# **1. Introduction**

Within the next four years, the output capacity of the Panama Canal will roughly double as a new set of locks is installed, enabling ships larger than the current Panamax standard to transit the Canal. Several studies (ACP, 2006a; IMF, 2007) anticipate significant employment creation and growth effects of the Canal expansion through increased domestic resource utilization and large multiplier effects. This view, however, is not consistent with the long-standing characterization of Panama as a dual economy, where a dynamic services exports sector has few linkages with the rest of the economy. More importantly, the methodology of these studies cannot provide insights into the potential distributional consequences of the Canal expansion—an aspect of crucial importance in Panama where inequality is a serious concern.

This paper adopts a methodological framework that is focused on the likely effects of the Canal expansion on the distribution of income . The findings of the paper are obtained by linking a dynamic computational general equilibrium (CGE) model of Panama with a micro-simulation framework based on a recent Panamanian household survey. The objective of the simulations is to contrast the counterfactual income distribution that would have resulted in the absence of the Canal expansion project with the income distribution resulting from the Canal expansion during both the construction and operation phases. Compared to earlier studies, this framework is much less suited for comprehensive growth analysis, especially in the near to medium term; on the other hand, it has the advantages of explicitly recognizing the inter-sectoral linkages in Panama‘s economy, clearly identifying the income sources of households, and providing a direct mapping of changes in macroeconomic aggregates to household welfare. Thus, it is important to interpret the results of this paper not as forecasts, but as a consistent set of scenarios for the likely poverty and inequality consequences of the Canal expansion.

The paper is organized as follows. The next section discusses the data and presents some background information on Panama and the Canal shock. Section 3 summarizes the model framework, while section 4 discusses the macro and micro results of our simulations. Section 5 offers concluding remarks.

# **2. Background**

## **_2.1. Panama before the Canal Expansion_**

Panama has been often characterized as a dual economy, consisting of a dynamic, high-wage export-oriented segment and a rigid, low-earning domestic-oriented segment.<sup>1</sup> Service sectors dominate Panama‘s economy, accounting for 77 percent of total value

> 1 The data used in this exercise come from an updated 2003 Social Accounting Matrix (SAM) for Panama as well as two Encuesta de Condiciones de Vida (ECV) Panama household surveys for 1997 and 2003. The SAM has been constructed specifically for the purposes of this paper, with particular attention devoted to the identification of labor and capital remuneration in both formal and informal activities (Annex 1). Furthermore, considerable efforts have been devoted to improving consistency between macro (SAM) and micro (survey) data, although a full reconciliation of the two data sources remains beyond the scope of this paper. The SAM data is summarized in the table presented in Annex 1, which shows the structure of final demand and value added at the level of SAM accounts.

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