Will Asian investment follow trade with Latin America?
Latin America is now firmly on the economic radar of Asia in the post-global financial crisis world, with both regions having grown faster than the world economy.
Latin America is now firmly on the economic radar of Asia in the post-global financial crisis world, with both regions having grown faster than the world economy. In 2009–2013, annual average growth was 4.6% in Asia, 2.4% in Latin America, and 1.9% for the world economy. Trade between both regions has also grown, prompting a flurry of diplomatic activity, including high-level visits by Asian leaders accompanied by pledges of trade, foreign direct investment (FDI) and foreign aid.
This is a dramatic turnaround.
Before the 1990s, there was little trade between the two regions. Transport links were poor, and trade barriers were high. Latin America, which traditionally focuses on exporting to North America, used to view Asia as poor, riddled with economic crises, and risky for business.
Why has trade grown?
Falling trade barriers have enabled land-rich Latin America to supply commodities in return for manufactured goods imports from Asia, where skilled labor is abundant. Strong demand for Latin American commodities and food from the People’s Republic of China (PRC) and other Asian economies has provided an alternative to declining industrial markets in Latin America, particularly since the global financial crisis.
Latin America is a growing destination for Asian industrial goods and FDI. Advances in information and communications technology as well as better logistics have supported inter-regional trade. Lastly, more free trade agreements (FTAs) across the Pacific have supported market access, rules-based trade, and business confidence.
However, much needs to be done before Asia and Latin America can reach their full trade potential. The two regions must engage more economies in mega-regional FTAs like the Trans-Pacific Partnership, still under negotiation. Their economic ties need to cover more sectors, such as services. Other priorities are enhancing cross-regional policy cooperation, and accelerating structural reforms.
The Asia-Pacific Economic Cooperation (APEC) forum is useful for business confidence, but only Chile, Mexico and Peru are in APEC. A newer institution is the Forum of East Asia Latin America Cooperation (FEALAC) which agreed in August 2014 to set up a body to promote cooperation in trade and investment. Brazil, Latin America’s largest economy, needs to strengthen ties with Asia but it has only one FTA in place and Asian investors are concerned about its protectionist tendencies.
Argentina could be another key player, if it can sort out its financial crisis and escape going into default. Meanwhile, Chile, Colombia, Mexico, and Peru have formed the Pacific Alliance and are attempting to become more market-friendly.
Why has FDI lagged?
Asian FDI can help transform Latin American economies. Asian capital and expertise can help upgrade Latin American infrastructure, Asian technology transfer and marketing connections can support Latin American firms joining global value chains and promote internationally competitive industrialization. Small- and medium-sized enterprises (SMEs) in both regions can be suppliers, subcontractors, and service providers to multinationals.
But despite growing trade between Asia and Latin America, FDI has remained lackluster in the past decade. The annual average greenfield investment from Asia in Latin America in 2003-2013 was $14.1 billion, while the other way around it reached just $1.2 billion. Firms from Japan, the PRC, and the Republic of Korea account for the bulk of Asian investment into Latin American automotives, machinery, electronics, metals, chemicals, petroleum, and food and tobacco.
Geographical remoteness, differences in culture and business practices, and especially cumbersome domestic regulations in Latin America help explain the low levels of Asian FDI. It takes an average of 47 days to start a business in Latin America compared to 12 days in Asia, 90 compared to 54 to get an electricity connection, and 215 compared to 109 days to deal with construction permits.
Some Pacific Alliance members boast a better business environment than other Latin American economies which have not implemented economic reforms to boost growth and want to attract Asian investors, even if they are still not as open as the most outward-oriented, market-friendly Asian economies.
More Asian FDI in Latin America will bring economic benefits to both regions and help diversify sources of world growth. But to realize that potential Asian and Latin American governments must do more to open up markets, cut redundant regulations, conclude comprehensive FTAs, build trade-related infrastructure, and promote inter-regional cooperation initiatives like APEC and FEALAC.
This blog post first ran in a slightly different form in ADB Institute’s Asia Pathways.