Analysis of the impact of dollarization and CAFTA-DR on El Salvador's trade flows

In January of 2001, El Salvador adopted the U.S. dollar as its currency, going through a full dollarization process that fixed the exchange rate at 8.75 colones (El Salvador’s former currency) per U.S. dollar and that took the colón out of circulation. Dollarization was expected to increase trade and attract international investment among other benefits. Later, in 2005, El Salvador signed CAFTA-DR which is a bilateral trade agreement between the United States and five Central American countries and the Dominican Republic. CAFTA-DR was also expected to increase trade, especially exports to the United States, El Salvador’s main commercial partner. Although several studies were conducted to evaluate the potential benefits of these two events on El Salvador’s Trade flows, studies evaluating the actual impact of these events are very limited. To evaluate the actual impact of these two events on trade flows we estimate two gravity models (one for imports and one for exports) using panel data on trade flows between El Salvador and 13 other countries between 1994 to 2012. Our preliminary results suggest that dollarization and CAFTA-DR did not have a major effect on El Salvador’s bilateral trade.