Nearshoring and Industrial Opportunities
The recent conflict in Eastern Europe is expected to compound the pandemic in slowing down recovery of the global economy. It should also expand the magnitude of a movement that was already underway, to wit: the “geopoliticization” of trade and investment, which gained momentum with the strain on U.S.-China economic relations. This movement is at the base of political measures such as nearshoring.
But emerging measures have had an even greater impact. The United States has approved industrial policy packages to replace critical imports and control exports of technologies, and is examining mergers and acquisitions. Japan, for instance, recently presented a package of measures to parliament to protect its supply chains, promote the autonomy of the sector and control mergers, acquisitions and the export of selected goods and services. Other countries have been adopting similar policies, while others have implemented preferential margins for domestic production in government purchases and export tariffs.
The impacts of these measures will be devastating for globalization and, in a foreseeable horizon, we will have to live with a more segmented global economy, with higher production costs, with some disruption in financial and capital markets and with more public interventions in markets and the internet.
All this is negative for Latin America and the Caribbean, which was hit hard by COVID-19 and has been, with great difficulty, promoting policies to boost business recovery and create jobs. This also impinges on us, as it reduces the efficiency of the international markets that supply the region with food, and its companies with raw materials, machines and technologies.
While the region is highly exposed to the effects of geopolitics on markets, countries in the region can actually benefit. In fact, Mexico and the countries of Central America and the Caribbean seem to be particularly well positioned to do so. After all, they are geographically close to the United States, already have experience in international industrial investments, as reflected in the respectable maquila base and free trade zones, and benefit from free trade agreements such as the United States, Mexico and Canada Agreement (USMCA) and the Central American Free Trade Agreement (DR-CAFTA) signed by the United States and the Dominican Republic, Costa Rica, El Salvador, Honduras, Guatemala and Nicaragua for preferential access to the U.S. market. Also in favor are young demographic patterns and low labor costs, the use of the dollar as the official currency in some countries, the use of U.S. standards, and the high integration of financial markets with the U.S. market.
It is no coincidence that manufactured goods already account for no less than 79% of exports from Mexico, 73% from El Salvador, 57% from the Dominican Republic and Costa Rica, and 42% from Guatemala. This makes these countries natural candidates for nearshoring.
On the other hand, countries with a small share in U.S. supply chains are further from enjoying the same attractiveness and should look for other alternatives. Paraguay, for example, geographically distant from the United States, is setting up a maquila base aimed at its large neighbors, Argentina and Brazil. Therefore, the potential benefits of nearshoring are asymmetric.
While nearshoring helps promote employment and exports, maquilas and free trade zones are not ideal solutions nor do they guarantee comprehensive economic development or sub-regional economic integration. Empirical evidence suggests that this mechanism should be regarded as a starting point and not as a goal for a broader economic development process.
Indeed, maquilas and free trade zones are more than welcome, even more so in a region with such an urbanized population and with informal labor rates in the excess of 70% in some countries. But countries must be more ambitious and turn opportunities such as close relocation into drivers of growth with deeper and more permanent economic effects. To that end, we need public and private policies that capitalize on this opportunity base.
Measures to capitalize on nearshoring as a development tool include: standards and mechanisms to regulate the relationship between free trade zones and the national customs territory in order to stimulate a more comprehensive industrialization and with synergies and complementarities with local companies; ongoing training programs for the workforce; support from local universities for industrial development; promotion of innovation and technology; promoting the creation of local supply chains; supplier diversification; promoting sustainability as an integral part of the business model; quality and competitiveness programs; promotion of e-commerce enablers; promotion of infrastructure; digitalization of companies and production chains; market diversification; trade agreements and facilitation; regulatory harmonization; and the strengthening of relevant public institutions.
Lastly, the objective of policies should not only be to attract companies, but to create the necessary conditions for them to take root, expand business and investment, attract suppliers, add more value and help create clusters. It is always worth remembering that comparative advantages are not the destination, and that they can be built. China, South Korea and Singapore can help tell this story.
