In 2018 United States President Donald Trump started a trade war with China. Mexico benefited; companies seeking to avoid tariffs by diversifying production out of China saw the country as a good option thanks to affordable labour, decent infrastructure and, most importantly, its free-trade agreement with the United States.

As Mr Trump’s second term approaches, that logic is souring. Chinese companies looked to Mexico more than most. Their investment in the country has surged. Mr Trump (who has already threatened to apply a tariff of 25% to Mexican imports “on day one” unless it stops migrants and drugs from illegally crossing the border) believes those firms are using Mexico as a tariff-free gateway to the United States. His conviction may end up blowing apart the United States-Mexico-Canada Free Trade Agreement (USMCA).

Concerns about Chinese activity in Mexico are bipartisan and long-running. In 2019 American officials worried that Chinese exporters were simply using Mexico as a route to the United States market, especially for steel and aluminium. This has largely been dealt with by Mexico imposing tariffs on imports of the metals from China, and a “melt and pour” rule that requires steel to be “substantially transformed” in Mexico before it is exported to the United States. Outright fraud—where products are imported from China, relabelled as Made in Mexico, then exported to the United States—is probably rare.

Today the focus is on Chinese firms assembling or manufacturing products in Mexico for sale in the United States. There is plenty of this happening. In 2023 Mexico overtook China to become the leading exporter of goods to the United States; meanwhile, Chinese exports to Mexico have boomed (see chart 1). In 2002, Mexican exports to the United States contained less than 5% Chinese components by value. By 2020 that number was 21%.

Electric-vehicle (EV) production is the big issue. Most of the EVs sold worldwide are Chinese-made, usually at a lower price than those made by American firms, and of equivalent or higher quality. In September President Joe Biden raised tariffs on imports of EVs from China to 100%; without them, sales would boom. But the tariffs do not apply to vehicles made in Mexico.

Mr Trump claims that Chinese carmakers are constructing “monster” factories south of the border. That is false. Just one Chinese joint venture makes EVs for the Mexican and regional market. BYD, China’s leading EV manufacturer, has said it will build a factory in Mexico to churn out 150,000 vehicles a year, but it has yet to materialise. This month Solarever, a smaller producer, announced it would build a factory in northern Mexico.

The areas where Chinese firms really are expanding tend to be further down the supply chain. Eight Chinese auto-parts manufacturing companies operated in Mexico in 2018. By the end of 2023 there were at least 20. They make trims and battery casings as well as high-tech elements such as software to assist drivers. Many cars made in Mexico with Chinese components meet the USMCA requirement that 75% of a car must be made in Mexico, whether by Chinese companies or otherwise, to qualify for free trade. But it doesn’t matter if it is legal, says Joshua Meltzer of Brookings, a think-tank in Washington: “Political tolerance [for China] is going down.” Anything with a whiff of China is seen as suspicious. “Made by China is the new Made in China,” says Jorge Guajardo, a former Mexican ambassador to China.

Today the free trade that USMCA enshrines is subordinate to the China concern, says Enrique Dussel Peters, who runs the Centre for Chinese-Mexican Studies at the National Autonomous University of Mexico. The issue looms over a review of the deal in 2026. In September Marco Rubio, Mr Trump’s nominated secretary of state, warned of “China’s rampant exploitation of Mexico as an intermediary,” and its “manipulation of USMCA”. Politicians in Canada have suggested booting Mexico out of USMCA and drawing up a bilateral free-trade agreement.

Mexican officials complain that the focus on Chinese investment in Mexico is hypocritical; Chinese FDI into Mexico is small compared with the billions China invests in the United States every year. But in Mexico Chinese FDI has been growing sharply, while its FDI into the United States has fallen. It does not help that Mexico’s official FDI figures seem to undercount Chinese investment by a factor of six (see chart 2), according to the Rhodium Group, a research firm, which finds that $13bn has been invested cumulatively since 2013. Mexico is paying the price for “being slow to read the writing on the wall”, says a North American diplomat.

Claudia Sheinbaum, Mexico’s president, has read it. Her government is scrambling to please its northern neighbour, setting up a body to screen foreign investments that apes those in the United States and Canada. It has plans to substitute imported Chinese components with ones made in Mexico. Marcelo Ebrard, the economy secretary, says Mexico must start making microchips and lithium batteries. Other Trump-pleasing measures are coming thick and fast. “Mexico wants to be a team with Canada and the United States,” says Luis Rosendo Gutiérrez, an official with Mexico’s economy ministry.

Yet the discussion is detached from the reality of the complex nature of trade, says Mr Dussel Peters. Foreign companies in Mexico, predominantly American ones, account for 70% of the exports to the United States. American car makers like General Motors and Ford are among those that have integrated Chinese companies into their supply chains. Some encouraged Chinese suppliers to set up shop in Mexico.

Import substitution takes time and requires incentives. Mexico’s cash-strapped government cannot offer the kinds of subsidies that are available for domestic production of chips and batteries in the United States. And some items simply can’t be sourced outside China. “We haven’t developed supply chains in the region for items like batteries for EVs,” says Odracir Barquera of the Mexican Automotive Industry Association.

Meanwhile Mexico has another reason to fret. In the early 2000s it lost out to China in exports to the United States. Now, if Chinese companies start displacing Mexican ones in North American supply chains, Mexico will suffer again, notes Margaret Myers of the Inter-American Dialogue, a think-tank in Washington. Here American and Mexican officials see eye-to-eye. “The message to the United States is ‘how do I help you make what you import from Asia?’” says Mr Gutiérrez. “Because it will help us, too.”