How North America can turn today’s turbulent economic environment into a competitive advantage.
In today’s turbulent economic environment, the world’s understanding of global manufacturing competitiveness is being redefined from one based on profit to one founded in resiliency, quality, and sustainability. North America is poised to influence this to its advantage, and in doing so reinvigorate its global leadership. While much of the current debate on this issue in the United States has focused on reshoring to North America to reduce dependence on Asia, there are limits to this strategy—ranging from the cost and size of the labor pool to a convergence of capabilities in the region. Regional integration across the Americas would combine the high-value leadership of North America with the powerhouse supply of raw materials in the Southern Cone of South America, a large and growing low-cost labor force, broad diversity in development levels, and abundant green energy. Together, they would create more enduring advantages for global industries.
While NAFTA provided excellent terms for North America’s leadership in the early stages of globalization, the continuous, dynamic rise of other regional groups has exposed shortcomings in the region’s long-term competitiveness.
The past few years have demonstrated that global value chains—where the different manufacturing stages are located in different countries—are an integral part of the world’s economy. Today, most industries, from automotive and clothing to aerospace and medical devices, are organized in these cross-border networks of goods and services, which account for an important share of global trade and employment. Now a widely adopted business model, global value chains have fragmented industries, with activities spanning multiple countries and firms around the world. This has ushered in prosperity in a large range of countries, which can now participate in international trade without needing to develop the full range of industrial capabilities. At their core, these global networks leverage each location for its relative competitive advantage. Usually, developing countries offer low labor costs and raw materials, and focus on lower-value operations, such as assembly and production. Meanwhile, developed countries with highly educated talent focus on their core strengths in R&D, innovation, branding, and sales.
The Eroding Competitiveness of the North American Trade Bloc
For the past three decades, this globalization of production has been shaped and led by North America—comprising the United States, Canada, and Mexico—which has heavily influenced what, how, and where goods are produced around the world. Since its signing in 1994, the regional North American Free Trade Agreement, or NAFTA, has made North America the world’s largest trade bloc, with more than $1 trillion in goods and services being exchanged. The region is home to major firms, carries out the highest-value activities with their chains, and exercises power and influence over global standard setting in virtually every industry. The success of this regional partnership is due to the complementarities in comparative advantages across the three countries. The US, the world’s largest economy, leads these chains by providing high-value services and advanced manufacturing, while Canada and Mexico have key roles supplying raw materials, parts and components, and producing final products to the US. US-lead firms, from Apple to Microsoft and Nike, are household names around the world. The US has been supported by Canada—as a natural resource provider and niche high-value manufacturer—and Mexico, whose original role was as a large, low-value assembly provider with large-scale maquilas (factories) along the border with the US. However, since the turn of the century, faced with high competition from lower-cost locations in Asia, Mexico has been pushed to become an advanced manufacturing hub. The automotive, aerospace, and electronics industries, along with medical devices and pharmaceuticals, now account for close to half its exports. Unable to compete with Asia on cost, Mexico left behind its role as the low-cost partner within this regional agreement; in doing so, it has reshaped North America’s global competitiveness. As a region, North America no longer has a low-cost supplier and has grown increasingly dependent on Asia for this supply.
North America’s failure to engage in more comprehensive regional economic initiatives has strengthened the trade relationship between South America and Asia.
While NAFTA provided excellent terms for North America’s leadership in the early stages of globalization, the continuous, dynamic rise of other regional groups has exposed shortcomings in the region’s long-term potential to maintain and upgrade its competitiveness in global value chains. A basic comparative review of how the United States–Mexico–Canada Trade Agreement (USMCA)—NAFTA 2.0—stands up to the evolving trade blocs of Asia and Europe is telling. The newly implemented Regional Comprehensive Economic Partnership (RCEP) in Asia brings together 30 percent of the global population and 30.5 percent of the world’s GDP, surpassing that of the USMCA, at 28 percent. Combining 15 member countries with a diverse range of GDP per capita and a labor force 1.2 billion strong, the region is well prepared to perform both high- and low-value activities. Intraregional trade in Asia was already high and growing rapidly, at 58 percent; it expected to receive a further 2 percent boost from the implementation of the RCEP agreement in 2022. Intraregional trade in Europe is even higher, at 68 percent; since its inception, the European Union has steadily expanded its membership, from 15 to 27. The ascension of Hungary, Poland, and other Central and Eastern European countries to the EU contributed greater differentiation in costs and capabilities across the bloc. The EU plans to extend regionalization further, by providing market access to other countries in Europe, the Middle East, and North Africa through the Pan-Europe-Mediterranean agreement. The geographic expansion of trade agreements in Europe and Asia has incorporated countries with differing levels of development, allowing regional supply chains to leverage extensive complementarities, diverse capabilities, and cost arbitrage——buying a security in one market and simultaneously selling it in another market for profit—while acting as a singular bloc in trade negotiations gives them greater market power.
Figure 1. North America’s Current Regional Scope Is Highly Limited Compared with Other Important Regional Blocs in Asia and Europe
With just three member countries, the USMCA’s intraregional trade is the lowest of these three major blocs (figure 1). Less able to tap into regional comparative advantages, particularly for low-value production activities, North America’s dependence on interregional trade is growing. With limited scope and scale, North America has grown dependent on other regions—particularly Asia—to fulfill key low and medium manufacturing activities within its supply chains. In this, the region and its companies have pursued a different strategy. Where the EU and Asia sought to deepen and broaden trade ties with geographically proximate partners to enhance competitiveness, since the mid-2000s, North America has instead decoupled from its closer neighbors in Latin America and turned decidedly to Asia. Between 2000 and 2021, the US share of imports from Asia almost tripled, from $485 billion to $1.24 trillion, led by imports from China, Japan, and South Korea. Indeed, US companies led foreign direct investment into China; by 2020, US investors accounted for the largest share of Chinese foreign direct investment stock. Simultaneously, imports from its southern neighbors have declined. For the past two decades—buoyed by cheap, available Asian labor, growing production capabilities, and streamlining transpacific logistics—this strategy has yielded tremendous returns and has been a major driver of North American competitiveness. Yet this strategy has simultaneously set the stage for the region’s potential decline.
North America’s Peril: Undervaluing Latin America and Embracing Asia
North America’s failure to engage in more comprehensive regional economic initiatives has strengthened the trade relationship between South America and Asia. As Asian manufacturers have grown, they have drawn raw materials suppliers from South America into closer trade relationships. Along the way, South America has become the largest extraregional supplier of numerous, nonenergy raw materials for Asia’s manufacturing machine. Ninety percent of the products exported from South America to Asia are natural resources, such as minerals, metals, food, and wood. The United States’ global value chain dependence on Asian low- and mid-value manufacturing has resulted in a triangulation of sorts. Natural resources flow primarily from the Southern Cone to Asia where they are manufactured and sold to North America; 70 percent of North American imports from Asia are manufactured products. Deep capabilities and growing economies of scale within Asia made it almost impossible for firms to explore alternatives, and value chains became entrenched in finely tuned, just-in-time global supply operations. The exponential opportunities and sheer profits—for both North and South America—driven by the rise of Asia, provided little incentive to change the status quo.
The turbulence of the past five years has created an opportunity for North America to influence the reconfiguration of global value chains to its advantage.
Within just two decades, China has replaced the US as South America’s largest export destination (figure 2). Enhanced trade flows have fostered trade agreements; the largest number of interregional trade agreements globally are between Asia and South America, institutionalizing this division of labor in global value chains. Indeed, the most proactive trading block in the region and a major global source of raw materials—approximately half the world’s copper supply—the Pacific Alliance (Mexico, Chile, Colombia, and Peru) has explicitly declared that deepening its trade relations with the Asia-Pacific region is a principal focus. Paradoxically, the more North America depends on Asia, the deeper the relations between Asia and South America have become, and the more competitive and powerful Asia has grown, expanding its influence across the United States’ southern frontier.
Figure 2. South America’s Main Noncontinental Export Partners
A Turning Point? Time to Tap into Latin America’s Strengths
The turbulence of the past five years, however, has created an opportunity for North America to influence the reconfiguration of global value chains to its advantage. Rising geopolitical tensions, the COVID-19 pandemic, and the Ukraine-Russia war, along with longer-standing climate change and labor issues, are fundamentally reshaping the economic landscape for global sourcing decisions. The convergence of these disruptive trends has created persistent uncertainty that is forcing companies to rethink their supply chains for the long term. Specifically, a new era of in-depth trade and investment engagement between North America and its Latin American neighbors could once again cement North America’s leadership in global value chains. Where North America provides an excellent environment for high-value activities—such as design and R&D—South America has proven itself a global powerhouse in supplying raw materials. Yet low- and mid-value manufacturing capabilities are largely absent in the region. Though it is not possible to fully replace the Asian manufacturing machine, North America must foster the development of the missing middle in the manufacturing global value chain within the Americas region by encouraging the diversification and replication of production operations. This will incentivize regional value chain development, promote intraregional trade, and stabilize relations.
Inaction could mean risking North America’s leadership of the global economy, and squandering its competitive edge.
In addition to the region’s global prominence as a major source of upstream raw materials for global networks of goods and services, Latin America has three largely untapped major sources for its competitive advantage: a large and growing low-cost labor force, diversity in development levels, and abundant green energy. A continental trade pact would double North America’s current labor force to 500 million. Most of the South American population is of working age, and its labor force continues to expand in several countries. While the EU and Asia have already exploited the trade and labor dividends of working together, in the Americas, these remain largely untapped. This potential partnership would constitute 21 countries, with a diverse array of GDP per capita; with more low-income countries than Europe, and more middle-income countries than Asia, facilitating both labor arbitrage and access to talent. Furthermore, they could underpin a shift to green production; at 30 percent, Latin America has the highest share globally of renewables in energy consumption, doubling all other regions in the world except Europe. For example, an electric vehicle assembled in North America could draw on the copper and lithium sectors of Argentina, Bolivia, Chile, and Peru; on green aluminum from Brazil; on low-emissions assembly in Central America and Mexico; and on US design and development. Fostering increased regional engagement could not only produce these economic and sustainability gains but also would enhance security. In the longer term, forging closer economic ties between Central and South America and North America will yield significant geopolitical benefits (figure 3).
Figure 3. North America Can Forge a New Path by Extending Its Understanding of Regionalism to That of the Americas as a Whole
Regaining the Competitive Edge by Joining Forces in the Americas
Today, the understanding of global value chain competitiveness is being redefined, from one based on cost arbitrage to one founded in resiliency, quality, and sustainability. North America has the opportunity to lead this change by harnessing the potential of its continental neighbor, Central and South America. Yet major policy efforts are required in four key areas to ensure that this approach can deliver on its promises: multilateral trade agreements in the Americas, regional infrastructure investments, capability development across Latin America, and a continental focus on sustainable production. Unless these are addressed, it is unlikely that global corporations will seriously consider relocating sourcing operations to the region in the long term.
North America should aim for a regional trade agreement, but it should first negotiate cumulative allowances across multilateral trade agreements with Central and South America. Regionalization of trade in the Americas has had a rocky past, and current agreements have produced fractured subgroups or bilateral agreements that do not allow the region to leverage its collective strengths. These include the US–Central American Free Trade Agreement (CAFTA); the Pacific Alliance (Chile, Colombia, Mexico, and Peru); and the Southern Common Market, or Mercosur (Argentina, Brazil, Paraguay, and Uruguay). However, the current crises—and importantly, the opportunities they offer—justify a renewal of past integration efforts to ensure the growth of competitive and sustainable chains in the future. North–South trade agreements will greatly benefit Central and South America as well, providing them access to a high-value market. The recently announced Americas Partnership for Economic Prosperity is a start, but it lacks the essential element of preferential market access, and thus it is a source of disappointment for Latin American countries, as noted at the Summit of the Americas. An initial approach should leverage the protrade western flank of the Americas, linking USMCA, CAFTA, and the Pacific Alliance. Collectively accounting for some 88 percent of the region’s exports, and two-thirds of its population, there are extensive existing trade agreements across members of these groups as well as with the US. Establishing adequate cumulation clauses across these subregional groups would allow them to develop productive linkages and provide a first step for broader integration. In a second stage, once the Pacific Alliance and CAFTA are integrated into the bloc, new players should be invited, specifically Mercosur. This would pave the way for a broader, and more comprehensive, trade agreement of the Americas.
North America should invest in upgrading hard and soft trade infrastructure to better connect the Americas. Poorly integrated trade infrastructure in South America is considered one of the primary barriers to regional integration; deficits affect both physical infrastructure, such as ports and road transportation, as well as in trade facilitation with shortcomings in cross-border agency cooperation, single window creation, and information access for logistics processes. There is a persistent infrastructure investment gap in the region due to insufficient public spending that undermines development; South America invests less than 3 percent of its GDP on infrastructure, while in East and South Asia, countries invest more than 5 percent. It is almost more expensive to trade with neighboring countries in South America than it is to trade with the EU or Asia. Regionalizing supply chains should not mean expanding the time and cost associated with trade; instead, its advantages lie in curtailing these.
North America should lead workforce development to create capabilities for regional value chains. Having remained on the upstream margins of global value chains in recent decades, capabilities in midstream operations across the Americas are relatively stagnant, with only a few exceptions in countries close to North American production systems. Currently, labor force participation, productivity, and skills mismatching are problematic. This suggests a huge potential upside for skills programs. Workforce programs focused on engaging youth and women in global value chain manufacturing would draw new workers into the labor force without affecting labor costs; while anticipating skills, detecting mismatches, and linking education and training curriculums with industry’s needs would boost productivity. As a global leader, North America is well positioned to transfer these capabilities to its southern partners.
North America should prioritize the development of sustainable production chains in the region. Central and South America’s general absence from global manufacturing chains to date should be seen as an advantage for developing greener operations; there are only three countries in the Americas (US, Mexico, and Costa Rica) where manufacturing output accounts for more than 50 percent of exports. With few legacy plants, factories can be built with cutting-edge global sustainability standards. In terms of energy, a major pillar for manufacturing, the region is already a global leader in its transition to renewables, outperforming all other regions. Some countries—including Costa Rica, Uruguay, and Nicaragua—have radically shifted toward a fully renewable electrical grid; over the past decade, in these three countries renewables have reached 98 percent, 97 percent, and 75 percent of supply respectively, and more are on the path to doing so. As a leading market for global value chains, the US should provide the impetus for this green manufacturing by establishing cleaner production requirements for market access, as the EU has already done with its Green Deal Agenda. Greener global value chains will improve North America’s competitiveness in future global markets, where sustainable products will dominate.
The cost of successful regionalization is high financially, and it will take considerable economic vision and political will to achieve. However, inaction could mean risking North America’s leadership of the global economy, and squandering its competitive edge.
Penny Bamber and Karina Fernandez-Stark are senior fellows at the Duke Center for International Development and codirectors of TradeUpgrader. They are global value chain experts with more than 15 years’ experience leading numerous research projects related to economic development and competitiveness around the world. Their consulting is action-oriented, focused on leveraging academic research into tangible sustainable development outcomes, and advising policymakers around the world how to gain from trade.
Cover photo: US President Joe Biden, Mexican President Andres Manuel Lopez Obrador, and Canadian Prime Minister Justin Trudeau meet at the 10th North American Leaders' Summit at the National Palace in Mexico City, Tuesday, January 10, 2023. AP Photo/Andrew Harnik.