Global Report

How Mexico’s manufacturing sector is eclipsing Canada’s

Amid weak growth and cheap oil, a falling loonie was supposed to boost Canada’s exports. Too bad manufacturing is headed south

On the assembly line of the Honda Motors factory in Celaya, Guanajuato state, Mexico in 2014

On the assembly line of the Honda Motors factory in Celaya, Guanajuato state, Mexico in 2014. (Omar Torres/AFP/Getty)

Near the end of August, the price of oil dipped under $40 a barrel for the first time in more than six years, further imperiling Canada’s sluggish economy. The loonie, meanwhile, touched its lowest level in more than a decade. If there was a bright spot amid the bleak news, it was the hope that a low dollar would buoy the country’s manufacturing and export sector, providing some lift to the economy. But not this time.

That’s because Canada’s role as a dominant supplier of manufactured goods to the U.S. faces a serious challenge from Mexico. Fuelled by a low peso and cheap labour costs, Mexico’s booming manufacturing industry has already overtaken Canada’s in terms of the dollar value of exports to the U.S. Indeed, Canada is contending with more than just low oil prices. “Oil isn’t Canada’s only problem,” says Steven Englander, global head of G10 currency strategy at Citibank in New York. “It may not even be the major problem.”

Canada’s non-energy exports have been underperforming all year, but the reason hasn’t been clear. Even Bank of Canada governor Stephen Poloz struggled to explain the situation, commenting in July that “the extent of the weakness is puzzling.” With the U.S. economy picking up steam at a 2.3% annualized rate, American firms should be importing more goods from Canada. But Englander says Mexico, not Canada, is poised to gain more from a U.S. recovery.

While Canada’s non-oil exports have dropped by 10% to around US$30 billion per month since a pre-recession peak in 2008, Mexico’s have soared by 50% to just surpass that amount, according to Englander’s figures. “Given what we’ve seen, it doesn’t look like Mexico is done gaining market share,” he says.

Pullquote: “We're in a situation where we're operating at full capacity, but we're not growing. If you look at your auto production data, it's sort of going sideways” – David Madani, Capital Economics

A number of factors explain Mexico’s rise. To start with, the peso tumbled this year by more than 20% against the U.S. dollar, curbing the advantage of a depressed loonie for Canadian manufacturers. “The exchange rates in Canada and Mexico recently have moved in the same direction, as the U.S. dollar increased,” says Scott Szalony, the national manufacturing leader for Deloitte Canada.

But it’s not just the low peso. Mexico’s labour costs are cheaper, and the quality of goods produced in the country has improved. The workforce is younger, too, with higher graduation rates from trade and engineering schools, all of which makes Mexican manufacturers look much more appealing to U.S. importers.

The auto industry is a sobering case study. Carmakers such as Ford and General Motors have either invested or earmarked $22.6 billion over the past two years toward parts and factory expansions in Mexico. Canada, meanwhile, is negotiating to renew auto production commitments before their expiry at the end of next year, hoping to prevent a hollowing out of a former bread-and-butter sector.

Ward’s Automotive Group, which tracks global vehicle production data, forecasts that by 2020, one in four cars produced in North America will roll out of plants in Mexico. Canada is expected to take a less than 10% share of the projected 18.6 million units. “We’re in a scenario in Canada where, for the most part, we’re operating at full capacity, but we’re not growing,” says David Madani, an economist at Capital Economics in Toronto. “If you look at our auto production data, it’s going sort of sideways.”

Reclaiming market share in the U.S. will be tough, but there are some measures the Canadian government and manufacturers can take to strengthen the export sector, beyond amping up plant productivity. Looking outside North America to develop and expand trade agreements may be one way to reverse sluggish exports. The federal government has already made signing trade agreements a priority. Along with 2013’s free-trade agreement in principle with the European Union, large markets such as India and Japan are on the radar. The government is pursuing trade pacts with more than two dozen nations, according to Industry Canada. “These agreements aren’t going to provide any near-term relief, but those are things policy-makers should continue to pursue,” Madani says.

Szalony says Canadian companies need to pivot their thinking away from a reliance on U.S. markets. “It’s a bit myopic to think of it as just about Canada-Mexico,” he says. “The U.S. will always be an important market, but diversify by looking at other emerging markets, whether it be Europe, the Middle East or Asia Pacific.”

Luis de la Calle, a Mexico City–based trade expert, foresees Canadian companies moving up the value chain to focus on more sophisticated technological processes and working in partnership with Mexican manufacturers, allowing both countries to exploit their strengths. “We can use your engineering abilities and your distribution systems,” he says. “Canada will specialize in higher-end components of the manufacturing process. Mexico has the younger, cheaper workers, so we do the final assembly. And we ship all over the world.” De la Calle cites Bombardier Aerospace’s production facility in the Mexican state of Querétaro as one example of this kind of partnership. Aircraft designs and engineering plans are drawn up in Canada, but much of the hands-on construction and wiring occurs in Mexico.

For now, though, a strong recovery in U.S. exports looks like a dim possibility. Englander notes the U.S. economy, which accounts for roughly 75% of Canada’s trade, is only growing about 2.5% a year, which underscores the need for manufacturers to look elsewhere for opportunities. “The U.S. recovery coattails are very short for Canada,” he says. Ultimately, a more drastic change might be necessary, and the current economic malaise should serve as a wake-up call. Rather than “competing on making shoelaces or cheap shirts,” Englander says, a shift to a more service-oriented economy could play better to Canada’s strengths. “The real question,” he says, “is whether pounding metal is what Canada really wants to be competitive in.”