Latam trade: Another opportunity missed?

The US economy is running at full employment and US foreign trade is reaching its maximum ever. Even after one of the steepest and fastest increases in interest rates in history, US business activity is showing remarkable resilience supported by fiscal spending and strong investment flows into technology firms leading innovation in artificial intelligence.

By contrast, Latin American economies are struggling to recover from the recession that hit in 2023. Growth in the region in 2023 fell in response to higher interest rates across the world and less foreign investment in most countries. This year is expected to bring higher—but insufficient—growth to the region. In spite of the advantages that derive from their location close to the US, very few countries in Latin America are profiting from the strength of the American economy.

The US is the largest market in the world and it imports manufactured goods. Given that most Latin American exports skew toward raw materials, the region’s economies have become more intertwined with China and other Asian economies, and less with the US.

The numbers tell a clear story. Measured in US dollars, Brazil, Chile and Peru export between two and three times more to China than to the US. The difference becomes bigger if other Asian economies such as Japan and South Korea are added into the comparison. The three countries also buy much more from China than from the US.

The only country in the region that largely exports manufacturing goods to the US is Mexico. Mexico-US trade represents 70% of all trade with the US in the region. Some 80% of Mexican exports go to the US, and as of 2023 Mexico became the US’ main trading partner, ahead of both China and Canada.

A lost opportunity

The sheer size of the trade between the US and Mexico underlines how big an opportunity nearshoring can be to Latin America. It’s an opportunity that, so far, is being missed by many.

Intense trade with economic potency is usually accompanied by increased cross-border investment. US investment in Mexico in 2023 accounted for 40% of the $36 billion investment flows into Mexico. Also, in 2023 most of the rest of investments in Mexico originating elsewhere went to facilities that produce for the US market.

FDI into Mexico grew 27% in 2023 and reached its maximum ever at $36 billion. The main sectors benefiting from this trend were auto parts, furniture, machinery and electronics. A case in point is the Tesla Gigafactory that was announced in 2023 and will become the world’s largest factory for electric cars.

However, the country that gets the most FDI in the region is Brazil. According to the Economic Commission for Latin America and the Caribbean (ECLAC), in 2023 the South American giant received around $62 billion of net inflows of foreign direct investment. Although this was 18% less than in 2022 and remains below pre-pandemic levels, it’s still about half of the total for the whole region. Brazil is also a prime destination for US investment abroad. In 2023, the US contributed more than a fifth of total FDI into the country.

Colombia is a different and very interesting case. Although the US is still its main trading partner, Colombia largely exports oil, oil derivatives and bituminous coal to the US. In 2023, however, it bought as much from China as from the US. It also received most of its FDI from the US and has been experiencing solid growth in foreign inflows, despite electing its first ever left-wing government. Whether President Gustavo Petro’s effort to halt all new projects in oil and coal extraction (both Colombia’s main legal exports) will reverse this favorable trend remains to be seen.

The fact that FDI grew to its maximum ever in Mexico, it still growing in Chile and Colombia, and fell sharply in Brazil and Peru in 2023, tells the story of how heterogeneous the effects of trade regionalization have been, so far. The winners seem to be those most welcoming to foreign investment. Regulatory complications, protectionism, corruption or political instability seem to be the main detractors with different relevance in each country.

The US economy is largely a producer of services that buys mainly manufactured products and energy from the rest of the world. Except for manufacturing from Mexico, most Latin American exports to the US are made of oil, coal, minerals and foods. Although there is room to grow in this line of business, the extent of such trade is limited.

Leveraging FTAs

There are many factors that suggest Latin American countries could step up production and become manufactured goods exporters. First, many have free-trade agreements with the US similar to the USMCA that governs trade in North America. Second, most Latam countries have high unemployment levels—on average, double that in the US. Third, all Latam countries have ready access to the main ports in the US. Fourth, Latam is rich in renewable energy sources and natural gas. Fifth, the region is rich in copper, lithium, rare earths, iron and many other raw materials that could supply new manufacturing lines.

As of 2023, the US was the main origin of FDI in the region with about 40% of the total. The EU was number two with approximately half of that. LatAm, as a whole, imports more goods and services than it exports. As a result, as a region it runs a current account deficit that needs to be financed with foreign investment. It is noticeable that the region’s trade deficit, mainly with China, is financed with money coming mainly from the US and the EU.

However Chinese firms are solidly taking control of some of the advantages Latam has. For instance, they will soon be in control of the largest port on the Pacific Coast in South America being built in Peru. Also, they are investing in the ports of Paranagua and Santos in Brazil on the Atlantic coast, they control large stakes of electricity distribution and generation in Peru and Chile, they run several copper and iron mining operations in Peru.

Although China is unlikely to displace the US and EU as the main source of FDI to Latam in the near future, governments in the region could address the current imbalances and capitalize better on the opportunities already available to grow trade and investment with the US and the EU.

José Martinez Sanguinetti manages a $3.5 billion global portfolio as chief investment officer at Rimac Seguros

Research conducted by Lorenzo Martinez Roveda