November 14, 2022

When it began its first steps decades ago, the globalization of production sought in the low cost of labor the determining factor for the location of industrial investments. It didn't take long for Asia to become the world's manufacturing destination. Sometime later, the rise in labor costs and the search to reduce dependence on supplies from China would come into play. These, together with geopolitical issues, would lead to a growing revisionism on industrial location.

Three new factors would be added to them. The first, and perhaps the most important, is the environmental agenda, which goal is to reduce the carbon footprint of products. It would not be an exaggeration to think that we are already witnessing the transition from the globalization of production determined by the cost of labor to the globalization of production determined by environmental impact. This issue particularly affects China. The second factor is associated with the war in Ukraine, which has generated major security fears, significantly increased energy prices and volatility, fueled cost inflation, and increased risks of energy insecurity.

The volatility of energy prices and supply is not expected to normalize in the short term, which will have important economic repercussions globally, but especially in Europe, which is highly exposed to the geopolitical agenda and depends on fossil energy imports from Russia. To meet its needs, Europe is reviving dirty power plants and delaying its carbon neutrality commitments. The third factor is the growing increase in energy consumption in industrial production due to technology. These factors are affecting the rates of return and even the economic viability of many industrial plants and are already leading multinational companies to reconsider global investment location strategies.

An immediate reaction to all this is the nearshoring policy, which advocates the transfer of industrial plants from China to friendly countries, with cheap labor and close to Western consumption centers. But it is "powershoring" that seems to best serve the present and, above all, future needs and interests of Western economies. Powershoring refers to the decentralization of production to countries that offer clean, safe, cheap and abundant energy and are close to consumption centers, in addition to other virtues to attract industrial investment.

Latin America and the Caribbean (LAC) meets many of the conditions of the powershoring economy. After all, the region is geographically close to North America and Europe, and several countries already have clean or mostly clean energy matrices, while others are walking the same path. In fact, the region in general has defined sustainability as a priority source of growth, taking as a starting point its enormous potential in hydraulic, solar and wind energy, in addition to the enormous potential for energy production from biomass, geothermal, biogas and biofuels.

Many countries have already developed policies to encourage the production of green hydrogen, which can benefit, during the transition, from the generous region's reserves of natural gas to blend the two gases, increase efficiency and reduce costs. Estimates indicate that the cost of a kilo of green hydrogen in LAC will be very competitive, a decisive element to transform the region into a platform for industrial production in general, but for energy-intensive products in particular, such as steel, pig iron, aluminum, glass, cement and cellulose, to mention just a few sectors. In addition to green, competitive and secure energy, the region also offers a wide variety of mineral and agricultural products for industrial use. And on top of all this is the region's estrangement from complex geopolitical issues.

There is no way that developed regions can significantly reduce their CO2 emissions without slowing down the growth rate of their economies, which could lead to an even slower and politically more costly energy transition. The need to prioritize energy use, the commitments to the Paris Agenda, the exposure of industrial production to geopolitical issues and the increase in costs, seem to underline the attractiveness of LAC for Europe as a partner for energy security and to accelerate the decarbonization, in addition to ensuring industrial supply security and reducing energy cost pressure. The eventual entry into force of the Carbon Border Adjustment Mechanism (CBAM) will be an additional attractive factor for European industrial investments in LAC.

But the benefits of powershoring are two-way. Industrial investments would have important positive repercussions in the urban areas of LAC, which is where the vast majority of the population, informality and poverty in the region are concentrated. In addition, it could benefit small and medium-sized companies, have substantial impacts on productivity and competitiveness, generate taxes, exports and foreign exchange, and help reduce the region's exposure to commodity cycles that so much frustrate economic, social and environmental indicators. Finally, it could also contribute to fueling regional integration. 

To implement a project like this, a roadmap that encourages foreign direct investment in powershoring will be needed. This should include consistent, coherent and solid policies and regulations for the promotion, financing and management of clean, safe and cheap energy, the development of quality projects, investments in physical and digital infrastructure to serve industrial zones and export logistics, promote investments in professional and industrial services, workers training, investment facilitation agreements, reduction of bureaucracy, legal certainty and a lot of institutionality. There should also be present the progress of the Mercosur-EU agreement and the support of national and multilateral development banks for the financing and reduction of risks and costs of the private projects of powershoring.

LAC and the EU already have a long history of alliances and shared visions that further justify the strengthening of the transatlantic relationship, which could take advantage of already successful experiences, such as the high stocks of direct investment that Europe already has in the region.

Finally, the high liquidity of the global markets and the search for new businesses and investment destinations are additional elements that lead us to bet that powershoring will be the hot ball in the coming years.

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Jorge Arbache
Jorge Arbache

Vicepresidente de Sector Privado, CAF -banco de desarrollo de América Latina y el Caribe-