Donald Trump’s 25% tariff hike on Mexican and Canadian imports over the weekend threatens the nearshoring phenomenon that has boosted their foreign direct investment (FDI) flows, however opinion is divided over the extent they will spur more US FDI to sidestep the new levies.

On February 1, the US president followed through on campaign promises to lift import duties on Mexico and Canada, and slap an extra 10% tariff on all Chinese imports. The changes quickly sparked a tit-for-tat response from Canada which announced a 25% tariff on C$155bn ($107bn) worth of US goods, while Mexico’s government agreed to send more soldiers to its northern border to curb drug trafficking in exchange for a one month pause on its levies. Those against Canada take effect on February 4.

Levies on the US’s southern and northern neighbours risk closing a loophole that has helped them attract investment in supply chains that serve the world’s biggest economy, and contributed towards their announced FDI volumes hitting record highs in recent years, fDi Markets data shows. 

Instead of nearshoring projects to Canada and Mexico — which can offer cost, labour, regulatory and other benefits over the US, and have historically benefited from preferential market access under the US–Mexico–Canada Agreement (USMCA) and its predecessor Nafta — more companies are now expected to start looking to invest directly into the US. 

“During his first term, Trump was focused on ripping supply chains from China. There was a certain acceptance with supply chains coming back to the West, but not necessarily America,” says Abishur Prakash, founder of Toronto-based advisory firm The Geopolitical Business. “This outlook no longer exists.”

In 2018, Mr Trump’s administration imposed up to 25% tariffs on steel and aluminium imports from Canada and Mexico, however these were dropped one year later as part of the USMCA negotiations. His tariff moves this time around capture all imports — although at a lower 10% rate for Canadian energy — and comes one year before USMCA is due to be renegotiated

Mr Prakash now expects a “rapid reshoring of manufacturing back to the US” with supply chains moving away from Canada and Mexico.

A recent study of the new White House’s FDI impacts by Henry Loewendahl, head of investment consultancy firm Wavteq, similarly predicts a greater focus on tariff-jumping directly into the US rather than its neighbours. “During the first Trump presidency, foreign and US firms largely relied on friend-shoring, shifting production to allied countries to sidestep tariffs. However under a second Trump presidency, friendshoring is likely to be less viable,” it states. 

The study concludes that tariffs will “play a more effective role in attracting FDI during the [second] Trump administration”. Notably, Unctad data shows that FDI inflows declined throughout his first term, even before disruption from Covid-19 pandemic began. 

The warnings are particularly dire for Mexico, where nearshoring led it to overtake China in 2023 as the US’s biggest trade partner. Its success has been driven in no small part by Chinese firms using the Latin American country as a backdoor to sell into the US and avoid the White House’s long-standing tariffs against Beijing. 

In a recent analysis, Marcos Carias, an economist at trade credit risk manager Coface, wrote that “firms are right to be concerned about the future returns of nearshoring investments” in Mexico in light of a 25% US tariff. 

Diego Marroquín, a Mexican trade expert at the Wilson Centre, argued in a Substack note yesterday that trade is North America’s economic backbone and the tariffs risk the collapse of “countless cross-border businesses … as their margins disappear.”

More tariff-jumping, with caveats

While North American nearshoring appears on shaky ground, there is less consensus on whether the White House’s new trade policies will spur more FDI directly to the US. 

Mark O’Connell, executive chairman of OCO Global, says the threat of these tariffs has made “many of our corporate clients think hard about their US market strategies”. He argues that “reshoring production may be the only option” for American companies using Mexico and Canada for their supply chains, with the cost of tariffs exacerbated by the White House’s focus on ‘Buy American’. But he stresses that reshoring decisions are complicated by the fact productivity and competitiveness shortcomings in the US that drove them abroad in the first place continue to exist at home.

As shown by the one-month pause on Mexico’s tariffs, these levies are motivated by the flow of illegal immigration and drugs into the US — not trade issues — means they are designed to be temporary and in place until Mexico and Canada can address the president’s concerns, notes Global Business Alliance’s president and CEO Jonathan Samford. Mr Trump’s use of import duties as a bargaining tool means companies are also expected to avoid tariff-driven investment decisions until it’s clear how long they will be in place.

Nonetheless, some are bullish on the impact of the White House’s early trade policies on foreign investment. “Companies will increasingly source and produce in the US to safeguard against tariffs. FDI will soar,” says Harry Moser, president of the Reshoring Initiative

Both China and Canada have threatened to contest the US’s tariffs under World Trade Organization rules.