By William F. Maloney, Chief Economist, Latin American and the Caribbean, World Bank
The global landscape has changed rapidly, posing challenges over both the short and long runs that Latin America and the Caribbean (LAC) will need to navigate.
On the short-run macroeconomic side, only a few months ago, inflation and interest rates were on downward trajectories, offering the prospect of easing stress on firms, families and, particularly, government budgets. In the current scenario, inflationary pressures still lurk, and global and local interest rates are unlikely to decline soon. High borrowing costs will remain a drag on growth, but they also imply that the relief expected on debt finance will be postponed. This is problematic. Over the 2014-24 period—marked by accumulated debt and higher borrowing costs—interest payments in LAC rose with respect to the previous decade to 3 percent of gross domestic product (GDP), while they fell roughly half a percent in Asia to 2.5 percent and closer to 2 percent in Eastern Europe. Further, Brazil, Colombia and Mexico all face particular challenges in bringing deficits under control. A debt crisis is not in the cards, but fiscal space will remain elusive going forward for necessary investments in infrastructure, education and innovation.
In other areas, stricter migration policies may lower remittances to Central America, where in some countries, they constitute more than 20 percent of GDP. However, the extent of these policy changes is not yet clear. Increased uncertainty around Chinese growth will continue to depress commodity export prices.
Trade and growth policies in a less open world
Over the longer term, the evolution of the global trade landscape has raised new questions about mainstream growth strategies that were already under scrutiny. In particular, the question is how LAC will respond to increased uncertainty about market access and the continued relevance of the nearshoring drive. On the one hand, advocates of “Big Push moonshot”-type industrial policy have been received warmly in many quarters over the last few years, and, as Figure 1a and Figure 1b shows, there already was a tendency, especially in Brazil and to a lesser extent in Mexico and Argentina, toward greater use of industrial policies and import barriers.
However, overall, there have been relatively few movements toward closing global integration and important movements toward increasing it. The challenges to Chile’s mainstream model have not led to major changes in industrial policies, while Argentina is aiming toward greater openness. The signings of the European Union-Mercosur free-trade deal and the recent EU-Mexico Global Agreement suggest not only an acknowledgment of the need to diversify markets and trade ties but also that greater integration is called for. In some sense, the breaking of the logjam in the former case after 25 years may be a result of the new imperative felt in both European and Latin capitals to diversify their trade partners. Central America, led by Costa Rica, and the Dominican Republic in the Caribbean have pursued the nearshoring model, with the former attracting another $US1.2 billion in investment from Intel over the last few years. Across the region, an openness to Chinese investments and trade ties continues. LAC is not so much turning inward as hedging its bets.
The more profound question is whether, with or without changes in the global trade system, LAC can lift its lagging growth rates and determine what the new barriers will be. Most recent forecasts put 2025 growth for the region at 2.5 percent in 2025 and 2.6 percent in 2026, partly driven by Argentina’s recovery from recession. These numbers are not anomalously low. In the 2010s, LAC grew at 2.2 percent, while the world grew at 3.1 percent. We have a structural growth problem.
This problem is confirmed through the lens of trade and investment as well. To begin with, LAC continues to “under export”, trading below what would be expected given its proximity to and size of the large destination markets and the presence of free-trade agreements. That is, even when the door was open, LAC firms proved reticent to walk through.
Further, nearshoring has been timid. In the wake of the reorganization of value chains during COVID and the afterglow of the renegotiated USMCA (Agreement between the United States of America, Mexico, and Canada), there was some substitution of Chinese exports by Mexican exports to the United States. Careful mapping of the sectors in which China lost and Mexico gained exports (mostly machinery and electrical, followed by textiles, footwear, base metals and transport equipment) amounted to $US20 billion over the six years. However, in 2022, this amounted to only 5 percent of the roughly $420 billion in Mexican exports, or less than a 1-percent increase per year.
Foreign direct investment (FDI) has been similarly lackluster. As Figure 2 shows, FDI to the region, while having increased since the pandemic, nonetheless remains substantially below 2010 levels and roughly at the average across the last 20 years. Further, announcements of greenfield investments (Figure 3) show Asia, Eastern Europe and Central Asia being more attractive than LAC. While there have been sharp increases in Chinese greenfield announcements in Mexico (an increase of 20 projects over the last few years), given that the total over the period was around 500, this represents an increase of 4 percent.
Reports from Northern Mexico speak of a scramble for industrial park space and vibrant, in particular Chinese, interest. However, to date, the official statistics have not reflected that.
Homework to do
What the above suggests is that the pending reform effort necessary to facilitate trade and productivity growth, rather than losing salience, gains even greater importance. With few exceptions, governments do not have cohesive approaches to pursue nearshoring and haven’t sought the necessary reforms energetically. As noted in the April 2023 LACER report, “The Promise of Integration: Opportunities in a Changing Global Economy,” LAC’s evolving wage and geographical advantages are offset by high domestic financing costs, low worker skill levels and high violence levels and trade-transaction costs, all exacerbated by some of the highest corporate tax rates in the world. For a firm leaving China faced with Vietnam as an option (where wages remain low, education scores are above the OECD [Organisation for Economic Co-operation and Development] average, crime is not notable, taxes are modest, and the government is an unambiguous booster of FDI), Latin America is not a slam dunk. Distance is not determinant—if it mattered so much, industry wouldn’t have flocked to China in the first place.
Further, a complete technology-transfer-and-innovation agenda is required to leverage foreign investment and new green-energy alternatives, as well as to raise productivity and product quality across the economy. Exports of lithium and other rare-earth metals are unlikely to be affected by new tariffs, but ensuring that they generate broad-based development and not just taxes requires the development of capabilities and strategies. LAC’s very green electricity matrix and potential for non-fossil fuels will give producers an edge relative to coal-intensive producers. But again, the effort will require more firms close to the technology frontier in other dimensions.
The forthcoming “Recovering the Lost Century of Growth: Creating Learning Economies in Latin America” documents how LAC has always had trouble applying new technologies to both natural resources and manufacturing and continues to rank low on all the factors of education, STEM (science, technology, engineering and mathematics) graduates, managerial and entrepreneurial quality, private sector-university linkages and functioning research institutes that constitute national innovation systems and contribute to technological absorptive capacity.
We cannot know how the new trade order will settle. However, emerging challenges will require intensifying the reform effort in the overall enabling environment, as well as the capabilities supporting technology transfers and innovation to succeed in it.