direct tax revenues, which are obtained via a small increase in the household income tax rate.<sup>19</sup> This increase explains why per capita income accelerates less than real GDP (Table 3) during the construction phase, although the poverty impacts are likely to be very mild due to the small aggregate magnitude of the change.

What about the operation phase? According to the background studies of the Panama Canal Authority, the expanded canal becomes operational in 2015. At this date in the simulation model, the capital stock as well as the output of the canal sector more than double. Current available projections indicate that there will be enough demand for the expanded Canal but much less is known about the price elasticity of this demand.<sup>20</sup> In this particular market, Panama clearly operates in a monopolistic position which is reflected by a downward sloping world demand curve for the Canal services. However, from one year to the next, demand also shifts outward following the increasing trend of global trade. Depending on the relative sizes of the price elasticity of the demand for canal services and the outwards shifts of this demand curve, the dynamic path of the canal fees will be either growing or decreasing. Statistics on the recent years show that Panama has been able to raise the transit fees without affecting demand (see Latin Source, May 20, 2007) and the current simulation assumes that this trend continues in the future even with an expanded canal.

A major consequence of the new locks coming online is the acceleration in the yearly growth rate of real GDP to 3.7 percent from 3.1 percent in the BaU scenario. There are two major reasons for faster income growth during the operation phase. The first reason is the now larger (Canal sector-specific) capital stock, which raises the factor endowment of Panama and generates new income through higher Canal capacity and increased fees. The second reason is a boost in total factor productivity, which occurs as workers move from lower-productivity (and lower-paying) occupations into the canal sector, where both productivity and wages are high (Table 1). Furthermore, additional income growth generates more demand for manufactured goods and services (relative to agriculture) and encourages worker migration into non-farm occupations where productivity tends to be higher.

The Canal sector is skill intensive and the additional demand for skilled workers resulting from its expanded operation generates a significant increase in their wages (see Table 4). The Canal sector can afford to pay higher wages because higher wage costs are passed on to higher Canal fees with low or no effect on revenues. Higher skilled wages generate labor income gains which in turn increase domestic demand and benefit all workers.<sup>21</sup> For these reasons, wages of unskilled workers also rise, but the rate of increase in the earnings of unskilled employees falls short of the acceleration in skilled wages. As a result, the skill premium widens from 329 percent in 2020 under the BaU conditions to 360 percent in the same year in the Canal scenario. Even before moving to micro analysis, these results already indicate that the growth dividends of the Canal operation

> 19 For example, the 2014 direct tax rate rises from 8.82 percent in the BaU to 8.85 percent in the Canal scenario.

> 20 See Panama Canal Authority study ACP (2006a, b) and IMF (2007).

> 21 Notice that workers in the Canal sector enjoy a large exogenous premium vis-à-vis the other sectors. Increased employment in the Canal and rising wages thus combine to produce a very significant gain of labor incomes for the household sector.

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