A New Geography of Investments?

What do nearshoring and the carbon tax have in common? Both will influence the global geography of foreign direct investment. The former, because it will attract business to countries geographically close to the United States; the latter, because it will change the competitiveness of production and export from countries with high carbon emissions.

Nearshoring results from the US policy of improving resilience and diversifying the sources of supply of its domestic market and the production chains in which it participates. This policy gained traction during President Trump’s administration due to geopolitical issues, but the war in Ukraine and the long shutdown of the Chinese economy caused by the pandemic accelerated the process. Through active industrial policies and incentives of various kinds, the government has been encouraging the relocation of companies in parts of Asia to produce on American soil, but Latin America and the Caribbean (LAC) could also benefit from this initiative.

However, it is unclear what the impact will be for countries in the region, as U.S. policy prioritizes re-industrialization and job creation in the United States. The rapid drop in prices of advanced productive technologies will stimulate relocation to the US. This will affect LAC’s comparative advantages, e.g. labor costs. But even so, the spillover effects for the region are very likely to be significant. IDB estimates suggest that nearshoring could increase exports of goods and services produced in the region by up to a whopping USD 78 billion in the coming years, but the impacts could be even greater on productive ecosystems, capacities and productivity and competitiveness of the private sector.

In addition to proximity and costs, LAC countries offer other attractive conditions for nearshoring, including support from local governments, the absence of sensitive geopolitical issues, cultural affinity with the United States, and a similar time zone. It is reasonable to think that Central American countries and Mexico would benefit, but Argentina, Brazil and Chile could also leverage these opportunities for their integrated productive industries and human capital, among others.

To make the most of new investment flows, the region would need to improve its appeal, including issues such as legal stability, sophistication of the work of investment attraction agencies, reduced red tape, training, digitalization, availability of companies and business support services, logistics infrastructure and credit funds. In addition to targeting large multinational companies, countries should also consider attracting medium-sized multinationals, as they tend to value the region’s value propositions better, in addition to supporting the expansion of foreign companies already established in the country and with interests in the United States, encouraging the formation of productive clusters and production also targeting markets of the region.

Incorporating climate change commitments to the international trade agenda is another likely source of change in global foreign direct investment flows. The most emblematic case at the moment is the Carbon Border Adjustment Mechanism (CBAM), a legal device being evaluated by the European Union (EU). The CBAM will match the carbon price between domestic and imported products, ensuring that the EU’s climate targets are not undermined by the relocation of production to countries with less ambitious climate policies. The mechanism, for example, would prevent carbon-intensive EU-based companies from moving to third countries with lower emission controls and then exporting to the EU, thus undermining climate efforts. EU importers would buy carbon certificates at the carbon price that would have been paid if the goods had been produced under EU carbon pricing rules. Furthermore, once a non-EU producer can demonstrate that it has already paid for the carbon used in the production of goods imported from a third country, the corresponding cost to the Community importer could be deducted.

Border carbon adjustment mechanisms already exist in some U.S. states, such as California, and Canada, Japan and the U.K. are considering similar initiatives. There is a growing academic critical mass on this issue, as multilateral organizations are studying how these measures would contribute to reducing emissions, and the G20 is considering international coordination on the use of carbon pricing mechanisms. This suggests that the issue will remain on the table for years to come. The CBAM will be implemented gradually and applied initially to a selection of goods with a high risk of carbon leakage, including steel and cement. Green hydrogen, ammonia and spillover effects such as electricity will also be covered.

The inclusion of indirect emissions in the CBAM agenda will benefit countries that already have or are redoubling their commitment to clean energy matrices. As of now, Brazil, Costa Rica, Paraguay and Uruguay would qualify as potential destinations for climate-sensitive investments, but this group will be joined by other countries in the region in the coming years. As the transport of hydrogen and ammonia can be very expensive, the region could become a platform option for production processes with a low carbon footprint, with potential substantial economic and social impacts.

LAC countries must also accelerate the development of their carbon markets, adopt international taxonomies and best reporting practices, combat greenwashing, and implement ambitious ESG policies, bearing in mind that investment cycles are long and that first comers will benefit first.

Lastly, it is reasonable to consider that countries in the region that combine their proximity to the United States with attractive conditions for green investment will especially benefit from the likely realignment of investments globally.