What political challenges does Mexico have?

Mexico's strategic positioning has garnered praise from analysts who view it as well-placed in the current geopolitical climate. The country's automotive sector, with key players like Ford, Tesla, Audi, and BMW, has played a significant role in Mexico's attractiveness to international investors. However, despite these advantages, Mexico presents challenges that potential investors must carefully consider.

Geopolitical Undercurrents

The geopolitical narrative driving Mexico's nearshoring ascent is deeply entwined with the reshuffling of global supply chains, particularly in response to the geopolitical tensions between the U.S. and China. Former U.S. President Trump's tariffs on Chinese imports set the stage, prompting a strategic reevaluation of supply chain dynamics. Mexico, however, faced its challenges during the renegotiation of the North American Free Trade Agreement (NAFTA). The subsequent establishment of the United States-Mexico-Canada Agreement (USMCA) in 2022 provided a new framework, offering Mexico preferential market access to the U.S.

USMCA's stricter rules of origin incentivized companies to increase production within North American borders, leading to a surge in U.S.-Mexico trade. The geographical advantage of Mexico, especially its proximity to the U.S., became increasingly vital amid supply chain disruptions triggered by the pandemic and global conflicts. With 80% of Mexican exports to the U.S. transported by land, the nation demonstrated resilience against seaborne disruptions, further solidifying its position as a nearshoring hub.

Economic Forces at Play

Mexico's nearshoring appeal extends beyond geopolitical considerations, encompassing a wealth of economic advantages. The country's longstanding experience in serving the U.S. market, particularly in the automotive sector, positions it as a natural candidate for nearshoring activities. The strategic location, coupled with historical trade relationships, has enabled Mexico to cultivate expertise in industries like aerospace, defense, and, more recently, semiconductor and pharmaceutical manufacturing.

While nearshoring has seen significant attention in the media, the data suggests a nuanced reality. Foreign direct investment (FDI) into Mexico witnessed growth in Q1 2023, primarily driven by reinvestment of profits. New investments, however, exhibited a modest trajectory, prompting a closer examination of the actual pace of nearshoring. Notable announcements, such as Tesla's USD 5 billion investment, highlight the potential, but the gap between rhetoric and tangible investment remains a focal point.

Political Landscape and Key Challenges

Mexico's political scene is marked by the leadership of President Andres Manuel Lopez Obrador, characterized as a populist with a limited focus on promoting the country's manufacturing hubs. The Economist Intelligence Unit classifies Mexico as an undemocratic "hybrid regime," highlighting concerns about corruption, institutional frailty, and high levels of violent crime.

One of the critical factors influencing nearshoring decisions is the stability of the Mexican government. While there's a push toward economic reforms and policies to attract foreign investment, inherent challenges exist. The resilience of the government in navigating these challenges becomes pivotal for the success of nearshoring initiatives.

The political risks associated with doing business in Mexico extend beyond nearshoring considerations. Policies implemented by the Mexican government can have a direct impact on the business environment. Understanding Mexicans policies, ranging from trade regulations to economic reforms, is essential for companies seeking to establish a foothold in the Mexican market. Political risk analysis must encompass the broader spectrum of policies that shape the business landscape.

Insecurity, encompassing organized crime, cyber threats, and general crime rates, poses a significant challenge for businesses considering nearshoring. Collaboration between the government, businesses, and security service providers emerges as a key strategy. Embracing technologies like AI and IoT, alongside traditional security measures, becomes crucial to creating a safer environment for companies.

Mexico's readiness to capitalize on the nearshoring opportunity hinges on its policy orientation. President Andrés Manuel López Obrador's approach to foreign direct investment (FDI) reflects a nuanced perspective. While AMLO welcomes FDI, the increasing politicization of economic management introduces uncertainties, particularly for companies perceived to have ties with former governments. From a policy standpoint, Mexico's industrial response to nearshoring has been gradual, with a notable focus on select sectors.

However, at the state level, variations emerge, with bordering states and industrial powerhouses exhibiting more proactive efforts to attract businesses. Tax incentives and support for specific industries have been unevenly distributed, raising questions about the comprehensive national strategy for nearshoring.

As Mexico undergoes political transitions, the upcoming elections in 2024 add a layer of uncertainty. The stance of the new government on nearshoring, economic policies, and international collaborations will shape the nearshoring landscape. Businesses must closely monitor political developments to adapt strategies accordingly.

Political risk analyst Ian Bremmer emphasizes that Mexico's nearshoring appeal often exists independently of the government's policies, indicating that investors are drawn to the country despite certain challenges. This sentiment is echoed by Ryan Berg, Director of the Americas Program at the Center for Strategic & International Studies, who gives President Lopez Obrador a C- grade for his nearshoring promotion policies.

Security Concerns and Impacts on Foreign Investment

One prominent challenge for potential investors is Mexico's security landscape. Cargo truck hijackings, totaling nearly 35,000 during President Lopez Obrador's term, underscore the critical importance of addressing security issues. The security situation, rated at 8 or 9 out of 10 by Ryan Berg, poses risks not only to property rights and contracts but also to the physical security of goods in transit, crucial for a successful nearshoring endeavor.

Recognizing the severity of security issues, collaboration between businesses, government, and communities becomes paramount. Security service providers, such as Grupo IPS, play a crucial role in transitioning to models that address risks proactively, aiming to offer these services remotely.

Technology as a Mitigating Factor

In addressing security concerns, technology emerges as a pivotal player. Beyond traditional measures like GPS and CCTV systems, emerging technologies such as AI and the Internet of Things (IoT) are becoming integral to ensuring safer conditions for companies considering relocation to Mexico. Alejandra Soto from Control Risks emphasizes the importance of data analysis, combining algorithms and AI with human elements for hyperlocal security.

Political Challenges: Navigating Short and Long-Term Complexities

In the short term, Mexico grapples with immediate political challenges that cast shadows over its nearshoring appeal. The pressing issue of insecurity, intertwined with organized crime and cybersecurity threats, poses imminent dangers. The need for a swift, collaborative approach between businesses, government, and security service providers is crucial to mitigate these risks effectively. Moreover, the upcoming 2024 elections inject an additional layer of uncertainty, demanding vigilant scrutiny of evolving political landscapes.

Looking into the long term, the intricate web of legal frameworks governing foreign investments, labor regulations, and the overall stability of the Mexican government emerges as a pivotal concern. Questions regarding the country's commitment to nearshoring, especially in the Security, Energy, and Infrastructure (SEI) domains, loom large. As businesses plan for sustained operations, understanding the evolving political climate, anticipating legislative changes, and adapting to the outcome of the 2024 elections become integral components of long-term strategic planning in the Mexican nearshoring narrative.

Possible Electoral Scenarios in Mexico

In the event of an electoral victory for the ruling party, the capture of the Supreme Court by the Executive is solidified. This could be achieved through the appointment of another sympathetic minister after the departure of Luis María Aguilar in November, or via a constitutional reform to elect members of the Judiciary through popular vote.

• If the governing coalition secures a qualified majority in Congress, it may pass constitutional reforms that significantly impact the business environment and the system of checks and balances. Potential reforms include electoral changes affecting the structure of the National Electoral Institute (INE) and its leadership selection through popular vote, the elimination of the National Institute for Access to Information (INAI), and energy reform, among others.
• Criminal groups might exploit the electoral situation to expand their control over local governments and markets. In the short term, this could increase political violence, while in the medium term, it strengthens their territorial authority, leaving communities vulnerable to crimes such as extortion, protection money demands, or theft.
• The process of militarization may intensify, either because López Obrador achieves a qualified majority to assign the National Guard to the Ministry of Defense, and/or because the new government decides (or is compelled) to continue AMLO's policies regarding the Armed Forces.
• A victorious election for Donald Trump could deteriorate the bilateral relationship with the United States, placing Mexico in a vulnerable position due to threats of tariffs, ongoing reputational attacks, aggravation of the migration crisis, and pressures on security matters.
• Congress may pass "surprise" reforms and laws affecting the business climate, such as changes to labor regulations, the administrative apparatus of the State, or concession grants. These changes might occur without allowing for a transition and adaptation period for the private sector.
• Post-election conflicts, both nationally and locally, may arise fueled by polarizing campaigns, government intervention, open and continuous violation of rules, untimely or weak political arbitration, operational inefficiency of local electoral bodies, and closely contested results. These factors could create nervousness in markets and plunge the new administration into the same polarization climate as the outgoing one.
• The first budget of the new government may fail to meet the fiscal goals set by the outgoing administration. This failure to carry out the necessary fiscal adjustments could alert credit rating agencies and unsettle markets.
• Corruption, opaque and unusual administrative practices for electoral purposes, and the lack of sanctions for such cases may increase in both the federal and local governments.
• Following a potentially unfavorable electoral outcome, tensions and divisions within opposition parties may grow, contributing to weak checks and balances for the new government's operations.

Mexico stands at a critical juncture, balancing economic opportunities with political and security challenges. As it positions itself as a nearshoring hub, effective collaboration, technological solutions, and strategic political decisions will be essential in navigating the complex landscape.

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