Unlocking Trade Potential: Building Resilience in LAC Amid Global Economic Fragmentation

The IMF study explores Latin America and the Caribbean's lagging trade integration, highlighting infrastructure deficits, reliance on commodities, and limited regional cooperation as barriers. Addressing these challenges could boost trade, enhance resilience to global fragmentation, and position the region for sustainable growth.

A study authored by Rafael Machado Parente and Flavien Moreau under the International Monetary Fund’s Western Hemisphere Department delves into the complexities of LAC’s trade performance in an evolving global landscape. Despite strides in trade openness over the years, LAC remains behind other emerging markets and developing economies (EMDEs). While trade in goods and services grew from 30% of GDP in 1995 to 47% in 2019, this lags significantly behind regions like East Asia or Europe. The region’s reliance on commodities, limited diversification, and infrastructural deficits have kept its trade potential constrained. Compounding these issues, LAC’s integration into global value chains (GVCs) remains minimal, with China emerging as a dominant trading partner alongside the United States and Europe. However, LAC’s trade responsiveness to tariff reductions is lower than that of other EMDEs due to structural challenges like the predominance of commodities with inelastic demand and production constraints.

Infrastructure: The Missing Key to Trade Growth

The study identifies infrastructure as a cornerstone for LAC’s trade potential. Closing half of the infrastructure gap with advanced economies could raise exports by 30% and boost output by 7%. The authors emphasize that both physical and customs-related infrastructure improvements are essential to reducing trade costs. While countries like Brazil, Mexico, and Chile have made significant investments, a considerable gap remains, limiting the region’s competitiveness. LAC’s intra-regional trade accounts for only 14% of total goods trade, far below regions such as Europe or East Asia, and its share of global services trade has stagnated at 15% since the 1990s. Regulatory barriers in the services sector, including licensing restrictions and limitations on foreign professionals, further hinder growth. Improving customs efficiency, streamlining trade procedures, and adopting digital technologies could significantly enhance trade integration without requiring large-scale investments.

Rising Geopolitical Tensions and the Threat of Fragmentation

The paper highlights the growing risks of trade fragmentation, driven by geopolitical tensions, particularly between the US, China, and Russia. In mild scenarios, where trade disruptions are limited to specific sectors or regions, LAC’s low integration into GVCs provides some insulation. In such cases, the region might even benefit from trade diversion, as global supply chains adjust to bypass disrupted routes. However, in extreme fragmentation scenarios, where trade splits into competing blocs, LAC faces substantial risks. Most countries in the region rely heavily on both the US and China as trading partners, and aligning with one bloc at the expense of the other would disrupt critical trade relationships. Additionally, if neighboring countries join opposing blocs, intra-regional trade could suffer, further weakening economic resilience.

Investment Challenges in a Fragmented World

Investment dynamics represent a key vulnerability for LAC in a fragmented trade environment. The region’s reliance on imported capital goods, particularly from Asia, exposes it to higher costs in the event of increased trade barriers. Using a dynamic trade model, the authors estimate that extreme fragmentation could reduce investment rates in LAC’s largest economies, such as Brazil and Mexico, by 2% to 5%. These declines in investment would amplify output losses and constrain economic growth. The disruption of access to affordable capital goods, coupled with policy uncertainty, could significantly weaken the region’s ability to attract foreign direct investment (FDI) and modernize its industries. The paper stresses that maintaining open trade channels and reducing reliance on single-source imports is critical to mitigating these risks.

A Path Toward Resilience and Sustainable Growth

To counter the risks of fragmentation and unlock its trade potential, LAC needs a comprehensive strategy focused on regional integration and infrastructure development. Strengthening intra-regional trade could help diversify economic dependencies and position the region to better navigate a fragmented global trade environment. Investments in transport and logistics infrastructure, combined with digitized and streamlined customs processes, are critical for reducing trade costs and enhancing competitiveness. Public-private partnerships and targeted fiscal policies can help fund these initiatives without placing undue strain on public finances. Additionally, harmonizing trade regulations across the region could foster greater cooperation and reduce barriers to services trade.

Environmental considerations are also becoming central to trade policy, and LAC must adapt to new frameworks like carbon border adjustments. As global trade increasingly intertwines with climate objectives, the region’s vast reserves of critical minerals, such as lithium and copper, present opportunities for sustainable growth. By adopting policies that balance environmental sustainability with economic development, LAC can position itself as a key player in the global green transition.

Bridging Gaps for a Competitive Future

The study provides a clear roadmap for LAC to enhance its trade integration and resilience. Addressing infrastructure deficits, reducing non-tariff barriers, and strengthening regional cooperation are pivotal steps toward unlocking the region’s economic potential. At the same time, preparing for the risks of global trade fragmentation by fostering intra-regional trade and securing access to diversified markets will be critical. By aligning trade and investment policies with global trends, such as digitalization and sustainability, LAC can overcome its structural challenges and achieve long-term growth. The authors emphasize that a predictable and cooperative multilateral trade framework will be essential to ensuring the region’s competitiveness in a rapidly changing world.