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Abstract
In this paper we develop a dynamic CGE model to examine the impact of CAFTA on production,
employment and poverty in Honduras. We model four aspects of the agreement: tariff reductions, quotas,
changes in the rules of origin for maquila and more generous treatment of foreign investment. We first
show that trade liberalization under CAFTA has a positive effect on growth, employment and poverty but
the effect is small. What really matters for Honduras is the assembly (maquila) industry. CAFTA
liberalized the rules of origin for imports into this industry. That raises the growth rate of output by 1.4%
and reduces poverty by 11% in 2020 relative to what it would otherwise have been. Increasing capital
formation through an increase in foreign investment in response to CAFTA has an even larger impact on
growth, employment and poverty.
These simulations say something important about the growth process in a country like Honduras
in which it seems reasonable to assume that there is underemployed, unskilled labor willing and able to
work more at a fixed real wage. In such an economy changing the structure of demand in favor of sectors
that use a lot of unskilled labor will have a big impact on growth. That is what the maquila simulation
does, because maquila uses a lot of unskilled labor relative to skilled labor and capital. Alternatively the
supply of capital can be increased by increasing the rate of capital formation. Either of these two has a far
larger impact on growth and poverty than tariff reductions alone.