Covid-19 and an Economic Disruption
Covid-19 has caused major disruptions to the global economy and international trade flows. Dropping productivity associated with the pandemic is projected to drag GDP growth in developed countries to -5 percent over the course of 2020. This staggering loss will wipe out four years of a steady growth in productivity. As countries reel from the economic downturn, they are turning inward: global trade fell 3 percent during the first quarter of 2020, and the United Nations’ trade body expects a 27 percent quarter-on-quarter decline for the second quarter. The longer the pandemic persists, the longer domestic economies will stall and the more international exchange will fade.
Covid-19 poses particularly significant dangers for Central America. The pandemic may cause up to a 5.2 percent economic contraction across Latin America and the Caribbean—the greatest in the region’s history. Over the past several weeks, Latin America has become the epicenter of the global pandemic, and economic projections could continue to darken accordingly.
The process of economic rebuilding that must follow the pandemic could offer growth opportunities for Latin American manufacturers, particularly in the textile sector. Before the situation improves, however, it may worsen.
Structural challenges could especially trouble the Northern Triangle countries (NTC)—El Salvador, Guatemala, and Honduras—which feature some of Latin America’s smallest economies and which will become less productive in 2020. Informal employment in NTC economies is over 70 percent, and Latin America’s informal laborers are expected to lose 81 percent of their incomes due to Covid-19. Their livelihoods, which are made outside of formal administrative systems, will prove difficult to support during recovery.
NTC domestic woes will be exacerbated by likely slowdowns in remittances, which primarily come from the United States. In 2018, remittances comprised over 20 percent of GDP in El Salvador and Honduras and 12 percent of Guatemala’s GDP. Today, however, as foreign nationals struggle abroad—jobless rates among Hispanics in the United States reached 20 percent in April—remittances to Latin America are expected to fall sharply. In El Salvador, remittances dropped 40 percent in April 2020 compared to April 2019.
These economic developments could be politically disruptive. In Mexico, depressed GDP per capita, which can be driven by joblessness and by interrupted remittance flows, has been linked to intense emigratory flows; El Salvador has previously seen similar migratory shifts driven by reduced cross-border exchange. The United States considers controlled, stable migration across Central America a national security interest, and it has pressured the NTC to directly address and resolve migratory push factors. A spike in migration to the United States associated with Covid-19 could alienate NTC governments from the United States given U.S. policy priorities.
A chillier U.S.-NTC relationship could set back social and political progress across Latin America and in the United States. Over the past several years, the NTC made substantial headway addressing migratory push factors, including violence and poverty, in partnership with the United States under the Alliance for Prosperity. Going forward, the recently launched América Crece initiative looks promising. Were such internationally collaborative programs drawn back, conditions in the NTC could worsen. Northward migration could ramp up in response to re-intensification of push factors.
As Covid-19 persists, Latin American countries, and the NTC in particular, need economic lifelines.
Central American Textile Sectors Are Vibrant
Robust textile industries could serve as lifelines. Despite their economic vulnerabilities, the NTC are textile powerhouses. In 2016, the Honduran government targeted the textile industry for expansion, aiming to raise employment in the sector from 150,000 to 350,000. In El Salvador, the textile sector, also targeted for growth, employs 75,000 workers directly (nearly one-half of the country’s 2015 industrial labor force) and 200,000 indirectly. In Guatemala, textile makers employ over 100,000, produce 8.9 percent of GDP, and have proven more resilient than other industrial manufacturers.
Textile industries benefit from the Dominican Republic-Central America Free Trade Agreement (CAFTA-DR), which was signed in 2004. Under this agreement, trade between the United States and the NTC is not subject to tariffs—and it has thrived. In 2018, the NTC collectively sent over $6.3 billion of textiles to the U.S. market and were among the United States’ leading suppliers. These countries are fully committed to trade in textiles, which make up more than one-half of exports from Honduras and El Salvador, and over one-third of Guatemalan exports, to the United States.
Encouragingly, exchange in textiles has been on an upward trajectory. A comparison of yearly figures shows the textile trade with the United States grew over the course of 2018 by about 9 percent in Guatemala, 5 percent in Honduras, and 2 percent in El Salvador.
Rethinking Economic Resilience
U.S.-NTC exchange aside, China is the world’s largest textile producer and exporter, and it is an increasingly significant trading partner for the Northern Triangle. China is Honduras and Guatemala’s second-largest trading partner in textiles (after the United States), and it is El Salvador’s third-largest trading partner in total. Over the past eight years, China has seen the greatest growth as a market of origin for NTC textile industries. China is also the United States’ leading supplier of textiles. However, while these trans-Pacific economic ties are strong, they may not be reliable in the long term.
Covid-19 has exposed vulnerabilities inherent to global supply chains. In early 2020, as the pandemic closed factories across China, U.S. firms’ access to Chinese materials was disrupted, and they began to suffer supply shocks before the virus had even reached their shores. Demand shocks soon followed as consumers panic-bought products like toilet paper faster than manufacturers could keep up. As Covid-19 eventually subsides, demand shocks may reverberate back up the supply chain: the bullwhip effect occurs when manufacturers over-compensate for demand shocks and continue to supply out of step with consumption patterns. Today’s producers and consumers are subject to different local conditions, public health and otherwise, which can make it difficult for markets to maintain equilibrium, particularly during force majeure crises.
The global textile industry is a case in point. Since Covid-19 began, the Chinese textile industry has been in disarray. Chinese factory closures and layoffs initially had international customers scrambling to identify new suppliers. As China reopens, constrained international demand places pressure on textile suppliers, many of which may fold. Doubts abound regarding the future of global production networks.
As they grapple with this uncertainty, U.S. firms are rethinking supply chains. In a recent survey, 64 percent of North American manufacturing and industrial firms said they are likely to bring production back to North America following the pandemic, investing in supply chain resilience. Such investments are valuable to the firms that make them, as flexible and resilient supply chains can improve customer satisfaction, cut costs, and accelerate growth.
While Covid-19 has escalated the urgency of returning U.S. firms’ supply chains to the Americas, these moves may have happened even without the pandemic. U.S.-China economic relations have been turbulent in recent years; the trade war and associated tariffs have dampened trans-Pacific trade with negative implications for the U.S. economic outlook. Even prior to Covid-19, U.S. firms were rethinking their ties to China.
The perfect storm for reorienting and nearshoring U.S. international commerce is upon us. CAFTA-DR, reflections on supply chain resilience, and a rethinking of U.S.-China economic ties position NTC textile industries as a lucrative alternative to China. The United States should seize this chance to relocate commerce to the Northern Triangle, driving long-term regional economic stability and resilience.
Importantly, while re-centering U.S. supply chains in the Americas would be a positive for multinational firms, it would be transformative for Latin America. Moving even $1 billion of U.S. trade with China to the Northern Triangle could create hundreds of thousands of manufacturing jobs for workers currently seeing economic opportunities fade and considering departures from the region. By directing investment south of its border, the United States can protect its own businesses while turning the prosperity associated with the American Dream into a Pan-American reality.
Originally published on csis.org.