Home Finance Nearshoring: A New Lever of Latin American Growth?

Nearshoring: A New Lever of Latin American Growth?

by internationalbanker

By William F. Maloney, Chief Economist, Latin American and the Caribbean, World Bank





The global movement toward nearshoring industries from Asia to the region offers an appealing window of opportunity for Latin America and the Caribbean (LAC), struggling to lift lackluster levels of growth. The question is whether the region can position itself better to attract potential FDI (foreign direct investment) and, more fundamentally, to leverage it for technological catch-up and dynamic growth.

Currently, most regional macro-indicators are good by historical and even global standards, reflecting the multi-decade process of professionalization by LAC ministries of finance and central banks. The COVID pandemic represented the second global crisis during which Latin America did not perform appreciably worse than other regions, and its inflation at 3.8 percent is below the OECD (Organisation for Economic Co-operation and Development) level of 5.6 percent, reflecting prescient early tightening by monetary authorities. However, growth remains elusive. LAC’s lackluster growth rates of 2 to 2.5 percent are half of those of other emerging markets, roughly equal to the slow pace of the 2010s (Figure 1).

Some observers see the nearshoring trend as an opportunity to kickstart growth. Last November, at a meeting with Latin American heads of state, U.S. Secretary of the Treasury Janet Yellen argued that “friendshoring” offered “tremendous potential benefits for fueling growth in Latin America and the Caribbean”. Indeed, many factors are moving in the right direction for the region to capture more FDI and parts of global value chains. If China’s low wages were once enough to outweigh LAC’s proximity in terms of language, culture and time zones, they are no longer, while recent supply-chain disruptions and rising tensions between the West and China have added additional impetus for firms to diversify.

At the same time, the region desperately needs an infusion of capital and technology. Growth has been hampered by low investments in plants and machinery, as well as the innovation that drives productivity (Figure 1). Public investment, including in infrastructure, is half of what it is in Asia or Africa as a share of GDP (gross domestic product), and the debt accumulated during COVID has complicated the fiscal space for any new projects in the foreseeable future. Boosting the roughly 3 percent of GDP in investment that FDI has constituted in the past would be an important contribution.

However, so far, the signs are not clear that LAC will be the destination of choice. Despite its 2022 post-COVID recovery, FDI flows to the region have just returned to 2010 levels after a decade of decline. Further, despite the steady rise in Chinese wages over the last 20 years, the 2018 tariffs imposed by US President Donald Trump on China and the derisking momentum, until very recently, LAC’s share of global FDI has been falling while Asia’s has been rising (Figure 2), partly reflecting the continued wage competitiveness of India, Indonesia and Vietnam.

The reality is that, besides wages, the region is perceived as expensive in other aspects, hampering its competitiveness. According to a recent study by KPMG and the Manufacturing Institute, primary costs, such as taxes and financing, are high. Moreover, when considering secondary costs, such as infrastructure, logistics, workforce quality and policy stability, Brazil, for instance, compares unfavorably with Canada, Korea, the United States and even Germany. The World Bank’s Logistics Performance Index (LPI) places Latin America and the Caribbean in the middle of the pack of the 139 countries ranked. Regarding infrastructure investment as a percentage of GDP, LAC lags behind East Asia, investing only about a third, and inefficiently so. World Bank Enterprise Surveys (WBES) reveal that 30 percent of companies report a lack of qualified labor as a hindrance to growth, compared to 15 percent in Asia. Even after the 30 years since NAFTA (North American Free Trade Agreement), industrial parks in northern Mexico still face major bottlenecks due to electricity and water shortages.

Measures can be taken to mitigate the effects of these shortfalls. The proactive policies of local governments in China attracted FDI by helping companies negotiate formidable local regulations and roadblocks, while Singapore, in its early years, offered a model of aggressively courting investors. But to date, there has been no consensus in LAC on how or even whether to seize this window of opportunity. On the one hand, Costa Rica is working with the US to take advantage of the 2022 CHIPS and Science Act and has leveraged its engineering capabilities and skilled workforce to attract $1.2 billion in new Intel Corporation investment. On the other hand, observers see Mexico’s closing of its FDI-promotion authority, ProMéxico, and numerous foreign offices as potentially leading to missing out on multiples of current FDI arrivals. Despite having ports on both the Atlantic Ocean and the Pacific Ocean, Colombia has made only modest efforts to attract investors. Proximity alone will not do the trick. A Singapore-style effort could help match these regions with potential partners, but improvements in trade facilitation and port efficiency are also required—perhaps deeper trade agreements along with improved worker skill levels.

The ambivalence toward FDI on the part of some countries may have historical roots in concerns around sovereignty and becoming dependent on foreign capital and technology or doubts about the profundity of the development impacts of enclave-type investments, be they mining or maquiladoras. This may also contribute to the resonance in the region of the “missions-oriented” approach of promoting targeted national mobilization of resources to engineer leaps in growth. Large multisectoral projects, such as extracting green hydrogen or leveraging lithium in Chile—or, in Brazil’s case, ship and oil-platform building—are big push bets on innovation and industry catch-up at a grand scale. This approach, promoted by scholars such as Mariana Mazzucato at UCL (University College London), is echoed in places like the US as well, where a concern with dependency on critical foreign inputs has seen the revival of NASA’s (National Aeronautics and Space Administration’s) Apollo program as a historical analog for the present mobilizations of the green and chips industries’ initiatives. Mazzucato uses the same moonshot analogy to motivate her alternative strategy to governments skeptical of the Washington Consensus growth model.

But history is clear that the original moonshot success was critically dependent on building the necessary underlying capabilities—the basic human capital in both the “astronauts” (the private sector) and “mission control” (the state). In the decade after the US announced its mission, PhDs in physical science tripled, and engineering PhDs quadrupled. Mid-level technical skills were promoted, as were science and mathematics in school curricula. In fact, in the absence of a clear economic justification with 50-year hindsight, NASA’s mission was arguably not about landing on the moon but rather demonstrating to the world that the US had the capabilities to do so. While the four Asian Tigers engaged in mission-like support of particular sectors, the capabilities-development agenda was absolutely central, as seen in the rapid progress in education at all levels. The miracle was not the boom in manufacturing exports but the speed with which those countries caught up with the West in capabilities across multiple sectors—mining to automobiles—and thereby were able to manage a broad range of development and security challenges.

Brazil offers a cautionary tale for the region on missions-inspired efforts to create new industries or markets without attention to these underlying capabilities. In the early 2000s, the government saw the demand from Petrobras (Petróleo Brasileiro S.A.), eager to exploit the pre-salt deep-water oil fields off the coast, combined with the global shortfalls in platforms and tankers, as offering a clear window of opportunity for industrial catch-up. However, though government incentives allowed building the shipyard infrastructure with relatively updated equipment and machinery, the inability to bridge knowledge gaps through technological transfer, an absence of engineering-design capacity and inadequate worker skills, among other factors, led to long delays and, eventually, an uncompetitive sector.

The same concerns surround nearshoring. Moving up the value chain and leveraging FDI for an autonomous and diversified growth path will require building precisely these same capabilities. Japan, faced with Commodore Matthew C. Perry’s gunboats threatening its sovereignty and later the Asian Tigers, aggressively worked to upgrade local firms’ capabilities and innovation systems so that progressively more sophisticated tasks were undertaken and supplier networks could emerge organically and efficiently. (Similarly, Singapore’s Economic Development Board is seen as a critical ingredient, even in an extremely welcoming business environment, both to wooing FDI and encouraging it to engage in progressively more sophisticated tasks, the necessary learning agenda too often ignored in LAC.)

Mexico provides a dramatic counterexample. During the Porfirio Díaz (José de la Cruz Porfirio Díaz Mori) regime, Mexico faced the same existential concerns and necessity to catch up as Japan after being invaded by the same commodore and losing half its territory to the US. However, while it welcomed FDI and trade on a massive scale, it did not emulate Japan’s single-minded drive to the technological frontier. In fact, it slipped backward in capabilities. While the world’s technological frontier in mining advanced, Mexico’s education system did not; by 1900, foreigners ran the most important industries that had once been staffed by nationals well into the 1870s. (“Although Mexican officials and commentators voiced concern about falling ‘tributary’ to more powerful economies—and especially to their northern neighbor—they expressed less concern about continued dependence on foreign expertise,” according to author Edward Beatty.)

 As a result, the Porfiriato period achieved a kind of sterile integration: Few Mexican scientists and entrepreneurs could take advantage of the benefits of technology transfers and access to foreign markets to build an indigenous industry. This pattern was replicated across the continent, with regional governments effectively outsourcing the development of their largest source of revenues, mining, to foreigners and developing attendant feelings of dependency.

And echoes persist today. Although Korea and Mexico both started assembling electronics in the early 1980s, the latter has little to show in terms of a native high-tech industry, while Samsung’s Galaxy rivals world leaders. It’s unclear how the increased nearshoring interest in Mexico will lead to a different path without a different approach—namely, looking beyond FDI as a source of jobs and tax revenues to being a fulcrum to lever national learning.

In short, nearshoring alone will not be a magic bullet for growth, and the missions agenda cannot be seen as a shortcut around the region’s traditional inability to invigorate poor public-education systems, its absence of mid-level technical programs, the low output of scientists and engineers, limited interaction between universities and the private sector, and the general lack of faith in government. Remedying these shortfalls is a precondition for lifting LAC out of the growth doldrums. It’s also a mission with which its northern neighbor is well equipped to help.



William F. Maloney is Chief Economist for the Latin America and Caribbean (LAC) region at the World Bank. Maloney joined the Bank in 1998 and has held various positions, including Lead Economist in the Office of the Chief Economist for Latin America, Lead Economist in the Development Economics Research Group and Chief Economist for Trade and Competitiveness.


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