Do Preferential Trade Agreements Promote Growth? An Evaluation of the Caribbean Basin Economic Recovery Act

The few empirical studies which examine the effects of preferential trade liberalization on growth find no direct relationship between membership in a PTA and growth across countries. This is somewhat surprising, given the large literature which argues that trade liberalization is likely to encourage more rapid growth. However, sensitivity analysis has shown that this link between freer trade and growth may be indirect, as freer trade strongly increases investment, and higher investment strongly increases growth. This paper tests for both direct and indirect effects of preferential trade liberalization on growth and investment, by examining the impact of the Caribbean Basin Economic Recovery Act--a non-reciprocal PTA implemented by the U.S. in 1984 to encourage growth and development in Caribbean and Central American countries. A two-equation simultaneous system is estimated, using pooled data on twelve beneficiary countries, from 1970-1998. Results suggest that CBERA did not result in any "trade-induced investment-led growth." It may have had a direct impact on growth in the region, but the effect was small, and significant only when combined with trade and foreign exchange reforms on the part of the beneficiary countries themselves. However, preferential trade liberalization through the production-sharing program, and unilateral and regional trade reforms in beneficiary countries and in the US did lead to investment-led growth, and to higher growth directly, in the CBERA countries.