Again, the most likely cause was the trade war, which over the past two years jolted US producers to evaluate and reshape their supply networks, opening the way for Mexico to win a more prominent place among countries exporting manufactured goods to the US.

Kearney research shows that as early as 2016 more than half of US companies with manufacturing operations in Mexico had moved production there from other parts of the world (including China) specifically to serve the US market. The US–China trade war and the recently ratified United States-Mexico-Canada Agreement (USMCA) have accelerated production flow to Mexico. As Section 301 tariffs were imposed on China, importation of NAICS 33 goods from Mexico—which make up a majority (87 percent) of its exports to the US—increased by 11 percent from 2017 to 2018, the largest single-year gain since 2011.^4,5And as Section 301 tariffs further escalated in 2019, corresponding imports from Mexico rose 4 percent ($11 billion). When viewed in combination with the sharp tariff-related decline in imports from China, these figures strongly suggest that some US manufacturers have used Mexico as a substitute source for manufactured imports.

Similar to the discussion of Vietnam above, some of last year’s growth in Mexico-to-US manufacturing imports may have resulted from the transshipment of goods to circumvent tariffs. While Mexico’s total domestic manufacturing output increased by 1 percent or $9.8 billion, its exports to the US increased three-fold, $29 billion, over the same time frame, creating a gap of $20 billion which can potentially be explained by transshipments.⁶ As a further qualification, certain portions of the Asian manufacturing portfolio are difficult to replicate in Mexico—at least for now. While electronics manufacturers (for example, Foxconn, Flextronics, LG) have factories in Mexico, production is limited to goods with simplified supply chains and a lower technical content. Foxconn factories in Mexico are used for computer and cellphone assembly (the latter is done at a site acquired from Motorola), with modular circuit boards imported from China. The near-term likelihood of Mexico producing printers, cameras, and other products with complex supply chains is low.

Nevertheless, Mexico’s strengths should not be ignored. Compared to the Asian LCC countries, Mexico’s labor cost competitiveness continues to improve—the real wage CAGR over the past four years for manufacturing jobs was 7 percent in China, but only 5 percent in Mexico.⁷ Labor costs in Mexico are just 14 percent of a similarly skilled worker in the US. Further, Mexico has a production base comparable to China, at least in certain regards, allowing companies to nearshore capacity without massive investments in retraining labor forces or building out new infrastructure. Components can be sourced from the US, assembled in Mexico, and shipped back to the US in a short amount of time. Even when adding the cost of import/export logistics, labor arbitrage in Mexico can still save producers anywhere from 20 percent to 30 percent vs. their production cost in the US.

Mexico further benefits from US retailers’ push to shorten supply chain lead times, pressuring suppliers to deliver high on-time and in-full (OTIF) targets, and imposing financial penalties for deviations from their OTIF commitments. “Made in Mexico” could help manufacturers meet OTIF demands with less working capital; it takes 75 percent less time to transport goods to the customer from Mexico versus Asia.

Competitive labor costs, a renewed free-trade agreement, and the lingering effects of the trade war all positioned Mexico to gain import share in 2019. Of course, Mexico’s continued growth will also depend on investments to improve security, roads, ports, and other necessary infrastructure to accommodate long-term relocation of production capacity.

Kearney forecast: COVID-19 reveals that resilience is key

In sum, 2019 saw US companies actively adapting to what then felt like a major disruption—the US–China trade war. Specifically, US companies sharply reduced imports of manufactured goods from China while increasing imports from other countries in our Asia LCC sample, as well as from Mexico. The shift was sizable, but there was still a sense that manufacturing imports might revert to old patterns once the trade war ends.

Then everything changed. 2020 dawned with a disruption of a new order of magnitude—COVID-19. At this writing, the full extent of the societal and economic trauma the coronavirus pandemic may cause is still unknown. But it will be historic. In multiple countries, social and economic activity are essentially frozen. Governments as dissimilar as the US, Russia, and Italy are currently scrambling (and clearly struggling) to construct a coherent and effective response. The outlook is daunting.

For business leaders, Kearney has created a site dedicated to navigating the COVID-19 crisis. There you will find a continually refreshed range of practical insights and advice you can apply right now, as you guide your company through this period of epic disruption. The Reshoring Index puts a somewhat longer lens on the same challenge—drawing from historic context to help you interpret the confounding circumstances you face in 2020, more fully grasp the strategic implications, and start to think ahead.

The lessons we must learn from COVID-19 are as momentous as they are harsh. While the trade war triggered some notable tinkering, the massive operational disruption wrought by the coronavirus pandemic will compel companies to fundamentally rethink their sourcing strategies.

At minimum, we expect they will be increasingly inclined to spread their risks rather than put all their eggs in the lowest cost basket, as many long did in China.

Domestic outlook

Might such a strategic redistribution spur a dynamic resurgence of US domestic manufacturing? It seems unlikely. The limitations that held US manufacturing to flat growth in 2019, even as the trade war put Chinese manufacturing at a decided disadvantage, will continue to work against a US manufacturing revival. There is still a pronounced shortage of skilled manufacturing labor, and the long-promised productivity boom via automation has yet to be realized. Yes, companies will be more inclined to look at new sourcing options, but they will still want to place most of their eggs in cost-competitive baskets.

As highlighted in our prior reports, the keys to making US domestic manufacturing more competitive are (1) upgrade and modernize manufacturing equipment, and (2) prepare the labor force to work within this new type of manufacturing environment. In pursuit of those imperatives, the 2017 Tax Cuts and Jobs Act (TCJA) included a provision allowing companies to depreciate the cost of equipment in the first year of ownership, as opposed to over the life of the asset. The White House Council of Economic Advisers predicted that this policy would “result in higher worker wages as a result of changes in worker productivity that result from increased capital investment.” That is, the hope was that companies would purchase more automation equipment, which in turn would drive higher productivity and better wages for up-skilled laborers.

Manufacturers’ new orders for capital goods did increase by 6 percent in the seven months immediately following the passage of the TCJA in December 2017. However, new capital goods purchases have been anemic since the start of the trade war (see figure 8). One explanation could be that the uncertainty generated by the trade war overpowered the TCJA’s incentives to invest in capital goods.