Free trade in developing countries : What are the predictable long run effects of an implementation of the CAFTA for the different sectors of the Nicaraguan economy?

Abstract: Ever since the planning stage of the North American Free Trade Agreement (NAFTA) in the eighties there has been an incentive to create a free trade agreement with all the American countries. The next natural step for the USA has been the Central American Free Trade Agreement (CAFTA). This is a very controversial experiment as it is the first free trade agreement of this dignity between countries with such immense economic differences. This thesis will investigate how the CAFTA will affect the different economic sectors of Nicaragua. The studied sectors are the agriculture, the assembly industry and the micro, small, and medium businesses in the informal sector. To answer this question interviews have been made with representatives from the different sectors. The material obtained from the interviews have been than analysed with reference to theories about free trade, specialization, factor mobility and growth, together with information about the experiences from Mexico with the NAFTA. The results show that Nicaragua will have comparative advantages in some products in the agriculture sector but most likely the agricultural sector will decline. The assembly industry will grow as a result of an increase in FDI but there will not be any important technological transfers. The micro, small, and medium businesses are more orientated to the local market and will not be directly affected. The institutions play in important role en process of re-allocating resources from declining sectors to expanding ones and adapting policies to attract FDI. If they are successful than the expanding sectors will absorb the freed labor from the declining ones, this would raise salaries which in turn would raise internal demand positively affecting the micro-, small-, medium businesses. If the institutions fail to help in the re-allocation process than all the freed labor won’t be absorbed by the expanding sectors leaving them with no other option than to migrate to the cities and join the informal sector or to emigrate to Costa Rica or USA. This would leave the country worse off.