More than at any point in the last 15 years, Mexican industry is today able to compete with China as a low-cost manufacturing alternative, and with high-income markets as a viable location for outsourcing sophisticated manufacturing. If Mexico is to revitalise its economy after nearly flat growth in 2013, manufacturing, a pillar of the economy at 17% of GDP, will have to provide some of the lift.
US companies, particularly in the automotive and food industries, have taken advantage of low-cost Mexican labour for more than half a century. Their investments and Mexico’s shared border with the world’s biggest market, the US, gave rise to maquila model of manufacturing in the 1960s.
Mexico’s maquilas, or maquiladoras, concentrated in tariff-free zones along the northern border, are factories that engage in little or no design and to which companies, usually foreign ones, outsource basic manufacturing operations. Today, they remain the foundation of Mexican manufacturing, serving industries from textiles to electronics.
The growth of maquilas took off in the mid-1990s following the Mexican economic crisis of 1994 and 1995. Known as the “tequila crisis,” it was set off by the rapid devaluation of the peso, which dropped 50% in six months beginning in December 1994. With the price of Mexican labour and energy depressed by half for anyone paying in dollars, manufacturing contracts poured in. The implementation of the North American Free Trade Agreement (NAFTA) in 1994 spurred Mexican manufacturing to expand beyond the tariff-exempt maquilas, giving rise to the country’s modern-day manufacturing sector. The combination of a cheap peso and the tearing down of trade barriers with the US proved a potent mix. Mexican exports to the US increased from $39.9bn in 1993 to $280.5bn in 2013 in nominal dollar terms.
Mexico’s manufacturing sector faced its first big challenge of the NAFTA era in 2001, when China joined the World Trade Organisation (WTO). Once the global economy gained access to inexpensive Chinese labour, Mexico’s competitiveness fell. In basic manufacturing it could not compete, and in the two years after China joined the WTO, around 300 factories were uprooted from Mexico and moved to China. This competition, combined with the recession of the early 2000s, softened demand for Mexican manufactured goods. In 2001 the country’s exports to the US contracted for the first time since NAFTA’s implementation. In the following two years export growth to the US was nearly flat.
Soon, the question that industry, government and the press were asking was: what will Mexican manufacturing become? Competing with China on cost was out of the question, so the answer, given somewhat uneasily by industry representatives and government spokesmen, was that Mexico would become a centre of high-technology, high-design manufacturing. For years, this appeared to be the contention of the overly optimistic and, today, Mexico is still far from realising this vision. However, as advanced industries such as aerospace have taken root in Mexico in recent years, there are signs that it is taking steps toward becoming the advanced manufacturing economy its cheerleaders have dreamed of.
Meanwhile, as China turned into a manufacturing behemoth and Mexican politicians worried over their economy’s future, the country’s manufacturing sector quietly became competitive again in cost terms. Manufacturing labour costs in China have climbed significantly, increasing at an annual average rate of 24% in dollar terms between 2002 and 2009, the latest statistics available, according to the US Bureau of Labour Statistics (BLS). Wages have been more stable in Mexico, with manufacturing labour costs rising at an average annual rate of 4.1% in dollar terms between 1997 and 2012.
In gross terms, wages in China are still cheaper. A 2013 BLS study put hourly manufacturing wages in Mexico at $6.36 in 2012. It estimated that hourly manufacturing wages in China were $1.74 in 2009. The study pointed out that collecting data on wages in China was problematic and that the Chinese wages figure could not be directly compared to the Mexican one, which was presumed to be more reliable. Nevertheless, it would be reasonable to conclude from this data that, in gross terms, hourly wages in China were certainly lower than in Mexico in 2009, and probably in 2012 as well. This conclusion is also supported by OBG’s interviews with manufacturers.
Yet tallies of gross hourly wages on a national basis do not tell the whole story, as they do not account for differences in worker productivity or in labour costs between industries. Worker productivity in Mexico is typically higher than in China and Mexican unit labour costs, which account for both wages and productivity, are more competitive. A 2013 Boston Consulting Group study found that Mexican unit labour costs achieved parity with China’s in 2012, and will be 30% lower by 2015. This figure may be generous, but it illustrates an undeniable trend toward lower Mexican unit labour costs relative to China. This trend toward lower wages in Mexico appears to be stable in the medium term. The International Labour Organisation projects a 20% rise in Mexico’s economically active population between 2010 and 2020, which will exert downward pressure on wages. China’s economically active population is expected to grow by 2.9% in the same period.
Mexico’s advantage over China in freight costs has also widened over the last decade, as the price of crude has climbed to just under $100 per barrel in the first quarter of 2014, from about $43, adjusted for inflation, 10 years ago. The consequent increase in the price of fuel has made Mexico’s proximity to the US, and its relative proximity to Europe when compared to China, that much more important. According to Sea Rates, New York and Los Angeles can be reached from major Mexican ports in six days and four days, respectively. The trips from Shanghai are 31 days and 17 days, respectively.
Mexico does not only compete for investment with low-cost manufacturing countries, such as China. It is also a destination for outsourcing manufacturing from the developed world. Over the last decade, companies in the automotive, aerospace and electronics industries, among others, have transferred production capacity to Mexico from countries such as Japan, the US and Canada.
The potential cost savings from such moves can be significant. According to KPMG’s 2014 Competitive Alternatives study, overall manufacturing costs (including labour, real estate, transport and energy), based on an average of manufacturing industries, are 39% lower in Mexico than in the US, and 35% and 36% lower than in Canada and Japan, respectively. Most savings come from labour costs, which, in Mexico, are around one-third of those in the US.
FTAS: Mexico’s great advantage in manufacturing, besides cost, is openness. It has been one of the most prolific countries in the world in signing FTAs and currently has agreements with at least 45 countries, which the government claims represent 60% of world GDP. NAFTA is the most important of these trade deals. It catalysed the development of manufacturing in Mexico by enabling supply chains to be integrated across North America in industries such as aerospace and cars. It has also allowed low-margin businesses, such as segments of consumer electronics, to flourish by eliminating almost all tariffs.
The FTAs signed since NAFTA have given Mexican industry similar preferential access to markets in Europe, Latin America and, to a growing extent, Asia. At time of press Mexico was engaged in the 12-country talks over the Trans-Pacific Partnership, which, if ratified, would create a free trade zone around the Pacific Rim including Japan, the US, Mexico, Australia, Malaysia and Vietnam, among others. The country’s openness differentiates it from some emerging markets, such as Brazil, whose illiberal trade policies have undermined manufacturing competitiveness and devalued foreign investments.
Mexico’s primary weakness in manufacturing is its energy costs, although energy reform passed in 2013 should help to make it more competitive. Hector Balmaceda, owner of manufacturer Cajaplax, told OBG, “Reform was necessary to prevent Mexico from becoming dangerously uncompetitive, especially as the US approaches energy self-sufficiency. Today, energy costs are a bigger factor than labour costs in production-intensive industries. Mexico may have lower wages than the US, but energy costs are 80% higher.” The exact premium that Mexican factories pay for electricity compared to those in other countries is hard to define. The price of electricity charged to industry changes on a monthly basis and from region to region, based on formulas managed by the Regulatory Commission for Energy (Comisión Reguladora de Energía, CRE).
Rubén Flores García, a director at the CRE, told OBG that industry representatives report paying around 20% more for electricity than they would in the US. KPMG’s Competitive Alternatives Report estimates that electricity costs for manufacturing are 60% higher in Mexico than in the US.
The premium is partially due to the fact that the state electricity monopoly charges industry an artificially elevated price. The extra revenue brought in this way helps to subsidise residential electricity, which keeps households from feeling the consequences of Mexico’s inefficient electricity infrastructure, but renders manufacturing in the country less competitive than it might be. The energy reform is expected to eliminate this cross-subsidy, as it is called, and has the potential to reduce costs in the long term by liberalising the energy market. These consequences of the reform could address the greatest challenge facing Mexican manufacturing. However, it remains to be seen how 2013’s energy reform will be implemented through secondary legislation that was still pending in Congress at time of press.
Gaps in the domestic supply chain are another factor decreasing the competitiveness of Mexican manufacturing. Since the implementation of NAFTA, manufacturing operations in Mexico have become integrated with advanced supply chains spanning North America. However, in many industries, Mexican suppliers find themselves forced to import large proportions of the components, raw materials and inputs they use because of a lack of maturity in Mexico’s supply chain. The aerospace and automotive industries (see analyses), have achieved competitiveness despite this problem, but factory managers have reported to OBG that they could decrease costs by as much as 15% if they could source more parts and materials domestically.
The problem also affects the consumer electronics industry, and can outweigh Mexico’s advantages. When Swedish company Esselte was weighing locations to manufacture label printers, it considered Mexico. There were clear advantages: proximity to the US market and to executives who worked at corporate offices in the US. Also, labour costs were lower than in China and Esselte expected the gap to widen. But the expense of importing from China the electrical components needed to assemble the printers more than offset the projected savings in labour and freight, so the printers are now made in China.
One less often discussed challenge is a slowdown of transit at the border between the US caused in large part by increased security regulations put place by the US after the September 11 attacks. More than $1bn of goods crosses the border every day, but the flow of traffic is inefficient. Most trucks coming from Mexico do not deliver their loads to final destinations in the US. Rather, they hand off their trailers to cabs and drivers specialised in border crossing, which can take several hours.
As a result, Mexican industry cannot fully take advantage of its proximity and tariff-free access to the US. According to a study by Erik Lee and Christopher E Wilson of the Border Research Partnership, the number of northbound truck crossings from Mexico to the US has been nearly flat for more than a decade, increasing from 4.5m to 4.7m crossings per day between 2000 and 2010. This was a period when merchandise trade between the two countries increased by almost 60% on a current dollar basis.
The congestion at the border has pushed some trade toward more expensive shipping options such as air or water. It also threatens to undermine one of Mexican industry’s most important competitive advantages: the unrestricted flow of goods across the border afforded by NAFTA. However, Mexico has also worked to ensure the safety of its border trade and, since 2011, is a full member of the Wassenaar Arrangement for Export Controls of Conventional Weapons, Goods and Dual Use Technologies.
Another problem facing Mexican manufacturing, especially in high-technology and high-design industries like aerospace and medical devices is a shortage of highly skilled engineers with relevant experience in research and development (R&D).
According to OECD statistics, in 2011 Mexico graduated 155,000 engineers (in two categories, which the OECD calls engineering, manufacturing and construction, and engineering and engineering trades). The same year, the US, a country 2.5 times the size of Mexico in terms of population, graduated 271,000 engineers. Brazil produced 84,000 engineers in 2011. Engineers in Mexico often have trouble finding suitable work. Since 2006 the number of engineers graduating every year has nearly doubled, but the number of Mexicans employed as engineers only increased from 1.1m in 2006 to 1.3m in 2012. The lack of available positions has compounded the problem, leading to a loss of talented Mexican engineers to foreign markets, such as the US, that have more robust labour markets for designers.
Many of the engineers who do find work never obtain the skills needed to engage in advanced design because of a lack of investment in R&D by both the private sector and the public sector. According to data from UNESCO, in 2011, the latest year for which figures were available, Mexico’s gross domestic expenditure on R&D (GERD) was only 0.46% of GDP. This compared to GERD of 2.77% in the US, 1.84% in China, and 1.16% in Brazil (in 2010).
As a result, Mexico has engineers experienced in maintenance and industrial processes but not in design. Francisco Antón Gabelich, director-general of Ciateq, a public research centre for technological development, told OBG, “Mexico produces a great many maintenance engineers and has a good background in optimising industrial processes, making for some of the world’s most productive factories in certain segments. However, this is sometimes confused with being an innovative country, which Mexico is not, at least not from an industrial standpoint. The country needs more opportunities for engineers to work in the design phase of industrial processes.”
These situations appear to be improving somewhat. Foreign companies have increasingly transferred R&D work to Mexican facilities. Notably, Honeywell and General Electric operate testing and design centres in Mexico focused on the aerospace industries (see analysis). Also, as high-tech manufacturing in Mexico grows, universities and technical schools have added programmes that produce engineers specifically trained to work in industries, such as aerospace and medical devices that have growing footprints in the company. However, the problem is somewhat circular. Large numbers of foreign companies will not transfer R&D centres to Mexico without the existence of a qualified pool of labour in the country, and Mexican engineers will not become qualified without the opportunity to work in such centres. If it is serious about promoting the development of high-design manufacturing, the government may have to break the deadlock by increasing its commitment to research with greater funding.
The two pillars of Mexican manufacturing are the automotive and processed food and beverage industries. Mexico’s automotive industry is in the top 10 globally in terms of production and the second-largest in Latin America, and is projected to pass Canada in 2015 to become the number one exporter of cars to the US, where one in 10 light vehicles sold is made in Mexico.
Mexico’s auto parts segment was the fifth-largest in the world in 2012, with production of $73.3bn. The sector supplies assembly plants in the US and, to an increasing extent, in Mexico. As Mexican manufacturing has become more competitive, investment by original equipment manufacturers (OEMs) in assembly plants in the country has grown. Nissan, Mazda, Toyota and Volkswagen, among others, have announced or opened new plants in the last two years, totalling billions of dollars of investment. The industry, like many others in Mexico, is affected by gaps in the supply chain, notably in components provided by tier two and tier three suppliers, but these new investments should help the supply chain develop, enhancing the sector’s competitiveness.
The auto industry is export-oriented because the domestic car market is weak. Martín Rosales, managing director and president for Mexico at Goodyear, told OBG, “Car sales estimations for Mexico in 2014 are set at 1.4m units, a low number for a country with more than 110m people. This is mainly due to the impact of the used cars coming from the US and other countries which signed FTAs.” Importing used cars newer than eight years old from NAFTA countries is prohibited. Nevertheless, used cars from the US are widely available and inexpensive. Combined with many Mexicans’ limited access to financing, this has stunted the domestic market’s growth. It is one of the primary goals of the auto industry to boost domestic sales and develop a robust market in its own backyard. Until then the bulk of national production will be sent abroad, as it is today.
Processed food and beverages account for about a quarter of value added from manufacturing in Mexico and 4% of GDP. The industry produces mainly for the domestic market, with total production of $124bn in 2012 and exports of $8bn. Key segments include milk and pet food, primarily sold to the domestic market, and chocolate, bread and tortillas, which are produced for the domestic market and exported in large quantities.
Mexico runs a trade deficit – $1.6bn in 2012 – in processed foods, due largely to imports from the US of products including sweeteners and concentrated milk. Nevertheless, Mexico’s exports of $9bn of processed foods in 2012 represent a small percentage of national consumption, and the national industry meets the bulk of domestic demand. In 2012 the industry grew by 3% and modest, consistent growth can be expected to track demographic trends.
The electronics industry has a long history in Mexico and the country is now the largest exporter of electronics in Latin America. Today it is a broad industry that ranges from electrical components, such as circuits, to consumer electronics, including mobile phones and televisions, and from household appliances to industrial electrical equipment. It accounts for around 8% of GDP. Like much of Mexican manufacturing, the electronics industry received a boost from NAFTA and grew steadily through the 1990s. However, in the early 2000s the industry was damaged by China’s ascension to the WTO and the recession that was experienced throughout the developed world. Mexican electronics exports declined for three straight years from 2001, during a period when Chinese electronics exports were steadily growing.
The industry began to recover in 2004, as a result of the world economy’s stabilisation and changes in the electronics industry. In the last decade, the life cycle of consumer electronics products became shorter and the market became more competitive. This caused electronics OEMs to transfer electronics production from rich countries to low-cost-manufacturing countries; produce electronics near the markets where they will be sold; and outsource manufacturing and, to an extent, design to third-party electronics manufacturing services companies (EMSs) and original design manufacturers (ODMs).
Devices that were the height of technology five years ago are now ubiquitous and subject to intense price pressure. As a result, consumer electronics can rarely be built in the higher-income markets that they are sold to. With its proximity and free access to the US, Mexico has become an attractive choice as a low-cost destination for manufacturing electronics for the US. Today it is the number one exporter of flat-screen televisions to the US.
As pricing has become more competitive, production cycles have also shortened. Whereas a decade ago, the typical production cycle for a new consumer electronic device was two years or more, today the cycle has been reduced to months. As a result, quick access to market can be a significant advantage. This has led OEMs to place production facilities as close as possible to the markets they serve.
Today many leading EMSs and ODMs, including Foxconn, Jabil and Flextronics, have substantial operations in Mexico, concentrated in the northern states of Chihuahua, Tamaulipas, Jalisco and Baja California. These companies primarily produce flat-screen televisions and computers. In the household appliances sector, OEMs such as Samsung, LG and Mabe, a Mexican company, operate their own plants producing refrigerators, washing machines, heaters, and other large appliances for the domestic market and for export. Demand in this market has been somewhat volatile in recent years, with key Mexican export products affected. According to a study by BBVA Research, Mexican exports of compression refrigerators, vacuums and home washing machines all dropped by double digits in 2012. After the decline, they accounted for 18% of Mexican home appliances exports. Combination refrigerator-freezers, which account for more than one-third of home appliance exports, registered an increase of 5%.
With wages and energy prices trending in the right directions, Mexico’s electronics industry may begin to pull back some production capacity from China. However, in order to accomplish this on a significant scale, the supply chain will have to mature first. If sufficient numbers of components suppliers can be enticed to set up shop in Mexico, significant expansion of the industry may be possible.
During the last 15 years, several industries have grown in Mexico that require higher manufacturing standards than traditional maquilas were historically able to provide. Notably, this has occurred in the aerospace and medical equipment industries. Both of these industries registered exports of around $6bn in 2013 and have recorded 17.2% annual growth in the last nine years. Currently, there are 287 companies and support entities in the country.
The aerospace industry, in particular, has attracted much attention from the press and investors for its potential for growth, as well as its ability to have an impact on Mexican manufacturing in general. Aerospace growth has been very rapid since 2006 (see analysis). In this time, the industry has quickly achieved a high level of manufacturing sophistication, in part because it was built on a foundation of existing manufacturing expertise. Indeed, early investment in the state of Querétaro was influenced, in part, by the established auto parts sector there. The existence of industries such as auto parts, metal-mechanic and plastics in Mexico has enabled the aerospace industries supply chain to develop faster than would have been possible without this experience base.
In some cases, automotive industry suppliers have been able to transfer expertise directly to serving the aerospace industry. For example, KUO Group, a Mexican conglomerate, dedicated some personnel and factory space from TREMEC, its auto parts company, to a new aerospace division. This division, which is now called Alaxia Aerosystems, manufactures metal and plastic components for customers including Bombardier and Boeing. Industria de Turboreactores, a family-owned company, which has produced turbines for PEMEX drills for years, expanded its factory and opened a division making landing gear components drawing on its expertise in metalworking. Existing plastics suppliers, metalworking companies and electronics manufacturers have also shifted some production to products for the aerospace industry, expanding their revenue stream and leading to greater sophistication in their processes.
The high-technology segment of the medical devices industry has also drawn on existing manufacturing experience. Medtronics, an OEM that has had a presence in Mexico since 1970, today subcontracts work to EMSs and ODMs, such as Foxconn. Mexican plastics companies with experience supplying the consumer electronics sector also now count medical device OEMs among their clients.
Lastly, medical device companies have benefitted from the existing facilities and expertise of the low-technology segment, which produces “commoditised” medical devices, such as gauze, catheters and bore needles for syringes. Though not involving high-technology, these types of products must be produced according to rigorous manufacturing standards. Also, certifications and approvals are needed from national agencies, such as the US Food and Drug Administration, and international bodies, such as the World Health Organisation. The high-tech segment is subject to similar requirements.
The medical device industry in Mexico has taken root in the Baja California cities of Tijuana and Mexicali, both of which are relatively close to Silicon Valley, where many US medical device companies are based. The proximity affords engineers from those firms easy access to plants. It also enables plants to contract specialised services, such as clean room maintenance, from experienced firms in the US. Both of these factors have encouraged American medical device firms to establish operations in Mexico, rather than in China or other low-cost markets.
Mexico’s other advantage in this industry is its intellectual property (IP) laws. These laws are modern and enforced, which differentiates Mexico from some other emerging economies, especially China. The medical device industry, both in the high-tech and low-tech segments, is reliant on IP, and Mexico’s record here enables companies to outsource manufacturing without the same level of risk that they would assume in China. The primary obstacle the industry faces in Mexico is the lack of engineers and researchers capable of carrying out design. The ability to outsource design, in addition to manufacturing, would be an important advantage.
This is perhaps the most promising time for Mexican manufacturing since NAFTA was implemented 20 years ago. The story of the moment is Mexico’s surpassing China in labour cost competitiveness, a phenomenon that is hard to precisely quantify, but whose consequences should be easy to see in the coming years. Mexican manufacturing also benefits from the stewardship of a government committed to liberal economic policy and which appears resistant to the temptations of populism.
There are challenges, and they are not trivial. Holes in the domestic supply chain are the reason that Mexico will not, from one day to the next, supplant China as the world’s factory, whatever its other strengths. But this is a soluble problem, and one that comes with natural incentives for anyone who wishes to tackle it. Mexico’s economy is open enough that businesses can be expected to fill the void.
Mexico is a market to watch, especially now that industry is poised for a new surge forward. Whether it will be able to realise the vision of becoming a true industrial power, driven by innovation and design, is a matter of debate. Yet the fact is that few insurmountable obstacles stand in its way. When NAFTA began, only the most optimistic correctly imagined what Mexico’s economy would become over the next two decades. Could the optimists be right again?