_I_<sup>_subBaU_.Thisresultisnotparticularlysurprisingsinceproductionvolumechangesinthis</sup> _BL_<sup>and</sup> scenario are much more muted than in the simulations considered above, which leads to lower labor demand and less upward pressure on wages. The decline in the foreign capital rental rate is more pronounced than in the _IBL_ scenario (again due to lower production and demand), while returns to domestic capital rise significantly.

In the _IML_ scenario, production volumes of both agriculture and manufacturing rise relative to _IBL_ , although additional gains in manufacturing output (68 percent) are much larger than in agriculture (16 percent). As a result, growth in non-farm wages accelerates. The most noticeable difference is a more than doubling of the growth rate of farm wages, which occurs due to the fact that production of domestic crops is no longer falling. At the economy-wide level, the biggest winners in this scenario (relative to _BaU_ ) are still tertiary-skilled workers, although the second place now goes to unskilled labor.

In the _I_<sup>_λL_growthineconomy-widewagesisonlymarginallyfasterthaninthe</sup> _BL_<sup>simulation,</sup> _IBL_ scenario. This result is an outcome of two factors. On the one hand, workers are paid their marginal product and therefore increased productivity raises labor earnings. On the other hand, less workers are needed for any given increase in output, which reduces growth in labor demand. This can be seen in the behavior of capital rental rates, which grow faster (or decline slower) in this simulation relative to _IBL_ . Since labor productivity in agriculture remains unchanged, labor demand in the farm sectors rises relative to others, which explains the faster growth in farm wages. However, since growth in non-farm wages also accelerates, migration remains the same as in the _IBL_ scenario.

# **8 Conclusions**

The negotiations on DR-CAFTA were started with high expectations for the ability of the agreement to help the developing country members transition from a decade of poor growth performance to sustained improvements in income and welfare. In order to assess the likelihood of these positive developments, this paper has analyzed the likely patterns of adjustments to DR-CAFTA for Honduras with a dynamic CGE model. Several key messages emerge from the analysis. First, the welfare gains from bilateral tariff reform with the US are likely to be very modest, less than 0.1 percent of GDP. This is due to the fact that very little additional market opening takes place in the US, while Honduran producers face increased import competition and the government must make up the budgetary shortfall from lower tariff revenues by raising taxes or limiting spending. These welfare gains are much smaller than the estimates reported in the previous studies, which range from 0.5 to 4.5 percent of GDP. One of the reasons for smaller welfare gains in this paper is the use of much more recent (2004 vs. 2001 or 1997) tariff data, which means that the marginal reduction in protection considered in this paper is considerably lower than what the earlier literature used. Furthermore, the gains estimated in this paper are specific to Honduras, rather than the Central America average considered in the previous studies. In addition, rather than removing all protection at once, the modeling approach in this paper takes into account the gradual phase-in of tariff reductions as well as product exclusions and the different reduction schedules by sector (agriculture vs. manufacturing). Finally, we do not consider the implications of the liberalization of trade in services, which could potentially lead to larger gains, due to difficulties in quantifying service barriers.

The second message is that bilateral tariff reform favors agricultural producers of export crops, while manufacturing output rises less and production of domestic-oriented agriculture actually 43