Increases in China’s labor costs due to its thriving economy mean that the era of cheap Chinese manufacturing may be ending. However, I believe Mexico, which has lagged China in manufacturing for a decade, is catching up and may take the stage yet again as a major global player in manufacturing exports. If it does, exposure to the peso could present an opportunity for currency investors.
China accounts for approximately 20% of global manufacturing. Its manufacturing costs were so low that they helped curb inflation in many of their large trading partners, including the U.S. But as China’s increasing labor costs shrink profit margins, I believe that Chinese exporters will pass on those cost increases. What does this mean for the U.S consumer? Higher prices for imported goods.
By contrast, Mexico’s wages have risen over the past decade, but not as fast as China’s, which increased at a rate of about 16% from 1999 to 2011 due to a combination of the strengthening renminbi and annual nominal increases in wages. Wages in Mexico remained fairly steady with an average increase of about 5%.
Chart Source: LO, STPS, China National Bureau of Statistics, Morgan Stanley LatAm Economics. ILO figures through 2008; projected afterwards using wage data from local sources.
As China’s labor costs outpace those of Mexico, buying goods made in China doesn’t make as much sense as it used to. Plus, Mexico has proximity on its side as a logical choice of manufacturing base for U.S. and Canadian companies. The distance between the Americas and Asia puts Chinese-based manufacturing at an even further disadvantage when transportation costs, shipping speed and storage are factored in.
Indeed, Mexico’s U.S. market share—the U.S. is its largest trading partner for exports—is getting back to the levels of a decade ago. And Mexico is also diversifying exports beyond the U.S. Between 1994 and 2012, it entered into 12 free trade agreements involving 44 countries.
From a currency perspective, the Mexican peso has been one of the world’s worst performers, depreciating during a decade-long U.S. dollar bear market while the renminbi gained against the U.S. dollar and the euro. But I believe the peso is now poised for long-term growth with Mexico making a structural comeback as a major player in global manufacturing.
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