Prioritizing Nearshoring by Leveraging Special Economic Zones in Central America

Finding Alternatives to Mexico

Perhaps no other country was better positioned to benefit economically from the geopolitics of the last few years than Mexico. The Covid-19 pandemic, followed by the outbreak of war in Europe, has significantly hobbled supply chains and sent shockwaves through the global economy. The golden age of globalization, where economic efficiency trumped most other concerns, has given way to the need to secure supply chains and ensure timely delivery of critical products. Geopolitical considerations are pushing a realignment of the global investment landscape, with legislation before U.S. Congress potentially facilitating further movement in that direction. In other words, the future trajectory of supply chains looks less global and more regional. In fact, regional trade agreements establish the frameworks and rules for more than half the world’s trade.

Therefore, Mexico’s proximity to the United States, combined with a stable regulatory framework provided by the United States-Mexico-Canada Agreement, means that it should be reaping the benefits of nearshoring for the next decade or more. However, under three years of President Andrés Manuel López Obrador (also known as AMLO), the country’s overall economy has performed anemically. In fact, Mexico’s economy is the only one in Latin America that is still expected to be performing below pre-Covid-19 output levels by the end of 2022. Indeed, 1970s-style statism is ascendant in AMLO’s thinking, and his party’s espousal of import substitution theories and the president’s willingness to upend contracts and Mexico’s previous market-oriented reforms have imposed a steep cost on growth and economic trajectory.

For companies seeking to extricate their supply chains from China and relocate them to the Americas, Mexico’s economic woes have left them with few choices but to strongly consider the Northern Triangle countries of Central America as the most logical alternative. Like Mexico, most countries in Central America face similar structural economic challenges and difficult political environments. However, to obviate economic environments characterized by poor governance, corruption, and weak institutions, companies (and countries) should consider the many special economic zones (SEZs) and other special jurisdictions in Central America that mitigate the uncertainties of the overall economic environment. By permitting greater amounts of local autonomy, SEZs have the potential to represent spaces where institutions, respect for rule of law, and intellectual property rights can realize the value proposition of nearshoring under the auspices of another regional framework for trade: the Central American Free Trade Agreement (CAFTA-DR).

The Biden administration, as well as members of Congress, are eager to lubricate supply chain reorientation to the Americas. Indeed, without the economic growth and job generation that comes with it, the Biden administration has little chance of successfully implementing its “root causes” strategy to curtail migration. The administration needs to seriously consider SEZs and other special jurisdictions that serve as potential catalyzing environments for nearshoring. These innovative hubs can foment the safe deployment of private sector capital to move supply chains. Greater consideration of various types of SEZs would also give the Biden administration greater appreciation of the level of transparency these zones encourage in their dealings, which is key to curtailing the opacity that only serves to create opportunities for China and other nondemocratic competitors.

SEZs, ZEDEs, and Nearshoring

Innovative frameworks capable of providing legal and institutional security may make all the difference in accelerating nearshoring to the Americas. Thankfully, for those companies and countries looking beyond Mexico, the Northern Triangle contains a number of hubs capable of leveraging the region’s proximity and connectivity to the United States, as well as its market access through CAFTA-DR. One type of SEZ in Honduras, the Zones of Employment and Economic Development (ZEDEs), are SEZs that provide local administrators with a high degree of autonomy from national authorities. ZEDEs are geographic areas recognized and protected by Honduras’s constitution that permit autonomy for zone administrators to provide public services and efficient arbitration of legal proceedings in a way that helps address investor concerns about inefficiency and lack of predictability in Honduras’s macroeconomic environment more broadly.

Indeed, given that ZEDE operators are free to adopt their own tax codes and legal regimes within their borders, these zones start with a competitive edge in attracting private investment and, potentially, nearshoring of supply chains. Because ZEDEs can borrow from tax codes and legal regimes outside of traditional Honduran law, they can streamline business operations to a significant degree. By tailoring institutions and legal systems toward efficiency, cost-effectiveness, and even specific industry needs—borrowing from a plethora of countries, such as the United States, France, and Japan—ZEDEs offer a viable option for businesses seeking to reorient their supply chains to the Americas but are wary of the costs associated with doing so. The ZEDE framework may help some businesses build efficiencies and thereby defray the initial costs of extricating their supply chains from China. Innovative hubs that can catalyze supply chain relocation and mitigate company concerns should be welcomed by the Biden administration in its push to nearshore, ally-shore, and generally build greater regional competitiveness in North American and Central American markets. And while the ZEDEs have come under legislative fire in Honduras, they remain protected by robust legal stability agreements.

Nearshoring and the “Root Causes” Approach to Migration

The dire situation at the U.S. southern border elevates the urgency of generating jobs in Central America, partly through supply chain relocation. Annually, 407,000 people have fled the Northern Triangle region between 2018 and 2021. Following a short drop in 2020 due to the Covid-19 pandemic and deterrent factors such as Title 42, migration to the United States increased the following year. In 2021, U.S. Border Patrol agents apprehended a total of 684,000 migrants from the Northern Triangle, 309,000 of whom were from Honduras specifically. A new record was set in May 2022 with Customs and Border Patrol (CBP) stopping more than 223,000 migrants . In general, CBP has been apprehending well north of 200,000 people per month throughout the current fiscal year, putting it on pace to surpass two million encounters by the end of September, a number unseen since March 2020.

Many of these migrants are motivated by a range of factors, including deteriorating security conditions, natural disasters, food insecurity, draught, and too few economic opportunities. Economic prospects are bleak and too many of Central America’s industries remain concentrated in the hands of a tiny circle of wealthy elites. In Honduras, a youth bulge means that 42 percent of the country is under the age of 20— an especially problematic statistic for stemming migration flows, given that young people are highly mobile and likely to migrate. This increases the pressure on policymakers to create better paying jobs. Lacking strong economic prospects, Hondurans will be forced to seek work in the informal sector or seek employment abroad.

Since assuming office in 2021, Vice President Kamala Harris has been tasked with addressing the root causes of migration from Central America. In March 2021, Harris began her diplomatic efforts across Honduras, El Salvador, and Guatemala. The administration’s root causes strategy focuses on rebuilding civil society and engaging the private sector.

According to the Biden administration, the U.S. Agency for International Development (USAID) has been one of the largest providers of aid in the region. Its efforts in support of the private sector have contributed to more than 70,000 jobs across the Northern Triangle with a total of $415 million in sales in 2021. In addition to USAID’s efforts, the public-private entity, Partnership for Central America, has raised commitments of approximately $3.2 billion in private sector investments for Central America. For instance, Mastercard has promised to digitize one million small businesses across the region. Major clothing retailer Gap Inc. also announced a $150 million investment to relocate more of its supply chains to Central America.

Notwithstanding these positive announcements, significant headwinds remain. A $4 billion aid package the Biden administration requested for Central America remains stalled in Congress. Furthermore, concerns over corruption have soured the prospect of implementing more ambitious projects. Tensions over this issue have been building, with Vice President Harris traveling to the inauguration of Honduran president Xiomara Castro in January 2022 to affirm her commitment to the Biden administration’s root causes strategy. Most concerningly, many of the gains made over the past year are in danger of proving ephemeral unless the Biden administration works purposively to consolidate them with supply chain relocation that is permanent and capable of generating employment for decades to come. One-off, splashy investment announcements may be important to galvanize momentum but pale in comparison to long-term, durable reorientation of supply chains and a focus on increasing regional economic integration and competitiveness. Consolidating such gains would require a more long-term, strategic focus.

The Americas Partnership for Economic Prosperity

At the U.S.-hosted Summit of the Americas last month, the Biden administration unveiled its signature economic plan for Latin America and the Caribbean: The Americas Partnership for Economic Prosperity. Building largely on the existing architecture of U.S. trade deals in the region, the Americas Partnership emphasizes the need to make U.S. supply chains more resilient to external shocks. The document states the “importance of diversifying and rebalancing our supply chains to minimize disruption risks.” Fulfilling this goal and ensuring it dovetails with efforts to curb migration requires a heavy focus on the Northern Triangle countries of Central America. Furthermore, in the absence of a domestic political environment conducive to inking trade deals that expand market access around the world, the Biden administration appears reconciled to leveraging the United States’ existing regional frameworks to advance trade. This dovetails with approach to the vast majority of trade integration over the last few decades, which has been regional, not global, in nature.

Beyond vague statements, however, many of the stated goals of the Americas Partnership for Economic Prosperity remain limited in scope and detail. The Biden administration has promised to send negotiators to hash out more details later. In the meantime, Biden administration officials should examine where their efforts at nearshoring should be concentrated and consider SEZs and other types of special jurisdictions within countries that provide some of the best governance pillars for catalyzing growth. To compete effectively in the Americas, an environment long characterized by a mismatch in allotted resources to the region’s importance, the United States will have to leverage its existing trade architecture in the region with some of the region’s best economic architecture, including SEZs and special jurisdictions such as Honduras’s ZEDEs. As a recent CSIS commentary noted, the Americas Partnership for Economic Prosperity should be viewed as “an opening bid to go bigger.”

Policy Recommendations

In the absence of the creation of new free trade agreements and a desire to work within the existing trade architecture, Honduran ZEDEs represent existing economic mechanisms that the United States could utilize to nearshore supply chains. Thanks to the existence of CAFTA-DR, the Biden administration could leverage the power of SEZs and ZEDEs to think about stimulating economic growth in the region. ZEDEs could act as a tool through which important industries could be nearshored, all of which would be protected under the investor guarantees furnished by CAFTA-DR.

Growing geopolitical competition with China and snarled supply chains brought on by continued government lockdowns have reinvigorated calls for nearshoring. In February 2021, President Biden ordered a review of U.S. supply chain dependency in key industries such as defense and pharmaceuticals. The administration appears to be in the process of galvanizing and focusing some of its economic policies toward moving more supply chains into the Western Hemisphere. If these policies take hold and meet with success, it is most likely that companies will look to duplicate and create shorter, regionally based supply chains. The guiding theme is that regionalization is more important than globalization.

ZEDEs possess another advantage in the push to nearshore, which is that they do not have to pay export or import duties. This could permit them to become manufacturing hubs for supply chains previously located in Asia. Companies shifting operations to Honduran ZEDEs would also have the advantage of working inside a SEZ with lower labor costs than in neighboring Mexico. Finally, from a geographic standpoint, the Northern Triangle of Central America possesses similar advantages as Mexico given its proximity to the United States. Final goods would not have to be shipped long distances to be sold and the use of trucks as opposed to cargo ships could save time and money for companies.

The Biden administration should consider the current challenge to ZEDEs mounted by the Xiomara Castro government in Honduras as an unwelcome development that frustrates some of the United States’ critical nearshoring objectives. U.S. policymakers should also take advantage of the fact that another vote must occur for ZEDEs to be officially repealed, providing ample time to accelerate diplomatic and public outreach efforts on the importance of ZEDEs, SEZs, and other special jurisdictions in the effort to build economic growth and momentum in valuable supply chain reorientation. There is also an opportunity to apply the lessons learned from the Honduran experience with ZEDEs throughout Central America to build and strengthen other SEZs and accelerate nearshoring efforts in the other countries of the Northern Triangle.

Record levels of Honduran migrants arriving at the U.S. southern border and a rising China compound these challenges and provide a sense of urgency. Because they take advantage of the existing U.S. trade architecture (the Biden administration’s preference with the introduction of the Americas Partnership for Economic Prosperity), ZEDEs are well aligned with the administration’s stated objective of addressing the root causes of migration in Central America by generating private sector-led economic growth and job creation. Sizeable foreign investment can be created through ZEDEs and special jurisdictions in a way that would be mutually beneficial to all the countries in the region.

Ryan C. Berg is senior fellow in the Americas Program and head of the Future of Venezuela Initiative at the Center for Strategic and International Studies in Washington, D.C. Matthew Carusi is an intern with the CSIS Americas Program.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2022 by the Center for Strategic and International Studies. All rights reserved.

Matthew Carusi

Intern, Americas Program