China, Mexico, and US Trade

Originally published at Geopolitical Futures

Last week, it was widely reported that in the first half of 2019 Mexico replaced China as the United States’ top trade partner. China is now in third place, while Canada is in second. There has been a great deal of discussion in the media about what this means for U.S.-China economic relations. Much less attention has been devoted to what this new alignment means for economic relations within North America.

A Third World Country?

The importance of U.S.-Mexico trade may surprise some. In the minds of many Americans, Mexico is still a Third World country whose largest export is poor people looking for jobs. Truth is, Mexico has the 15th largest economy in the world measured in U.S. dollars. Australia ranks just one spot above Mexico, and countries like Spain, South Korea and Canada are not too far ahead either.

Measured in purchasing power parity, however, Mexico ranks as the 11th largest economy in the world. PPP measures economic activity against the ability of a country’s currency to buy goods. Both PPP and nominal gross domestic product measurements have their flaws. Measuring purchasing power in a country as diverse as Mexico is tough, to say the least. Measuring it against the dollar is also difficult, as currencies fluctuate against the dollar all the time, thereby changing their GDP totals and rankings even though the economy itself hasn’t grown or declined. (Those who already knew this – and those who didn’t want to know this – please forgive me for explaining this in detail.)

The important point here is that Mexico’s economy, whether it’s ranked 11th or 15th, isn't a developing economy. It is a major economy and a major target for investment. Some parts of Mexico, particularly those in the south and some areas of major cities, resemble the Third World. But most countries have major regional inequalities. Mexico’s are somewhat larger than the average, but its economy is nonetheless substantial. The U.S. and Chinese economies are highly intertwined, but so too are the U.S. and Mexican economies – Mexican auto parts, for example, are indispensable to U.S. car makers. Mexico is also an aeronautical hub, housing Airbus and Bombardier manufacturing plants.

We’re presented, then, with two geopolitical realities. First, North America’s trading bloc is now larger than the European Union in terms of both population and GDP. Many believe that the alternative to globalism is insular nationalism. Many also believe that the only path to regional integration is a high degree of political integration. The European Union demonstrates that excessive politicization of a trade block can breed potentially uncontainable tension. The North American trade system has no significant joint political structure. The U.S., Canada and Mexico have not compromised their sovereignty, yet they are part of a successful trade system that was renegotiated in such a way that maintained the level of interdependence between the three major trade partners, despite expectations that renegotiation would lead to a decline in trade.

The second geopolitical reality is that increased trade creates increased vulnerability. China learned that excessive dependence on exports to the U.S. gives Washington leverage. Exports are essential to economic development but pose political risks. Interdependence – particularly in economic terms – seems an innocuous concept. But it also means vulnerability to forces in other countries that are less reliant on the trade relationship.

In Mexico’s case, the sense of vulnerability goes back to the 19th century, when the United States defeated Mexico in the Mexican-American War and seized much of what is today the American southwest. Mexico remained in a subordinate position to the United States for more than a century. In emerging from its past and becoming an increasingly potent economic player, Mexico can neither avoid the relationship nor feel comfortable with it. The size of the U.S. economy makes it less dependent on Mexico than the Mexican economy is on the United States. And that leads to political friction.

Political friction between nations is inevitable. It also exists between Canada and the U.S. The U.S. has the same economic advantage over Canada that it has over Mexico. But having economic advantage doesn’t necessarily mean a country will use it – at least, not without political cause, as the U.S. had with China. Even in unequal relationships, the less powerful party can still have an economic impact on the more powerful party.

The Migration Issue

The problem is that there are both historic and contemporary political issues with Mexico, primarily over migration. Mexican migration to the U.S. has declined significantly. Mexicans used to migrate north for economic reasons, but economic conditions in Mexico over the past few years make it more attractive to remain in Mexico than to go north. The current wave of migrants crossing the U.S. southern border comes from Central America. In an ironic twist, Mexico doesn’t want Central American migrants to enter Mexico, but like the U.S., it can’t seal its southern border to stop them from crossing into its territory. Until recently, Mexico did not want to give them asylum, and those it could not block or expel were permitted to move north to the U.S. border.

Migrants are often the cause of tensions between and within countries. Historically, the U.S. metabolized Mexican immigrants. Mexico has had more difficulty metabolizing Central American migrants because the regions they entered in the south were among the poorest in Mexico, Mexican institutions are not well-equipped to handle the influx, and some Mexicans have objected to the influx. Mexico, therefore, sought to shift the burden north, triggering a political confrontation with the U.S.

Mexico knows that it cannot press the U.S. too hard. Mexican politicians threaten impractical retaliations, but they know the U.S. can absorb an economic rupture with Mexico more than Mexico could bear one with the United States. The U.S. can’t press Mexico too far, either. Imposing a heavy economic penalty on Mexico would not only disrupt access to the agriculture and manufacturing supplies on which the U.S. economy depends and hurt the economies of border states like Texas and California, but it would also threaten to energize 130 million people with a historic grievance and an economy that is now world-class.

Mexico has come a long way and is now the United States’ leading trade partner. But that position makes it vulnerable and limits its political options against the U.S. China has discovered what that vulnerability can lead to if it engages in political actions unwelcomed by its biggest trade partner. Mexico understands the U.S. far better than China did. But what will happen if Mexico moves from the 11th-largest economy to the fifth-largest? At a certain point, the risk-reward ratio shifts.

A final point on what Mexico becoming the United States’ largest trade partner means for China. China is following Japan’s path. Japan was the leading exporter to the United States in the 1980s, but it was increasingly squeezed by higher costs, falling profit margins and competition from other countries. There was also significant political tension between the United States and Japan over informally closed Japanese markets. It did not lead to massive tariffs because Japan buckled under the weight of its own economic weakness and became a less-important trade partner for the U.S.

China was doing the same before the U.S. imposed tariffs. Its products were facing stiff competition, inflation was pushing its own costs higher, and profit margins in key sectors were falling. As with Japan, China faced serious problems with its banking system. U.S. tariffs compounded China’s problems and perhaps accelerated the process, but the path it is following is not new.

Copyright 2019 Geopolitical Futures, LLC. Republished with permission.

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