Energy transition can help unlock Latin
America's potential from nearshoring
Atradius Economic Research – October 2023

Summary•

The world is currently undergoing a reorientation of global trade driven by the pandemic and geopolitical shifts, including
so-called nearshoring or friendshoring. Latin America and the Caribbean (LAC) is in a seemingly good position to benefit.

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But there are challenges. Despite a high number of trade agreements of LAC countries, the region's integration ininternational trade and global value chains remains comparatively low, suggesting existing trade agreements are
relatively shallow.

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Moreover, LAC continues to grapple with structural weaknesses that drag on trade and reduce its attractiveness forinvestments in higher value-added sectors like manufacturing and the green economy.

•

The bright spot is the energy transition, for which LAC and particularly quite closed South America possesses criticalminerals. The need for those may trigger deepening of trade agreements with the EU and US and expansion of
intraregional trade.

Shifting trade winds could lift Latin
American & Caribbean economy
As the global trade order shifts and governments andbusinesses seek to strengthen the resilience andsustainability of supply chains through processes likenearshoring, Latin America and the Caribbean (LAC) may
have a once-in-a-generation opportunity to strengthen its
economy and reduce inequality. Given LAC’s geographicalproximity to the world’s largest consumer market and its
relatively strong institutional and cultural ties to both North
America and Europe, it’s worth considering its integration in
new global value chains.
Attracting investment to increase trade competitiveness andintegration is necessary to increase LAC’s stubbornly low
growth potential. While the region has weathered many
economic storms over the past years, its growth prospects
remain the lowest among all emerging market regions. Thisis largely due to major structural weaknesses like achallenging business environment, a large informal sector,
education and skill shortages, and lagging digitisation. A lesswell-known factor relates to trade. Despite a high number of
trade agreements of LAC countries, the region's integration
in international trade and global value chains remains
comparatively low. This suggests that not all trade
agreements are equal. For trade agreements to have an
impact on productivity and economic growth, it matterswhat and with whom you trade and what you agree in the
trade agreement (its scope or depth).
In this research note, we take a closer look into the changes
in global value chains and the accompanying opportunities
and challenges that face Latin America and the Caribbean.
We first take a close look at how LAC fits into the global
picture and the composition of LAC’s trade. We assess thequality and shortcomings of both. Then taking into accountthe shifting geopolitical backdrop for international trade, we
explore how it impacts LAC trade and close with anassessment of the most realistic opportunities for LAC toimprove its trade competitiveness, both within the regionand on the global stage, in the coming years.

High costs of trade limit LAC’s
integration
Latin America and the Caribbean’s structural trade
weakness begins with its lack of integration in the global
economy and the high costs of that trade. The region set up
early internal trade arrangements like the Andean
Community Agreement in 1969 and Caricom in 1973 before
accelerating integration with the rest of the world alongwith the establishment of the World Trade Organisation(WTO). This global trade liberalisation process starting in
the 1990s led to a range of preferential trade agreements for
LAC, largely within the region and to varying levels beyond.
Box 1 presents the most significant trade blocs today.
The developments within LAC show that not all trade
agreements are equal and provide the same benefits. For
starters, the ‘depth’ of the agreement matters: whether it
covers just simple market access for goods, through theremoval of tariffs, or if it goes deeper including beyond trade
to additional policy areas, like investment flows andenvironmental regulations. In recent research, Deep Trade
Agreements: Anchoring Global Value Chains in Latin America
and the Caribbean, the World Bank stressed that tradeBox 1 Main LAC trade blocs
CAFTA-DR: The Dominican Republic-Central America-UnitedStates Free Trade Agreement signed in 2004. Central American
members encompass Costa Rica, El Salvador, Guatemala,Honduras and Nicaragua. It is the third largest export market in
Latin America for the US, after Mexico and Brazil (almost onpar). Countries in Central America have an associationagreement with the EU since 2012.
CARICOM: The Caribbean Community is a political and economic
union of 15 member states and five associated members
throughout the Americas and Atlantic Ocean. It came into force
in 1973, making it the oldest surviving integration movement in
the developing world. It has a trade and investment frameworkagreement with the US since 1991 and an economic partnershipagreement with the EU since 2013.
MERCOSUR: Mercado Común del Sura, or the Southern Common
Market, is a trade bloc in South America encompassing
Argentina, Brazil, Paraguay and Uruguay established in 1991.
Venezuela was suspended in 2016. In 2019, the EU and
MERCOSUR reached political agreement on a trade agreement,
twenty years after negotiations started. Ratification by theindividual countries is still pending due to worries on both sides.
Pacific Alliance: Trade bloc between Chile, Colombia, Mexico andPeru, established in 2012. Costa Rica is in the process of joining(Ecuador and Panama are LAC candidate member-states). As
part of the agreement tariffs on the trade of goods have been
gradually phased out. The group also started other forms ofregional integration, including visa-free tourist travel, common
stock exchange and joined embassies. In 2022, the first free
trade agreement between the alliance and a third country,
Singapore, was signed. The individual members have FTAs with
the US (Chile since 2004, Peru since 2009 and Colombia since2012) and with the EU (Mexico since 2000, Chile since 2003
and Peru and Colombia since 2013).
USMCA: The United States-Mexico-Canada Agreement came into
effect in 2020, replacing the North American Free Trade
Agreement which was implemented in 1994 to encourage tradeand investments between the US, Canada and Mexico byeliminating most barriers. Strictly not a LAC trade bloc, but
important to understand the differences between Mexico andthe region's other large markets.

agreements that also reduce non-tariff barriers to trade,such as border compliance, trade finance and insurance
costs and regulatory discrepancies, are required to boost
trade and economic growth.
Generally, Mexico and members of the regional trade blocs
CAFTA-DR and the Pacific Alliance tend to have deeper
agreements, whereas the MERCOSUR countries haveshallower ones. In the MERCOSUR, non-tariff barriers totrade affect about two-thirds of the imported goods andthree-quarters of the value of these goods, against relatively
low barriers in the other blocs. Table 1 shows that the cost of
border compliance is quite high in terms of time and money
in LAC, but it is clearly skewed by the relatively shallow
MERCOSUR trade agreement. For CAFTA-DR members,
these costs of trade are even more favourable than East Asiaand the Pacific.
Table 1 Cost of trading across borders
Border Compliance

RegionEurope andCentral Asia
OECD (highincome)East Asia andPacific
Latin American
and theCaribbeanTime toexporthours

Cost toexportUSD

Time toimporthours

Cost toimport
USD

16.1

10

20.4

158.8

12.7

136.8

8.5

98.1

57.5

381.1

68.4

422.8

55.3

516.3

55.6

628.4

Mexico

20

400

44

450

CAFTA-DR

42.9

355.3

57.7

426.4

Pacific Alliance

60

487.5

70.5

496.3

MERCOSUR

71.5

716.3

30

643.8

Sources: World Bank Doing Business Indicators, 2020 and World Bank 2023

Despite the large amount of trade agreements, the barriers
to trade in existing trade agreements are both central causes
and effects of LAC’s lack of trade openness. Exports plus
imports as a share of GDP, a standard measure of trade
openness, are at 46% on average in 2010-2021 the lowest in
the world (see figure 2). Excluding Mexico, the most open of
the region's largest markets, the number would be evenbelow 40% of GDP. This reflects limited trade integration of
three of the region's largest markets, Argentina, Brazil, andColombia. Their average trade openness ranges between
26% and 36% (see figure 3), half that of Mexico, the region's
second largest market. Mexico's trade openness increased
significantly after the North American Free Trade
Agreement (NAFTA, now called USMCA) came into force in
1994. Argentina on the other hand became less open in thepast decade, due to an increasingly complex system ofimport, currency and transfer restrictions.
The disparity in countries’ openness to trade can be seen at
the subregional level, presented in figure 2. In the global
perspective, LAC as a whole is relatively closed to trade.
Within LAC, South America is by far the most closed region.
Central America and the Caribbean on the other hand are themost open, with average trade openness at 67% of GDP.
Particularly for most Caribbean countries, this partly
reflects the relatively small size of their economies andlimited domestic production capacity, which makes themreliant on imports. But trade agreements with the US, like
CAFTA-DR and the trade and investment framework with
the CARICOM contributed to these subregion's openness as
well.

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Figure 1 LAC is very closed due to largest markets

That said, despite their relatively high openness, even thesesubregions within LAC do not fully use their potential.
Research by the World Bank shows that LAC also undertrades relative to its predicted potential, accounting for trade
fundamentals such as distance to markets, special tradearrangements, common language, and partner's economic
size. Bolivia, Chile, Mexico, Nicaragua and Paraguay arenotable exceptions.
Latin America and the Caribbean also stands out in anegative light for its developments in intra-regional trade. In
the two decades since China joined the WTO, the share of
intra-regional exports in total exports of goods has fallenfrom the second highest (18.5%) to the second lowest (14.8%)
among emerging markets after the Middle East (see figure2). Meanwhile Emerging Asia has moved from second
lowest position to the highest position. But at 22.5% this Is
still below shares in advanced trade blocs in North America(45%) and the EU (60%). World Bank research (2019) showsthat intra-regional trade in LAC is mostly between countries
with similar structures. Such agreements often result in
trade diversion, rather than in trade creation in which new
trade that would not exist without the trade agreement iscreated.
Figure 2 LAC’s intra-regional trade has declined.

Struggling to move up the value
chain
More trade openness could help to boost Latin America's
growth potential, but Latin America also needs to improve
the quality of that trade. The composition of trade and natureof trade agreements are critical factors in the transfer ofknowledge and technology to increase economic efficiency
and productivity, and here we also see room for
improvement. Research shows that for emerging market
economies, so-called South-North trade contributes more
effectively to raising potential growth than trading amongst

each other. But only Mexico, CAFTA-DR, and the OECD
countries of the Pacific Alliance have significant agreementswith the US or EU. MERCOSUR, the region’s largest trade
bloc does not. Expanding these trade ties could help thetransfer of technology and stimulate innovation to develop
the region’s manufacturing sector.
With regard to the composition of trade, Latin America
stands out with high shares of food and commodities and a
low share of manufacturing in merchandise goods
compared to other regions (see figure 3). World Bank data
show that at 45.7% in 2021, the region's share ofmanufacturing is the lowest among all regions. Worse even,this share is down from 55.2% in 2000. Additionally, Latin
American countries mostly export low-technology
manufacturing goods. This indicates that moving up thevalue chain and participate in global value chains is quite astruggle for the region.
Figure 3 LAC’s manufacturing exports are low

The small share of manufactures in LAC trade partly reflects
the legacy of general policy choices after the outbreak of theSecond World War. This forced other countries toindustrialise as the war restricted access to manufacturing
imports. But different from, for example, East Asia, theseindustrialisation processes in LAC were mainly domesticallyoriented. Commodities continued to dominate exports. As aresult, the small size of most domestic markets and lack of
exposure to international competition constrained thedevelopment of the manufacturing sector both in size andlevel of innovation. But it also reflects a policy divide within
the region, and particularly between the three largest
countries since the 1990s.
Within the region, Mexico has been most successful inmoving up the value chain, as part of its trade agreementwith the US and Canada in 1994. At 77% in 2021, Mexico has
the highest share of manufacturing in merchandise exports
in LAC (see figure 4). Moreover, these exports are also mostadvanced: 80% are medium or high technology goods,
illustrating the importance of South-North trade. As a result,
Mexico is the only LAC country that is well integrated into
advanced manufacturing global value chains. Tradeagreements with the US also helped most countries inCentral America and the Caribbean to upgrade their exports
to manufacturing, with CAFTA-DR members El Salvador,
Costa Rica and Dominican Republic being most successful.
Their shares of merchandise exports are above the LAC
regional average and range between 75% (El Salvador) and
57% (Dominican Republic). Of these countries
manufacturing exports are most advanced in Costa Rica
(medical devices, aerospace, computer & electronic
components, and pharmaceuticals), followed by Dominican
Republic (medical and optical devices, electronics andAtradius Economic Research 3

pharmaceuticals) and El Salvador (textiles, chemicals,
rubber and plastics).
Figure 4 Mexico’s exports are most advanced

also grown in Central America and the Caribbean, recent
years. Chile, Costa Rica, Peru and recently Ecuador have free
trade agreements with China, and Panama and Uruguay areplanning treaties. Due to the regional trade bloc, Dominican
Republic-Central America-United States (CAFTA-DR), the US
is by far the largest export destination for countries inCentral America, but China is their second largest import
partner. The importance of China in this subregion might
increase further. Almost all countries that are a member ofthe DR-CAFTA trade bloc between the US and countries in
the region have switched diplomatic ties from Taiwan to
China. So did Panama. In LAC, only Belize, Guatemala andParaguay still have diplomatic ties with Taiwan instead ofChina.
Figure 5 China has rapidly increased its share of LAC’s trade pie

Overall, most countries in Central America and the
Caribbean have a higher share of manufacturing inmerchandise exports than commodity rich South America.
This subregion is struggling the most in moving up the value
chain, with a share of manufacturing in merchandise
exports at 18%. Quite strikingly, this share has significantly
declined over the past two decades. In South America, Brazil
has the highest share at 25%, but this is down from 57% in
2000. A similar, but less sizeable development took place in
Mexico: its share of manufacturing in merchandise exports
fell from 85% to the current 77% over the same period. This
reflects the rise of China after joining the World Trade
Organisation in 2001. As China became the world's
manufacturer, South America provided the raw materials
and lost competitiveness in manufacturing; to a lesser
extent, so did Mexico. However, the lagging behind of SouthAmerica with regard to openness and value added is not justa matter of the rise of China and the region's comparativeadvantage in commodities. In all countries in this subregion,
the share of manufacturing continued decreasing after theend of the commodity boom years of 2003-13 (Paraguay
was the exception, but here the share increased from a very
low level). It also reflects the policy divide in trade
agreements that MERCOSUR lacks integration withadvanced markets.

Nearshoring poses challenge andopportunity for LAC
The pandemic and geopolitical shifts – namely rising tradetensions between China and the West and the outbreak of
war in Ukraine – are prompting governments andcompanies worldwide to reduce vulnerabilities in essential
supply chains. The US-China rivalry is the most significant
development here for Latin America and the Caribbean, as
both the US and China are major trade and investment
partners for the region.
China has been the region’s fastest growing trade partner
over the past decades, substituting some of the trade with
the US and EU. While figure 5 shows the US is clearly thelargest trade partner of the region, 70% of that trade isbilateral with Mexico. Excluding Mexico, trade with the US
only accounts for 11% of the rest of the region’s trade, below
China's share of the 17%. China has become a moresignificant trade partner in terms of both exports andimports than the US in some countries, especiallycommodity-rich ones in South America. But China's role has

While China has been the largest growth partner in tradeover the past decades, the dynamics limit further
developmental gains for LAC countries. As discussed earlier,commodities dominate LAC-China trade which offer limited
value-added for domestic economies. The relatively low
competitiveness of other exports from LAC and the reduced
attractiveness of traditional natural resource extraction due
to climate change both drag on investments into LAC. As thegeopolitical landscape shifts and demand for new resources
to fuel the energy transition picks up, shifting focus to
improving trade relations with the US and EU andincreasing the value added of domestic manufacturing
would increase much-needed FDI inflows for the region –offering opportunities to move up the global value chain.
The US-China rivalry and the EU’s strive to reshape its
supply chains have major ramifications for the US and EU’s
foreign policies that could offer opportunities for Latin
America and the Caribbean. Reducing dependence on China
for crucial materials for the energy transition is of particularpriority. China's current share in the refining of suchminerals is for instance 100% for natural graphite, over 90%
for manganese and almost 60% for lithium. In 2021 forinstance, both the US and the EU launched a series of policy
initiatives aimed at raising the autonomy of strategic
industries such as semiconductors, electric batteries,
pharmaceuticals and critical minerals. To date, evidence ofa major reorientation of global value chains is absent – due
to high costs among other reasons – but this might change
once investors judge the disruptions to the global value
chains to be more permanent. Proximity to the US and
improved labour cost competitiveness make LAC an
attractive candidate for nearshoring. Estimates by the InterAmerican Development Bank (IDB) suggest that nearshoring
could add an annual USD 78 billion to the region's exports ofAtradius Economic Research 4

Box 2 Mexico and nearshoring
Different research suggests that Mexico is best placed to benefit
from nearshoring. It shares a 3,000-kilometre border with the
US and is a member of USMCA, one of the world’s largest trade
networks. Mexico already has a solid foundation to reap themost rewards from nearshoring with 13 FTAs encompassing 50
countries, integration in advanced global value chains andcompetitive labour costs. Currently, hourly wages ofmanufacturing in Mexico are USD 2 below those in China. The
IDB (2022) estimates that nearshoring in Mexico could add USD
35.3 billion annually in exports of goods.
Recent developments suggest that Mexico has indeed madesome progress with nearshoring: exports of goods to the US
have grown by 56% since the start of the trade tensions
between the US and China in 2017 as US companies such as
Walmart started buying goods from Mexico or opened factories
in Mexico (MGA Entertainment) instead of China. Also, foreign
direct investment (FDI) inflows in Mexico set a new record of
USD39bn in 2022 and remained strong in the first quarter of2023. Some European manufacturers, especially in theautomobile industry like BMW, are for instance. opening new
manufacturing facilities in Mexico to benefit from lower labourcosts and closer proximity to the US consumer market.
However, although Mexican exports to the US have increased,
both in value and as a share of Mexican exports, Mexico's sharein US imports so far has not. It is pretty stable around 13.5%
since 2016 (see figure 7). In other words, the increased Mexican
exports is the result of overall higher import demand from theUS. Meanwhile, the share of other Asian countries in US imports
has increased from 8.6% in 2016 to 12.4% in 2022. Thissuggests that US companies have so far been rerouting supply
chains to allies in Asia, particularly southeast Asia, instead of
Mexico. The fact that 90% of the higher FDI inflows came fromreinvestments from established companies, rather than new,greenfield, investors supports this. This bias is in part due topolicy uncertainty in Mexico. For instance, there have been
several conflicts recently between Mexico and the US andCanada under the USMCA. These concern an announced reformby Mexico to the mining law, a decree that limits imports ofgenetically modified corn and the administration's energy
policy, prioritising the state-controlled power utility company
over electricity generated by the private sector. Although theseconflicts have so far not scared established foreign investors in
Mexico, they have particularly raised investments in the – media& financial - services sector, with investments in manufacturingslowing. This is one of the reasons why Mexico's manufacturingsector has been stagnant since its recovery from the pandemic.

Figure 6 US opting for rerouting lost-Chinese trade with Asia
instead of Mexico

goods and services, with opportunities in particularly
sectors such as automotive, textiles, pharmaceuticals, andrenewable energy. The associated strengthening ofintegration in international trade, exchange of knowledge,
technology and financing (foreign direct investments)
would benefit the region and could lift its growth potential.
However, as we outlined above, the current state of trade in
Latin America and the Caribbean poses substantial
impediments to seizing these opportunities.

Energy transition can help unlock
gains from nearshoring
From the above we can see that only a few countries standto benefit in the coming years from potential near- or
friendshoring. Mexico and the CAFTA-DR countries are thebest positioned countries in Latin America and the
Caribbean to benefit from these trends in terms of trade
agreements with and geographical proximity to the US.
Within CAFTA-DR, Costa Rica and Dominican Republicstand out given their more advanced manufacturing
production. In South America, the OECD members, Chile andColombia, would be well-positioned to benefit fromnearshoring or friendshoring, as they have free trade
agreements with the US and the EU.
Most other countries in South America have seemingly
lower prospects when it comes to nearshoring or
friendshoring, considering the lack of trade agreements with
the US or EU. However, we see opportunities for thesecountries to expand their trade. The energy transition could
trigger this.
Firstly, the energy transition could push free trade
agreements with the US and the EU as these regions aim to
reduce dependence on China for raw and processedcommodities. Many South American countries are rich in
critical minerals such as lithium (Argentina, Bolivia, andChile), copper (Chile, Peru), nickel and graphite (Brazil) thatare strategic for the energy transition. Diversifying supply
chains through near- and friendshoring, especially forstrategic resources for the energy transition, may motivate
the US and EU to deepen trade ties with LAC.
Free trade agreements with the US and the EU might
facilitate near- and friendshoring that could lift the value
added of that trade. The updated FTA between Chile and theEU, concluded end-2022 (still needs to be signed andratified) and the agreement to prepare a ‘strategic
partnership’ for raw materials are positive examples in thisrespect. A key aspect of the ‘strategic partnership’ is to create
added value in Chile. This example might facilitate the longawaited ratification of the FTA between MERCOSUR and the
EU. The EU is now waiting for a MERCOSUR response to an
addendum it wants to add on sustainability and climatechange commitments due to deforestation concerns. This
offers an opportunity for the MERCOSUR to demand fromthe EU to create more added value in the MERCOSUR
countries.
Secondly, the energy transition could expand intra-regional
trade, especially within South America. One promisingexample is of Brazil's state-oil company Petrobras which

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has recently signalled interest in Bolivia's lithium resources
to help Brazil to migrate toward electric vehicles and the
production of batteries. As the demand for cross-border
trade increases, the pressure to reduce the high costs of that
trade and other non-tariff barriers also increases.

Limited prospects in the absence ofsignificant domestic development
While the energy transition and near- and friendshoring
offer opportunities for Latin America and the Caribbean,
they are both gradual processes that do not offer any quick
fix for lifting productivity and potential economic growth.
Mexico, the most promising destination for nearshoring, is acase-in-point (see box 2 on Mexico and nearshoring).
International trade and investment need to besupplemented by measures to create a businessenvironment that is more conducive to domestic
investments.

Prioritising the deepening of new and existing trade
agreements, boosting intra-regional trade and the reducing
high trade costs are key to integrating LAC in global value
chains and lifting productivity and economic growth.
Infrastructure, regulatory and administrative bottlenecks
need to be removed for this to happen, but they are not a
substitute for domestic reforms aimed at loweringtransaction costs, increasing market contestability, andboosting public sector efficiency.

Greetje Frankena, Deputy Head ERD
greetje.frankena@atradius.com+31 20 553 2406
Dana Bodnar, economist
dana.bodnar@atradius.com+31 20 553 3165

Atradius Economic Research 6

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