Evaluating the impact of trade agreement for Central America: Does trade integration improve poverty and inequality?

In recent years, trade and poverty have received enormous attention in Latin America and elsewhere. In Central America, this issue was culminated in the CAFTA negotiations and its subsequent ratification processes. Despite impressive achievements in the external fronts in the 1990s, the speed of improvement in poverty has been slow. High and persistent inequality remained unchanged. Central America is now engaged in the negotiations of a biregional trade agreement with the European Union. This study evaluates the impact of this trade agreement. We apply a sequential, top-down, CGE-microsimulation approach. The simulation results show that the agreement will be a favorable option. It is welfare-improving and unambiguously expansionary. Agriculture and agro-industries will be big winners. Central American will strengthen their comparative advantage in agriculture. But the agreement has little effects in enhancing export diversification of manufactured sectors, changing the economic structure and strengthening technology-intensive industries. The microsimulation analysis shows the agreement will have pro-poor and, to a lesser extent, pro-equality effects. Income generation process via labor market is the determinant factor to reduce poverty. Trade agreement will generate the positive impact on labor market for low- and semi-skilled workers—employment creation, wages increases or both. The aggregate inequality declines but, may not necessarily fall in all regions. In coordination with other domestic policies, Central America should well consider liberalization process in agriculture, which will be the focal point of the negotiations. Improved market access is the key of making trade work. But, export growth does not necessarily guarantee to reduce poverty. Lessons from CAFTA process should be fully capitalized. When all of these work, trade will play as a powerful catalyst for poverty reduction, and the agreement will truly give a window of opportunities for the bloc.