Less than a week into President Donald Trump’s administration, a showdown with Mexico over trade and a border wall has become US’s major foreign policy crisis, leading President Enrique Peña Nieto to cancel his forthcoming meeting with President Trump. The likely continued deterioration of relations between Mexico and the United States has severe implications for multinationals, particularly as a likely renegotiation of (and potential US exit from) NAFTA nears. Whether greater protectionism comes through tariffs or a controversial tax reform, multinationals operating in Mexico and beyond need to be closely monitoring events. Here are what multinationals need to know:
- Mexico’s economy will be hurt far more from a trade breakdown: Mexico is far more dependent on trade with the United States than vice-versa, and will suffer far more from the imposition of tariffs by the United States than the US economy would (though a breakdown in North American supply chains would almost certainly drive higher inflation in the US for key products). While the Mexican government would almost certainly retaliate, the pain would likely be worse for Mexico.
- Mexico’s government lacks fiscal and monetary space to mitigate pain: The Mexican government will have limited space to implement counter-cyclical spending measures to counter economic losses driven by tariffs on exports and falling investment given the need to tackle persistent government deficits in recent years. Mexico’s central bank will likely need to tighten interest rates further, due to the growing inflationary effects of a fast-weakening peso.
- Mexico’s elections in 2018 currently indicate a turn to leftist populism: President Trump’s belligerent stance toward Mexico, coupled with Mexico’s anemic economic growth and President Peña Nieto’s abysmal approval ratings have made the victory of leftist presidential hopeful Andres Manuel Lopez Obrador (AMLO) more likely. He currently leads opinion polls, and the current dispute with the US over trade and immigration will likely only bolster his prospects. His election could lead to both a more anti-business environment in Mexico and accelerating deterioration of relations between the US and Mexico.
- US-Mexico trade disputes are a prelude to further trade disputes: While the dispute between the US and Mexico involves both trade and immigration (cementing Trump’s desire to see Mexico eventually pay for a border wall likely to cost at least US$10-15 billion), President Trump has clearly signaled a desire to renegotiate trade relations with countries with which the US is running trade deficits. China is almost certainly next in line with dangerous ramifications for global supply chains and the global economy.
Multinationals need to prepare for the worst, and hope for the best
Executives with international responsibilities thus confront a perilous operating environment over the coming months, but global companies should keep these actions to take in mind:
- Rethink Mexico’s role in global and regional portfolios: Mexico will no longer be a source of stability for global multinationals, with significant external and internal headwinds to the business environment requiring significant reevaluation of how multinationals prioritize and assess investments in Mexico.
- Pressure-test regional supply chains: Old assumptions over global supply chains and local footprints will need to be reconsidered, and multinationals need to ensure that they have sufficient flexibility to adapt with a changing (and more difficult) operating environment regarding import tariffs and workforce localization.
- Reevaluate pricing and value propositions: Companies doing business in Mexico will need to determine what adjustments to pricing and value proposition will be necessary if cross-border costs increase.
- Push for greater lobbying efforts supporting trade openness: The US government will remain the most hostile to multilateral trade agreements in decades, but multinationals in the US and elsewhere will have to proactively make the case for continued trade openness, whether by protecting their interests from the renegotiation of current trade agreements to lobbying for bilateral trade agreements over the coming years.
Be prepared for a better outcome
While currently a downside scenario remains more likely, multinationals should prepare for a potential upside for Mexico. A more competitive currency, the potential for a diluted (or even modernized) NAFTA having limited material impact on Mexico’s export base, and faster growth in the US may leave Mexico with better growth over the coming years.