In the swirling currents of today’s global economy where disruptions seem to be the new norm, recent upheavals have prompted a critical reevaluation of supply chain dynamics. From the far-reaching aftermath of the pandemic to geopolitical tensions and logistical challenges such as those witnessed at the Panama Canal, there is a palpable drive to reassess factors like proximity to key consumer markets in the United States and Europe. The Latin American and the Caribbean (LAC) region stands at the forefront of this reevaluation, where the growth trajectory of Gross Domestic Product (GDP) is expected to shift slightly from an estimated 2.3% in 2023 to around 2% in 2024 (Figure 1), with a subsequent uptick projected to 2.5% in 2025, according to the latest International Monetary Fund (IMF) World Economic Outlook (WEO) published in April 2024.

Nearshoring, the practice of relocating business operations or processes to nearby countries, typically within the same geographic region or continent, is gaining prominence as a strategic response to supply chain complexities. This calculated move aims to trim operational expenses while optimizing efficiency by bringing production closer to end consumers. Recent insights from the World Bank offer hope, with a marked increase in Foreign Direct Investment (FDI) across the LAC region in 2022, surpassing levels since 2014, though still below 2010 peaks (Figure 2). The rising trend of FDI inflows is promising and may hint at a surge in nearshoring activities. This is especially apparent in countries like Costa Rica, the Dominican Republic, and Panama.

Positioning Mexico for Economic Prosperity…

Mexico stands poised to harness the benefits of nearshoring. Despite a sluggish performance in Q4 2023, the Mexican economy experienced a robust 3.2% expansion for the entire year, buoyed by factors such as the strength of the US economy and ongoing infrastructure projects. Looking ahead, Mexico anticipates a resurgence in growth, supported by domestic spending and strategic fiscal policies. However, projections from the IMF hint at a slight moderation in GDP growth for Mexico, with estimates pegged at 2.4% in 2024 and 1.4% in 2025 (Figure 3). Nearshoring is particularly prevalent in industries such as transportation equipment, auto parts, electronics, machinery, furniture, household appliances, and medical devices, sectors in which Mexico has developed expertise since the 1990s.

Mexico strategically benefits from its close geographical proximity to the formidable US market, positioning itself as a prime location for nearshoring endeavors. By shifting operations to Mexico, businesses can achieve notable reductions in transportation cost, given the shortened distance required for goods to reach target markets. Furthermore, Mexico presents an advantageous landscape with competitive labour costs compared to the US. This advantageous scenario is further emphasized by the discernible variance in wage levels between Mexico and the US, as illustrated in Figure 4.

Data from the Organization for Economic Cooperation and Development (OECD) shows a strong and upward trend in business confidence in Mexico. As of the latest available data from October 2023, Mexico’s business confidence index stands at 101.5, steadily increasing since 2020 (Figure 5). This positive trend aligns with Mexico’s position as a leading destination for nearshoring as higher business confidence indicates a more favourable environment for investment and growth.

Furthermore, Mexico’s active engagement in the United States-Mexico-Canada Agreement (USMCA) fortifies its attractiveness as a nearshoring hub. Its accessibility by sea from both Europe and Asia adds an intriguing dimension, insulating it from the vulnerabilities plaguing other critical trade routes like the Suez Canal and the Panama Canal.

Nearshoring’s Role in Mexico’s Future……

Nearshoring offers a significant opportunity for Mexico’s economy. Deloitte projects a potential 3% increase in GDP over the next five years, driven by several factors. Firstly, nearshoring is expected to attract substantial foreign direct investment (FDI). The Mexican Institute of Competitiveness (IMCO) reports a 47% increase in relocation linked FDI in the first nine months of 2023 compared to the same period in 2022. Key sectors benefiting from this trend include manufacturing, transportation, mining, professional services, and mass media information. This capital influx will be used to develop and expand Mexico’s manufacturing infrastructure, creating a modern and efficient ecosystem.

Secondly, increased manufacturing activity will naturally expand the sector, boosting output and exports. S&P expects Mexico’s manufacturing sector, which currently accounts for 22% of GDP, to remain the main driver of economic growth. For instance, US imports from Mexico have continued to rise, while Chinese exports to the US fell by 20% in 2023 compared to 2022.

However, achieving the ambitious 3% increase in GDP requires doubling the pre-pandemic manufacturing growth rate to an annual average of 5.6%, compared with 2.8% in the recent past. This challenging yet transformative goal is crucial for economic expansion. Moreover, nearshoring has the potential to create over one million new jobs, which would significantly boost consumer spending and overall economic activity, ultimately supporting the projected GDP growth.

Costa Rica: A Success Story in Development
Costa Rica’s development is a widely regarded success story, characterized by consistent economic growth over the last 25 years, driven by strategic foreign investment and trade liberalization. Despite this success, IMF data indicates a downward trend in GDP growth, from 5.1% in 2022 to a projected 4% in 2023, with an expected convergence to around 3.3% by 2026. Foreign direct investment (FDI) plays a vital role in Costa Rica’s economy, underscoring its attractiveness for nearshoring endeavours. The nation boasts a varied investment landscape spanning key sectors like Hotels and Accommodation, Medical Devices, and Semiconductors. In 2022, Costa Rica recorded a remarkable influx of USD3.7bn in FDI. Projections from Fitch suggest this robust trend in FDI inflows is set to persist, potentially surpassing previous highs. In the first nine months of 2023, Costa Rica experienced a notable surge in FDI announcements in the Medical Devices sector, serving as a testament to the continued allure of its investment landscape and reinforcing its growth potential.

Costa Rica paints an optimistic picture for future growth with a focus on export-oriented goods and services, buoyed by the presence of special export zones and a robust tourism sector. Leveraging its geographical proximity akin to Mexico, the nation offers advantages that position it favourably as a nearshoring destination. Operating on Central Standard Time aligns business hours with those of the US, facilitating seamless coordination and communication. Additionally, boasting a highly proficient English-speaking workforce, ranking third in Latin America with a notable EF English Proficiency Index score of 534 points in 2023 (Figure 7), ensures effective communication in business dealings and project management, easing the process for US companies outsourcing operations.

Nearshoring initiatives yield significant economic advantages for Costa Rica. The influx of companies not only stimulates the knowledge economy but also fosters innovation, particularly within the tech sector, attracting further investment. This, in turn, leads to job creation for skilled professionals and a subsequent increase in national income. Additionally, Costa Rica’s political stability and well-established legal framework create a secure and predictable business environment, offering a substantial advantage for companies considering nearshoring ventures.

Economic Opportunities in the Caribbean for Nearshoring

Beyond Mexico and Costa Rica, the Caribbean is becoming an increasingly attractive destination for nearshoring. The Dominican Republic exemplifies this trend with Eaton Corporation’s recent investment of USD750mn in 2023, of which USD10mn is allocated specifically for the Dominican Republic. This project is expected to create 300 skilled manufacturing jobs, underscoring the region’s skilled workforce and competitive advantages. Historically, foreign direct investment (FDI) in the Dominican Republic has focused on the mining sector. However, recent Greenfield FDI announcements from 2020 to 2022 indicate a strategic shift toward diversification, particularly in the sectors of hotels and accommodation and renewable energy, according to the World Bank.

Jamaica is also leveraging its logistical strengths and skilled labour force to attract nearshoring investments. The country’s emphasis on developing its information and communication technology (ICT) sector has established it as a hub for business process outsourcing (BPO), providing services such as customer support and IT management. The government’s commitment to enhancing digital infrastructure and regulatory frameworks has further bolstered Jamaica’s appeal as a nearshoring destination.

By embracing nearshoring, the Caribbean is emerging as a significant player, contributing to the economic growth of the LAC region. This shift promotes foreign investment, job creation, and technological advancement.

Despite the Plethora of Benefits, Challenges of Nearshoring in LAC Persist…

Nearshoring in the LAC region, offers significant benefits but also presents notable challenges. Language and cultural barriers, while manageable, can hinder communication due to variations in accents and fluency. Infrastructure limitations, especially in rural areas, necessitate rapid development to support growth. Political and economic instability in some countries poses risks, though many areas remain stable with strong economic growth. Thorough vetting of outsourcing partners can ensure quality and consistency. Additionally, reliance on the US market makes these economies vulnerable to fluctuations, and increased manufacturing activities raise environmental concerns requiring sustainable practices. Despite these challenges, strategic planning and investment can effectively harness nearshoring’s potential.

The potential for nearshoring in Latin America and the Caribbean is promising. To maximize this opportunity, a strategic approach focused on infrastructure development, workforce training, and regulatory reform is crucial. Investments in modernizing ports, transportation networks, and digital infrastructure will enhance connectivity and streamline logistics, but how can we ensure these efforts align with the needs of nearshoring industries? Continued development of targeted educational programs and skills training initiatives will ensure a workforce equipped to meet the demands of nearshoring industries. Additionally, fostering trade agreements and streamlining regulations will incentivize foreign direct investment and create a more predictable business environment. By embracing nearshoring alongside a focus on sustainability, Latin America and the Caribbean can position themselves as a competitive and attractive destination for global businesses. This strategic approach has the potential to unlock significant economic growth, diversification, and shared prosperity in the region.

DISCLAIMER 

First Citizens Bank Limited (hereinafter “the Bank”) has prepared this report which is provided for informational purposes only and without any obligation, whether contractual or otherwise. The content of the report is subject to change without any prior notice.  All opinions and estimates in the report constitute the author’s own judgment as at the date of the report.  All information contained in the report that has been obtained or arrived at from sources which the Bank believes to be reliable in good faith but the Bank disclaims any warranty, express or implied, as to the accuracy, timeliness, completeness of the information given or the assessments made in the report and opinions expressed in the report may change without notice. The Bank disclaims any and all warranties, express or implied, including without limitation warranties of satisfactory quality and fitness for a particular purpose with respect to the information contained in the report. This report does not constitute nor is it intended as a solicitation, an offer, a recommendation to buy, hold, or sell any securities, products, service, investment or a recommendation to participate in any particular trading scheme discussed herein. The securities discussed in this report may not be suitable to all investors, therefore Investors wishing to purchase any of the securities mentioned should consult an investment adviser. The information in this report is not intended, in part or in whole, as financial advice. The information in this report shall not be used as part of any prospectus, offering memorandum or other disclosure ascribable to any issuer of securities. The use of the information in this report for the purpose of or with the effect of incorporating any such information into any disclosure intended for any investor or potential investor is not authorized. 

DISCLOSURE 

We, First Citizens Bank Limited hereby state that (1) the views expressed in this Research report reflect our personal view about any or all of the subject securities or issuers referred to in this Research report, (2) we are a beneficial owner of securities of the issuer (3) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report (4) we have acted as underwriter in the distribution of securities referred to in this Research report in the three years immediately preceding and (5) we do have a direct or indirect financial or other interest in the subject securities or issuers referred to in this Research report.