Untethering trade from the US

Mexico cannot ditch the US completely, but it should diversify its economy away from it.

Global trade often works on the “gravitational principle,” in which commerce happens mostly between neighbouring markets. It helps explain why Mexico trades more with Central America as a whole than the much larger Colombian, Peruvian, and Chilean economies put together—all of which are, in theory, boosted by a free trade agreement with Mexico called the Pacific Alliance.

The United States’ gravity is so potent in this regard that it has tidally locked Mexico to become almost totally dependent on it. Around 80% of Mexico’s exports, 55% of its imports, and 41% of its foreign direct investment depends on the US.

This is not abnormal and, theoretically, a positive outcome of thirty years of the US-Mexico-Canada Agreement (USMCA) and its predecessor, NAFTA. That was until a Donald Trump-shaped crisis threatened to plunge the Mexican economy into turmoil on a whim via 25% tariffs on all Mexican goods imported into the US.

Catastrophe has been averted for a month, but even if Trump backs down Mexico needs to reconsider its utter dependence on its northern neighbor.

As the US becomes increasingly erratic and authoritarian, it can no longer be considered a reliable partner. It therefore becomes a matter of national security and economic stability for Mexico to diversify its trade relationships. It needn’t break off from the US, nor force companies to stop trading with it. Instead, with intense and concerted help from the government, new companies and new relationships with all the other countries in the world should be fomented and boosted.

A history of passive dependency

It is true that if Mexico wants to remain a buoyant economy, it cannot seek to decouple from the US entirely. It is equally true that for many years, this fact blinded policymakers to the dangers of lazily listing towards total dependence.

For those mostly liberalising thinkers and politicians, this was almost an inevitability given the toolbox they deliberately limited themselves to. From the late 80’s until 2018, the market was to do what it wanted, regulated minimally and interfered with to an ever lessening degree by the State. Over those years, 12 free trade agreements were signed with 46 countries, but without help from the government, they’ve largely been squandered.

Since 2018, Mexico’s government has taken a far more muscular and nationalistic approach to economic policy. President Claudia Sheinbaum’s Plan México is industrial policy like the country hasn’t seen in decades. It looks to boost key sectors of the Mexican economy—like pharmaceuticals, the auto industry, semiconductors, and more—which will be propelled, with help from the State, to new competitive heights.

Intelligently, the Plan seeks to reshore large parts of the supply chain with incentives, like getting the government to buy more Mexican goods. But, the plan also focuses almost entirely on China as Mexico’s main industrial adversary. Though not a bad approach, in doing so, the Plan by extension works on the assumption that it will need to integrate even more into the US supply chain.

This way, goes the thinking, Mexico will finally taste the sweet nectars of a fabled nearshoring boom that never was.

Plan México can and should be tweaked in the light of Trump’s brinkmanship and disregard for US agreements within the USMCA.

A diversified vision for the Mexican State

Back in 2001, on the back of winning a Nobel Prize in Economics, Joseph Stiglitz commented with some concern that Mexico had no idea what it wanted to become even in the medium term.

Often disregarded as hot air or ideological blather, for a country to conceive of itself as “the leader of the free world,” “Singapore-on-Thames,” or “socialist with Chinese characteristics to forge a shared future for mankind” can create a set of goals for an entire nation to push towards.

Mexico does not have a vision of State. Even today, in this new age of politics led by Sheinbaum, a vision of Mexican-ness has taken hold as described in the State ideology of Mexican Humanism, but its abstraction and vagueness does not make for a coherent vision of State. There is no real economic roadmap to accompany it.

In large part this has been because the country has constantly been in contingency mode—mopping up after the last calamity before bracing for the next. How Mexico’s approach to global trade is very much connected to this mentality.

Since the disastrous US invasion of 1846-8, Mexico has sought to balance its relations with its northern neighbour with other world powers. For a while, successive governments resisted expanding the railway into the north of the country, fearing the US would use those same lines to better invade again.

In the early 80’s, during Mexico’s oil bonanza, president José López Portillo sold oil at a discount to many countries other than the US so as to depend less on that single buyer. This form of diversification ultimately didn’t matter too much after the Mexican economy crashed following a big fall in oil prices.

Learning from that harsh lesson, Mexico today is one of the most diversified economies in terms of what it produces and exports—agricultural products, industrial goods, and services all weigh heavily. Oil went from representing more than 80% of exports to less than 5% today.

Yet, while the country has done well at diversifying its production, it has failed to diversify the markets it trades with. This is in large part because the liberalising approach to trade chiefly empowers already competitive sectors while forgetting about everything else.

Worse still, because Mexico’s relative competitiveness regarding the US consists in the need for skilled labour in certain industries at low prices. Consequently, the exporting boom has focused chiefly on just a few parts of the supply chain—mainly assembly—and in a small handful of sectors.

Just a few companies manage to reap the benefits of all this trade with the US. About 0.6% of Mexican companies export and, between 2002 and 2018, the number of exporting companies in Mexico actually fell slightly—from 33,398 to 33,000.

Big things come in small to medium-sized enterprises

This bad news, however, allows another benefit of diversification to come into view: For trade to competitively find new markets, it needs new small and medium-sized enterprises (SMEs) to flourish in sectors Mexico is not yet competitive in.

While the market can lead the way in already advanced industries, the government needs to take a far more active role in bringing those that are lagging up to speed. Aspirational sectors should be targeted alongside the mostly US-centric Plan México ones. The aim should be to support, fund, train, and enable exporting companies in industries not so dependent on the US.

Today, in Mexico, just over 4 million Mexican SMEs generate 72% of the country’s jobs but create just over half of its GDP. Turning some of these into productive, export-oriented companies could help drive a far more robust growth than the one Mexico has seen so far under NAFTA and USMCA.

Chile shows how to do this. In 2017, it boasted almost twice as many exporting companies per capita as Mexico did, because this South American invests heavily in its SMEs.

Less is more

A falling share of US-Mexico trade needn’t mean less trade between the two. It could mean growing trade with everyone else, even in industries geared at the US market.

This is particularly true in the automotive industry and where diversification towards Canada—which only makes up 3% of Mexico’s exports—would make the most sense.

Canada is already doing this on its end, pushing hard to increase exports to Mexico in the automotive sector. It has dedicated funds to this effect. The idea is not to bypass the US, but to create a complementary supply chain that is not only immune to Trump’s tariffs but which would make the region’s more competitive overall.

The seeming low-hanging fruit of the US market often dazzles governments and companies alike. This is a mistake. Mexico shouldn’t wait for the next trade war to pick up its notes on diversification nor should it forget about the subject as soon as the crisis seems over.

More importantly perhaps, instead of just focusing on industries that it has excelled in due to an accident of geography, Mexico has a chance at choosing the sectors and partners it wants to look to the future with. A new vision of State—perhaps focused on green industries and scientific excellence—is just an ambitious industrial policy away.