production toward foreign markets depends on the initial share of exports in total production,<sup>32</sup> the slope of the exports demand curve, and the transformation elasticities between exports and domestic supply (CET elasticities).<sup>33</sup> As mentioned in section 5, the CET elasticities used in this paper are not particularly high, and the small country assumption ensures that Honduran producers face constant prices on the world market regardless of the volumes they desire to sell.<sup>34</sup> Therefore, the final changes in export volumes are determined largely by the export orientation of each sector and the increase in export prices due to tariff liberalization in the US. Not surprisingly, the largest gains by far are recorded in the textiles sector, which was the most highly protected sector in the US market (Table 4). However, the increase in the export volume of food, beverages, and tobacco—the only other sector facing significant protection in the US—is smaller than several others including bananas, coffee, wood, and mining. This is explained by the fact that all of these sectors are highly export-intensive (the shares of exports in total production are 57 percent and above); therefore, falling domestic prices combined with negligible levels of protection in the US and the EU encourage Honduran firms to re-allocate production toward foreign markets.

The effects on total production are consistent with the analysis of the previous two paragraphs. Rising export volume is enough to offset the market share losses due to increased imports in the majority of sectors. There are also important second-order effects, since producers are able to take advantage of lower prices of intermediate goods to become more competitive in domestic or export markets. For example, many sectors are aided by the gradual elimination of tariffs on petroleum and petroleum products. These second-order effects help explain why import volumes in sectors such as mining and livestock decline at the same time as import prices are falling.<sup>35</sup> This occurs because the cost savings through lower prices of intermediate goods allow domestic producers to become more competitive and increase market share even with lower levels of external protection. Finally, firms in expanding sectors also take advantage of resources (labor and capital) released by contracting import-competing sectors.<sup>36</sup> Overall, however, with the exception of several heavily export-oriented sectors, the changes in output are generally mild. In fact, total output rises by just 0.9 percent relative to _BaU_ , consistent with the macroeconomic results of the earlier section.

As before, the _CHN_ and _CUS_ columns decompose the total effect of bilateral tariff reform ( _CBL_ ) into its respective components. Under own liberalization, changes in import volumes are slightly smaller than under bilateral trade reform, which is largely due to slower income growth (disposable income grows by 4.17 percent per year as opposed to 4.19 percent average annual growth under _CBL_ ). Perhaps the most interesting aspect of _CHN_ is the changes in domestic production, which isolate the effects of import competition from the impact of changing export prices. In agriculture, where the import content of final demand is relatively low, changes in production volumes are similar to those recorded in the _CBL_ simulation. On the other hand, the volume of production in the much more import-competing manufacturing sector declines significantly relative to the _CBL_ scenario. Combined with the _CUS_ column, these results show that most of the DR-CAFTA production gains in the agricultural sectors come from lower prices of intermediate goods, while changes in production in manufacturing sectors occur largely due to the lowering of tariff barriers in the US. Since the latter decline only marginally, the overall effect on production in manufacturing

> 32This is also a measure of revealed comparative advantage of Honduran firms.

> 33More fundamentally, this response also depends on social and economic infrastructure and institutions, such as roads, ports, access to information and credit, marketing facilities, etc.

> 34Recall this does not apply to sugar destined for the United States because of the sugar quota.

> 35Note that these reductions are taking place from a very small base, since the import content of domestic demand in these sectors is extremely low (0.2 and 2.7 percent, respectively).

> 36This point will be discussed in more detail in section 6.4.

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