Onshoring works in Latin America, but not as expected

Hopes for the positive effects of nearshoring in the region were high, but the reality so far has been different. Hardly any Western companies are relocating here, but China’s industry is seizing the opportunity.

by Alexander Busch, Latin America correspondent for Handelsblatt and Neue Zürcher Zeitung

Two years ago, a forecast by the Inter-American Development Bank (IDB) electrified governments and investors in Latin America. The IDB’s experts expected that Latin America could export an additional 78 billion dollars worth of goods and services per year in the medium term, an increase of around 6 percent.

The reason for this is the onshoring of Western companies in Latin America. Companies from industrialized countries are trying to locate their suppliers closer to them. For various reasons: Environmental concerns, the Covid pandemic, the trade disputes between the USA and China and Russia’s war in Ukraine would accelerate this trend – and lead to an investment boom in Latin America.

So far, Mexico in particular seems to be benefiting from this growing integration into the value chains. Proximity to the US, the North American free trade agreement USMCA and the Biden administration’s multi-billion dollar subsidy program (IRA) have increased investment in Mexico’s industry. For the first time in 2023, Mexico was once again the largest exporter to the USA – ahead of China.

However, if we look at the development of foreign direct investment in Mexico in a historical comparison, the resettlement effect is disappointing: Mexico has stabilized its foreign investment at pre-pandemic levels – nothing more. The share of Latin America’s second-largest economy in global direct investment remains below 3%.

The result is even weaker in Brazil, where foreign investment shrank by 18% last year. In Chile, Colombia, Peru and Argentina, political uncertainties have curbed investor interest. South America attracts less than 3 percent of global direct investment.

In the Far East, however, things look very different: Western corporations are no longer setting up their new companies in China, but in the surrounding countries such as Vietnam, Singapore and Indonesia. The onshoring effects are clearly noticeable there. Southeast Asia now accounts for more than 10 percent of global foreign direct investment.

There are various reasons why Latin America is not very attractive to companies from Europe or the USA: the difficult business environment in the region, the lack of qualified workers or the poor infrastructure are among them.

But the most important thing is the low level of integration in Latin America. The markets in Latin America are still barely integrated. Only 15 percent of foreign trade is conducted between the countries. In the Far East, the figure is almost two thirds.

Companies are reluctant to set up their production facilities in countries that are not integrated in the region. This also applies to large markets such as Brazil or Mexico: for high-tech producers or manufacturers of high-quality consumer goods, these are also too small to justify high investments.

Companies from western industrialized countries are therefore hesitant to invest in Latin America. In the case of European companies, this is also due to the crisis in their home markets. US companies also prefer to concentrate on the booming North American market.

To this end, China’s industry is making strategic use of onshoring in Latin America. In Brazil, as in Mexico, Chinese companies are investing in green hydrogen, sustainable power generation, e-mobility, consumer companies and joint research and development.

The influx of Chinese investors in Mexico began as early as 2018, when former President Donald Trump increased import tariffs on Chinese products. Mexico has now become an important bridgehead for Chinese companies exporting to the USA. In Brazil, Chinese companies want to supply the local market, but also South America in the medium term.

It looks as if onshoring could work in Latin America in the medium term – but with different players than expected.