• Wednesday, November 24th, 2010

Mexico is first in line to benefit from rising labor costs in China.

BY EMILY LEVEILLE
Frontier Strategy Group

China’s mandate to empower its domestic consumers through wage increases will bear significant fruit a world away, in the factories of Mexico. The importance of the manufacturing industry to Mexico’s economy has been well documented this year, as its recovery has pulled the country out of its deepest recession in decades. Being the single most important driver of the Mexican economy, the long-term potential of Mexico’s manufacturing industry should be a key consideration influencing growth expectations of both B2B and B2C companies, and with the industry well-positioned to capitalize on rising costs in China, Mexico’s manufacturing industry is here to stay.

THIS TIME IT’S SECULAR
Looking over the past 15 years, the cost difference to manufacturers between low-wage Mexico and lower-wage China has been narrowing at an ever-accelerating pace.  In 1996, Chinese labor cost about one-third of Mexican labor. In 2009, Chinese labor cost about half of Mexico’s—$1.69 per hour, on average, compared to $3.46 per hour in Mexico. By 2012, hiring a Chinese worker will cost about 85 percent of what it costs to hire a Mexican worker. Looking at changes in unit labor costs in each country, China’s labor costs are expected to increase steadily by around 5-7 percent per year through 2014, while the rate of growth of unit labor costs is decreasing in Mexico.

Before the downturn, a number of companies chose to shift manufacturing to Mexico from across the Pacific, driven by skyrocketing shipping costs. As soon as oil prices fell and the downturn set in, companies shifted their focus back to the east in search of lower costs.  However, in the wake of the economic downturn, China decided it wanted to be more than the factory to the world and began raising minimum wages to fuel its middle class. This trend, coupled with the expected long-term appreciation of the renminbi, is cutting China’s cost advantage over Mexico, and unlike the trend we saw a few years ago, this rise in prices is secular.

MOVE OVER, MAQUILADORAS
Those with longer memories will remember that Mexico’s manufacturing industry was once equated with low-cost, low-skilled production in assembly plants along the U.S. border, known as maquiladoras. But Mexico’s manufacturing has moved up the value chain; having established itself as an auto-manufacturing hub over the past decade, it is now becoming an increasingly attractive destination for hi-tech electronics and white goods manufacturing.

Automotive companies have already made big investments in Mexico this year: for instance, Volkswagen recently announced that the Jetta model will be produced exclusively by its Mexico plant. But there’s also been talk from hi-tech manufacturers such as Flextronics and LG about how rising wages in China are making Mexico more attractive.

WHY MEXICO?
There are many low cost manufacturing alternatives to China: India, Thailand, Central America, and Vietnam to name a few. One might wonder what Mexico possesses that these countries do not. This is where the fundamentals of Mexico’s manufacturing industry come in.  There are four key advantages that make Mexico an attractive venue for manufacturing.

Mexico’s labor force is relatively inexpensive, but seasoned in the manufacturing industry.  Executives often cite a deep pool of qualified management professionals who are often bilingual, easing day-to-day communication.

Mexico’s proximity to North and South America is also an advantage; orders can be filled in half the time that is generally required when sourcing from China. In times when demand can fluctuate wildly, the ability to respond quickly to changing market conditions can be critical.
Manufacturing in Mexico is also a hedge against rising shipping costs. As fuel and transportation costs rise, labor cost savings in China and other cheap manufacturing destinations will be offset.

The final advantage is Mexico’s participation in the North American Free Trade Agreement. This means that import duties are cheaper, the customs process is simple, and conflict resolution is more straightforward than with China or Brazil.

To summarize, Mexico is first in line to benefit from rising labor costs in China, particularly as low-cost production remains a mandate. Solid fundamentals and a steady climb up the value chain will ensure Mexico’s importance as a manufacturing hub in the Western hemisphere. And unlike other times, when companies have looked to Mexico for a reprieve from rising shipping costs, this trend will not be subject to the changing tides of oil prices. Given the importance of the industry to Mexico’s overall economic trajectory, this is a positive indicator of Mexico’s long-term success.

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