Mexico: The World’s New China

July 17th, 2014
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Investing Daily Article of the Week

by Ben Shepherd, Investing Daily

When President Bill Clinton signed the North American Free Trade Agreement twenty years ago, many economists feared that most of America’s manufacturing jobs would flee to Mexico where wages were low and labor protections were scarce. But before that process could really get into full swing, those started heading to China, where they ultimately stayed. Despite higher transportation costs from China to key American and European markets, labor costs were so low that shipping was of little concern.

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But while China may have become the workshop of the world, the country’s rapid economic expansion has sent wages in the country skyrocketing. Whereas Mexican wages were almost two times higher than China’s a decade ago, now they’re nearly 20 percent lower. As a result, many manufacturers are choosing to relocate their production facilities to Mexico in order to take advantage of lower labor and transportation costs, with easy access to both the North American and Latin American markets.

Those geographic and cost advantages have proven a strong lure to automobile manufacturers in particular. Toyota Motor Corp (NYSE:TM), Mazda Motor Corp (Tokyo:7261), Ford (NYSE:F) and a host of others already have manufacturing facilities in Mexico and BMW, Audi and Mercedes-Benz all have plans to begin to ramping up assembly lines there. BMW alone is investing nearly $1 billion, creating 1,500 jobs and a production capacity of about 150,000 vehicles per year.

So many car manufacturers have moved into Mexico that the country edged out Brazil as the region’s most prolific producer for the first time this year. Mexico turned out 1.6 million units in the first half of 2014 as production rose 7.4 percent, while Brazil’s output fell 32 percent to 1.57 million units. Just five years ago, Brazil was producing nearly 1.5 million units to Mexico’s 500,000. Mexico is now the 7th largest auto producer in the world, with China and the US in the lead.

While labor costs play a significant role in the growing production disparity between Mexico and Brazil, Mexico also has the advantage of lower taxes and duties. So while most of the cars made in Brazil remain in that country, 8 of every 10 cars produced in Mexico ultimately end up being exported with more than half arriving here in the US. Mexico is expected to edge out Japan as the second largest exporter of automobiles to the US this year and will likely overtake Canada to become the largest car exporter to the US in 2015.

In addition to lower labor costs and taxes, Mexico is winning a bigger slice of the automotive pie thanks to its relatively well-educated labor force, as nearly half of working Mexicans have a secondary education as compared to less than 15 percent a decade ago. Post-secondary education rates have also been growing by nearly 4 percent annually over the past decade. This means the average Mexican citizen is ready for production work, while skilled technicians to maintain factory automation equipment are more widely available. Mexicans are also willing to migrate internally to secure better paying jobs. As evidence: US farmers long dependent on migrant workers were facing labor shortages even before a number of states cracked down on illegal immigration and undocumented workers.

All-important transportation costs also can’t be ignored, but the argument there is straightforward. The cost of shipping a standard container from China to the US East Coast has risen from just under $3,000 in 2000 to about $7,000 today. Over the same period, the cost of shipping that same container from Mexico to the US only has risen from about $2,000 to $2,800.

In the grand scheme of things, automakers are likely only the leading edge in the geographic shift of global manufacturing. Given the relatively high costs and low margins in the industry, they are usually one of the first movers to take advantage of lower costs. Manufacturers of the rest of the world’s bits and bobbles will likely soon follow, especially as Mexico continues to liberalize its labor regulations, expands access to higher-quality educational opportunities and aggressively works to attract new businesses to the country.

[NYSE, F, TM, TOKYO, 7261]

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