Mexico, Friend-Shoring, and GDP

Genevieve Signoret & Delia Paredes

(Hay una versión en español de este artículo aquí.)

We continue to share excerpts from our September 11 report, Quarterly Outlook 2023–2025: Soft Landing Yet Again, where we present three scenarios for the global economy over the next two years. You can think of our scenarios as train tracks: each takes the economy in a different direction. A scenario is built on a group of assumptions. Our three sets of assumptions “pivot” the economy from one track to another.

We come at last to the question of friend-shoring, or nearshoring as it’s more often called in Mexico.

Currently, the financial press is abuzz with stories suggesting that Mexico is about to experience a boom in foreign direct investment in response to China–U.S. trade tensions. If this is true, then actual and potential GDP both will benefit, and long-term inflation can subside.

China, the story goes, is bypassing already or will soon bypass the United States by shipping intermediate goods to the shores of countries whose trade relations with the United States are friendly. Such countries include Algeria, Argentina, Bangladesh, Brazil, Chile, Colombia, Egypt, India, Indonesia, Poland, Philippines, South Africa, Tunisia, Turkey, and … Mexico! Local and foreign companies in these countries will in turn manufacture and ship the final goods to the United States. China holds on to a portion of its access to the U.S. market by switching from direct to indirect access but loses another portion to competitors.

Hard data backing up the claim that foreign direct investment in Mexico already is receiving a boost from friend-shoring is hard to come by, but anecdotal evidence clearly indicates that not only are foreign companies planning and even initiating investment projects to seize on this opportunity, but also that domestic companies are joining in.

Our challenge is to forecast the Mexican economy eight quarters out when it’s impossible to know how strong or how quickly the boost from friend-shoring will be felt. Our hunch is that that, over the next two years, for GDP, the effects will be weak, and for potential GDP, nil. Policy uncertainty, the threat of a constitutional crisis, deteriorating rule of law, Pemex debt and related doubt as to whether Mexico can hold on to its investment grade, won’t entirely offset the positive effect, but will cap it.

For purposes of our central scenario, we assume that our hunch will prove correct. This assumption feeds our central-scenario projections that core inflation in Mexico will subside only slowly, that interest rates will come down only slowly, and that Mexico will enter a recession in the first quarter of 2025.