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STUDIES & Macro Notes

Economic perspectives in the U.S. and Mexico and the Nearshoring Opportunity

I. The United States economy and the Fed

  • When we met last year, inflation in the U.S. was 7.1% and the Fed’s reference rate was at 4.0%. The Fed was in the middle of a trust crisis and the market was uncertain about how high rates could hike
  • Since then, the U.S. Fed increased its reference rate a further 150 bps, reaching 5.5% by the end of July 2023 and remaining at that level as of today (the Fed decided to “skip” any rate increases in its last two FOMC meetings)
  • Meanwhile, inflation decreased to a low of 3.0% in June 2023, to then increase for 3 consecutive months to 3.7% as of September 2023. Core inflation stands at 4.1%, its lowest level in 24 months but still >2x the Fed’s 2% target
  1. Sources: Board of Governors of the Federal Reserve System (reference rate) and U.S. Bureau of Labor Statistics (inflation).
  1. Wage growth: the fact that wages are still increasing >5% in annual terms is making inflation more “sticky”
    • This is being reinforced by the latest round of large-scale strikes (i.e., auto companies) and by relevant collective negotiations like UPS’ (~18% median wage increase gradually implemented in the next 5 years)
  2. Retail sales annual growth: after slowing down to 1.3% in April 2023 and to 1.5% in June 2023, they have accelerated once more during the last 3 months, reaching a 3.8% growth in September 2023 (note correlation with inflation)
  3. Employment creation: 297,000 in September (~2x the expectation), 150,000 in October (~17% below expectation)3

Although market consensus is that rate hikes are over, the abovementioned factors could mean otherwise

  1. Sources: U.S. Bureau of Labor Statistics (inflation) and the Federal Reserve Bank of Atlanta (wage growth; 3-month moving average of the median growth).
  2. Sources: U.S. Bureau of Labor Statistics (inflation) and U.S. Census Bureau (retail sales).       
  3. Source: Bureau of Labor Statistics.

Good news coming from inflation in the Euro Zone: 2.9% in October (while Germany’s is only a bit higher)

  1. Source: Source: IMF’s “World Economic Outlook: Report October 2023”.

II. The Mexican economy

  • Inflation in Mexico reached 8.7% back in September 2022, its highest level since December 2000. It has since considerably decreased to 4.5% as of September 2023
  • Meanwhile, core inflation reached 8.5% in November 2022 and currently stands at 5.8%, still ~2x Banxico’s target
  • As in the U.S., wages continue to grow above inflation2, putting upwards pressure to inflation and making it “stickier”
    • Contractual wages increased 8.9%, 8.2% and 5.1% in annual terms in the last three months, respectively
    • The minimum wage increased a cumulative 95.6% from 2018 to 2022 (expected to increase to 134.7% by EOY 23)
  1. Source: INEGI.
  2. Source: Banco de Mexico with data from “Secretaría del Trabajo”. The last three months with data are July, August and September 2023.
  • A key issue to highlight is that the real reference rate spread between Mexico and the U.S. still stands at 5.0%
    • This is ~2x the 2.6% average since January 2010, although lower than the 7.1% reached back in June 2022
    • This is key to explain the relative strength of the MXN since the pandemic started and particularly in 2023
    • If in the next few quarters Banco de Mexico decides to hold rates high for longer than the U.S. Fed (given the higher overall inflation levels in Mexico than in the U.S.), the real rate spread could increase and the Peso could appreciate somewhat more relative to the USD. Now, in the medium term, a smaller real rate spread is expected
  1. Sources: Federal Reserve Bank of St. Louis, U.S. Bureau of Labor Statistics, Banco de Mexico and INEGI.
  2. The real rate is relative to inflation (total annual CPI change) for both Mexico and the U.S.; inflation figures as of September 2023.
  • In September, Mexico’s Secretaria de Hacienda presented its Economic Package for 2024, where it estimates that 2023 will end with a primary surplus of 0.1% of GDP and a fiscal deficit of 3.9% of GDP (in line with previous years)
  • Nevertheless, the 2024 budget implies a primary deficit of 1.2% of GDP and a fiscal deficit equivalent to 5.4% of GDP
    • These deficits are the highest in more than 30 years and signal a rapidly worsening fiscal situation in Mexico
    • Anyone elected president will inherit a highly complex fiscal situation with very little room to maneuver
    • Moreover, going above a 5.0% deficit is going to raise concerns among the main debt rating agencies
  1. Source: SHCP.

III. Population trends around the World

  • During the past two decades Mexico has experienced a demographic shift caused by the Mexican baby boom. Today, we are entering the peak of such shift with the ratio of the number of working age to non-working-age people at 2.05x
  • This ratio is expected to reach its maximum in 2031 at 2.16, which compares to an expected ratio of 1.69x in the United States and of 1.58x in the European Union in 2031
  • Today, working-age population in Mexico grows at 1.0% per year, which compares to the U.S.’ growing at 0.1% per year and the European Union’s being stagnant. This solid growth is expected to continue in Mexico until ~2040, expanding disposable domestic income and leading to increased internal demand for goods and services over the next 20 years
  1. Source: The World Bank and authors’ calculations. The inverse of the dependency ratio is measured as (i) total population between the ages 16 and 64 divided by (ii) the sum of total population between the ages 0 and 15 and over 65 years old.
  • China’s demographic advantage over most of the World (including Mexico) peaked around 2009, when the ratio of the number of working age to non-working-age people was 2.70x (in Mexico it was 1.75x)
  • Today, China’s ratio is 2.23x, slightly above that of Vietnam (2.17x), India (2.11x) and Mexico (2.05x). Nevertheless, China’s ratio is expected to decrease (so is Vietnam’s), while those of India and Mexico are expected to continue increasing for the following decade. This demography signals increased relative competitiveness for Mexico and India
  • Moreover, working-age population in China decreases -0.2% per year. This contraction is expected to accelerate to -0.7% per year by 2030 and to -1.2% by 2040. This will further decrease China’s manufacturing competitiveness
  1. Source: The World Bank and author’s calculations. The inverse of the dependency ratio is measured as (i) total population between the ages 16 and 64 divided by (ii) the sum of total population between the ages 0 and 15 and over 65 years old.

IV. Mexico’s trade with the U.S.

  • Mexico has a geographically privileged location, just south of the U.S., the largest economy in the world as measured by GDP. Historically this has meant that Mexico’s natural main trading partner, by far, has been the U.S. 
  • Moreover, since the signing of NAFTA in 1993, the economic integration of North America accelerated and Mexico’s exports to the U.S. increased steadily: their 1994-2022 CAGR is 8.2%, with current exports being ~10x those of 1994
  • YTD as of August 2023, Mexico has exported USD $317 bn in goods to the U.S. (USD $1.3 bn every day)
    • This figure implies that exports to the U.S. should reach USD $475 bn in 2023
  1. Source: U.S. Census.
  • Furthermore, the signing of the United States-Mexico-Canada Agreement (USMCA) in 2019 and the growing nearshoring trend have brought new strength to the partnership between the three North American nations, particularly in industries considered by the U.S. as strategic in the long term (e.g., electric vehicles and its components)
  • As of August 2023, Mexico is the U.S.’ top trading partner, representing 15.8% of the U.S.’ total global trade. This market share of U.S. trade is slightly higher than Canada’s current 15.3%, while considerably higher than the rapidly decreasing 10.9% from China
  1. Source: U.S. Census.

V. Mexico’s key competitive advantages

  1. Source: The Economist Intelligence Unit.          
  2. Source: Freightos; during the 2021 glut in shipping, the difference reached ~8x.
  3. Source: International Energy Agency, prices as of October 31st, 2023. Henry Hub is used.
  1. Labor: it is crucial to strengthen the quality of human capital by aligning educational programs and labor training to the digital economy, a necessary condition to increase wages in a widespread and consistent manner
    • A focus on STEM education is required, with sufficient scholarships to allow for equality of opportunities
    • Today, individuals compete globally for the best jobs: the only way to have access is with a high-quality education
  2. Energy: for nearshoring to really take off, it is necessary to have widespread access to power at reasonable prices
    • Mexico’s electricity costs for the industry are 132% higher than China’s and 181% higher than Vietnam’s2
    • Moreover, as the World moves forward in the energy transition, power generation will have to come from clean and reliable sources, for which investments in infrastructure have to be made years in advance
  3. Infrastructure: to accommodate the arrival of new companies, large investments in infrastructure are required:
    • Roads, rails, ports and airports must be upgraded and expanded. Safe and efficient movement of goods and individuals within Mexico and towards the U.S. is a must
    • Water supply has to be also expanded and upgraded, both for industrial use and for the general population
    • Telecommunications must be improved and extended to bring the digital economy to more individuals

As a final point, all of Mexico should benefit from the nearshoring opportunity, not only the northern and Bajio regions. Adequate incentives and public policies are required to achieve this, particularly regarding labor training in the South. The next government will face a significant challenge, but also a once-in-a-lifetime opportunity to make things right

  1. Based on the Savills nearshoring index components, as described by Monica Aspe in “Near-Shoring in Mexico: An Opportunity for North America”.
  2. Source: GlobalPetrolPrices.com. Figures collected in 1Q23.

Source: INA – “Perspectiva del Sector Automotriz”.

Unit economics:

  • For a specific auto part manufactured by the company, the landed cost from China is USD $134, while the expected landed cost from producing it in Mexico is USD $107 (20.1% savings)
  • Even though the cost of raw materials is higher in Mexico, it is offset by lower manufacturing and logistics costs, with savings coming mainly from zero tariffs and duties in Mexico

Overall expected savings:

  • USD $20m in annual COGS (all of it coming from zero tariffs and duties in Mexico)
  • USD $20m working capital reduction: lower inventory given shorter lead times from Mexico
  • USD $750k lower annual interest expense: no longer need credit line to finance inventory
  1. Source: the company’s analysis to relocate production (2022). Identity of company is confidential.
  • Net FDI into Mexico accounted to 2.8% of GDP in 2022, considerably higher than India’s 1.5% and China’s 1.0% of GDP
    • Moreover, net FDI into China has steadily declined since peaking at 6.2% of GDP back in 1993, with the downward trend accelerating since 2010 when it was still 4.0% of GDP
    • In the last 5 years, annual net FDI into Mexico has been on average 1.2% of GDP higher than net FDI into China and 1.0% of GDP higher than net FDI into India
  • Evidence of this FDI can be found in Mexican industrial parks: net absorption of space more than doubled from 2020 to 1H23, while space availability shrunk to about a third (2.0%2 today, it’s evidence that more infrastructure is needed)
  1. Source: The World Bank. 
  2. Source: Mexican Association of Private Industrial Parks and CBRE. Space availability is measured relative to existing properties and those under construction. 

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