the start of this year reports revealed that Tesla has delayed expansion of its “gigafactory” in Shanghai. At the beginning of March, meanwhile, it announced a new plant in northern Mexico – an investment said to be worth over $5 billion.
If China’s outsourced operations relocate, though, it will be more a sign of its success than its failures. If businesses want to succeed in nearshoring their operations, they must consider the move carefully and look before they leap. Challenges remain, no matter where they locate, and if China has shown us anything, it is that the world can alter very quickly.
A long time coming
There have been several drivers for international businesses to look again at their reliance on Chinese manufacturing – for both the long term and short term. Working backwards, the most recent is the continued disruption from the pandemic and China’s “zero Covid” policies, which have only lately been abandoned and caused havoc for many businesses.
Long after the US, Europe and elsewhere had relaxed or even entirely abandoned restrictions. Outbreaks in China saw strict lockdowns hastily implemented and manufacturing facilities closed with little notice – continuing disruption throughout 2022. A Bloomberg analysis in May last year found 180 companies globally mentioning China and lockdowns In their first-quarter earnings calls.
By the end of 2022, an article on Forbes reflected, “The heavy-handedness and unpredictability of government policies caused a loss of confidence in manufacturing in China.”
With the virus currently spreading rapidly after the abandonment of the policy, there could still be further disruptions from the pandemic. Even out of lockdown, soaring demand in the pandemic’s aftermath has already seen significant issues with shipping and logistics, delaying deliveries from factories thousands of miles from the end customers.
Moreover, the pandemic merely exacerbated nervousness around China, which was already high due to the continuing trade war with the US. Starting under the Trump administration in 2018, it shows little sign of resolution under Biden. If anything, tensions have escalated, with the current president not just keeping Trump’s tariffs in place but introducing export controls, visa limits, and restrictions on investments.
“I can’t see the relationship between China and the US going back to how it was 20 years ago,” says Jason Yau, Regional Leader for RSM Asia Pacific. “The US now sees it as not necessarily an enemy but certainly a key competitor.”
Meanwhile, on the other side of the world, despite the effects of the pandemic, the maquiladora industries located in the northwestern region of Mexico continued operating thanks to a combination of factors - the government´s commitment and competitiveness of the labour force. It isn’t just the US taking a harder line with China. The current UK prime minister Rishi Sunak used his first foreign policy speech to mark the end of the “golden era” of relations with the country.
Perhaps most importantly, it is not simply current events but long-term trends leading some to consider relocating. With a growing middle class, China is now more than merely an exporter. In 2021, its imports lagged only a little behind the US. As Jason Yau puts it, “Thanks to the globalisation since China opened up its economy to the rest of the world, it now has the consuming power amongst the middle class to really support its own economy domestically.”
As the country has grown richer, wages have risen, with the average more than doubling in the last decade to 2020. That has eroded a critical competitive advantage of the country as a hub for low-cost manufacturing.
This is unlikely to bother China too much. In some senses, it is just following the pattern of others like Japan, Korea or Taiwan, which, as they developed, shifted to higher-value manufacturing, serving domestic as well as international markets. It’s also worth noting that the country retains a massive manufacturing base for overseas businesses, which will persist for the foreseeable future; Tesla’s Shanghai isn’t going anywhere.
The key question is not where China is headed but where international manufacturers may go instead.
For many, the answer will be near neighbours where wages remain lower – principally, perhaps, Vietnam. They might also look to the next biggest developing nation, India, to provide more of their manufacturing. Apple, for instance, has done both in recent years – declaring in May 2020 that it would shift around 30% of its Airpods manufacturing to Vietnam and shifting some iPhone 14 production to India last year to reduce exposure to China.
There are, however, also locations closer to home that look increasingly attractive for manufacturers. And – as Tesla has discovered – Mexico is a strong contender.
With labour costs adjusted for productivity equal to or below China’s, Mexico has several other advantages, too. Not least is its proximity, particularly for US businesses, resulting in much cheaper – and quicker – transport and travel. Time differences are negligible; business culture is more aligned; and, in place of trade wars, the country has extensive free trade agreements covering 50 countries. That includes the United States-Mexico-Canada Agreement (USMCA).
“Mexico has one of the largest networks of trade agreements in the world, not only with its partners in the region, but also with the European Union, some South American countries and Asia Pacific,” explains Edgar Lopezlena, Mexican Practice Leader at RSM US.
For manufacturers, there’s an added incentive, too: The maquiladora, or maquila – a vehicle for Mexican factories owned by foreign businesses that permits duty-free and tariff-free imports of raw materials, machinery and equipment.
As ever, though, the devil is in the detail. The maquila structure can be an efficient tool for nearshore manufacturing, but only if used correctly. Crucially, for instance, goods produced by the maquila must be exported. Ownership must remain abroad, too, with requirements for a 99% foreign share.
In recognition of the incentives maquilas provide, regulatory compliance is tough. “Maquilas are, in general, held up to a higher standard of compliance than other operations,” warns Lopezlena. Moreover, regulation in Mexico is constantly shifting. Failure to meet the requirements can undo many, or all, of the benefits. And the process of establishing one – in theory straightforward – can take months.
For many, Mexico and a maquila could still be the answer to rising costs and troubles in China in recent years; but, any move must be carefully considered in terms of taxes, foreign trade and logistics. Expert advice is essential. Without it, businesses may find they’re just swapping one set of problems for another.