The Park Place Economist

Volume 5 Issue 1 Article 17

4-1997

Ecuador : Potential Policies for the Future

Jeremy Cunningham '97

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Recommended Citation Cunningham '97, Jeremy (1997) " : Potential Policies for the Future," The Park Place Economist: Vol. 5 Available at: https://digitalcommons.iwu.edu/parkplace/vol5/iss1/17

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Abstract In 1531 Spanish explorers embarked from Peru and landed in what is now modem day Ecuador. Peru was "the richest of the New World prizes won for the Spanish crown" (Ecuador, 1991), but the Spanish wanted to find more colonies to plunder. Drunk with tales ofgreat riches in Ecuador, King Charles I of Spain decided to send an explorer by the name of Francisco Pizzaro to investigate. Pizzaro and his men killed thousands of Inca tribesmen; they also looted and. pillaged everything that they could find. By the early 154Os, the whole ofwhat is now Ecuador was under Spanish control.

This article is available in The Park Place Economist: https://digitalcommons.iwu.edu/parkplace/vol5/iss1/17 Ecuador: Potential Policies for the Future

Jeremy Cunningham

The body ofthis paper will consist ofthe many Indians were forced to work for years to following three parts: an introduction, a pay back their debts. Effectively, this was progress report, and a set of policy slavery. There were "real" slaves in Ecuador recommendations. The introduction will at this time, but to own them was far more introduce the . The expensive than using mila labor. progress report will be devoted to painting an When Napoleon deposed King Ferdinand accurate picture of modem day Ecuador. of Spain and placed Joseph Bonaparte on the Current policies will be addressed as well as throne, many Spanish colonies in South current economic and social indicators. The America protested. In 1809, the first third section of this report is concerned with rebellions started in Ecuador. These early policy suggestions for Ecuador to follow in rebellions were savagely put down by order to develop ·at a stable pace. Bonaparte's forces. Over the next 13 years Ecuador struggled for independence. Little I. INTRODUCTION success was had by the poorly trained and equipped Ecuadorian rebels until the early In 1531 Spanish explorers embarked from 1820s. It was at that time that the two great Peru and landed in what is now modem day armies of Bolivar and San Martin were Ecuador. Peru was "the richest of the New systematically emancipating various Spanish World prizes won for the Spanish crown" colonies. Bolivar from Venezuela and San (Ecuador, 1991), but the Spanish wanted to Martin from Argentina aided the Ecuadorians find more colonies to plunder. Drunk with in their struggles for independence. On May tales ofgreat riches in Ecuador, King Charles 24, 1822, Ecuador had its sovereignty. I of Spain decided to send an explorer by the The history of free Ecuador has been name of Francisco Pizzaro to investigate. anything but tranquil since that day in 1822. Pizzaro and his men killed thousands of Inca There have been 86 different governments in tribesmen; they also looted and. pillaged control since 1822, and there have been 17 everything that they could find. By the early different constitutions drawn up. There have 154Os, the whole ofwhat is now Ecuador was been periods ofextreme economic boom and under Spanish control. times ofgreat hardship. Border disputes and The Spanish government established a the occasional armed coup have added to the feudal system that placed the Spanish as the tunnoil that has engulfed Ecuador over the last elite land owners and the natives as the 174 years. working class. A system known as mila was established. Under this system, "all able­ n. MODERN-DAY ECUADOR bodied free Indians were required to devote one year of their labor to some public or A. Economics private Spanish concern" (Ecuador, 1991). The Ecuadorian economy faces three These Indians were paid so poorly that they problems that seem ubiquitous in developing incurred large debts to their employers in order countries around the globe. These are chronic to survive. The Indians were not allowed to inflation, an often devalued , and leave the mita until all the debts were paid, so monstrous international debt. It is difficult to

48 Cunningham

0.0%~""""'"""~"" 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 Year , .

Figure 1 : Annual Inflation

Year

Figure 2: Annual Sucre / Exchange Rate The Park Place Economist, v. 5

say which causes the other, but they are entire GNP in 1986 (World Tables, 1995). definitely related. Inflation averaged 47.5% This problem has only gotten worse over time between 1984 and 1994 (World Development because Ecuador continues to be basically a Report, 1996). To make matters worse, the monocrop economy with half of its export rise in inflation has not been marked by steady revenue coming from oil (Ecuador, 1991). As gains, but by violent shifts. Figure 1 shows the debt service grew, oil prices fell, and the wild ride that the Ecuadorian economy has government continued to devalue the currency. endured. Figure 2 shows how the Ecuadorian This further fed the inflation monster. As has compared to the US dollar since inflation grew in Ecuador, foreign goods 1973. The sucre was pegged at 25 per dollar looked more affordable to the common citizen. for most ofthe 1970s. The government could When Ecuadorians wanted foreign goods, the afford to peg and defend the sucre because Ecuadorian government had to buy these Ecuador had enough foreign currency from foreign goods with foreign currency. The profitable oil sales on the world market to fight increase in demand for foreign currency and offany speculation. When the price ofoil fell decrease in demand for the Ecuadorian sucre in the 1980s, Ecuador found itself no longer caused the "real" price (the market price that able to defend its currency and was forced to would prevail ifthe sucre were not pegged) of devalue it. What followed was a series of the sucre to decrease. Since the sucre was devaluations. For a period in the .1980s, the pegged, it could not fall right away, but the Ecuadorian government abandoned having a foreign currency reserves of Ecuador were fixed exchange rate all together. This caused decreased in order to defend its currency. the value ofthe sucre to drop even further and Eventually, Ecuador had to devalue its helped inflation reach nearly 80 percent (see currency because it could not fight the market Figure 1). While all of this was happening, forever. This c~sed increased inflation, Ecuador was doing its part to add to the debt higher international debt, and the vicious circle crisis of the 1980s. In the 1970s and early continued. 1980s, Ecuador had borrowed heavily from By the earIy 199Os, Ecuador's government around the world. Ecuador, like several decided to try to stop this downward spiral developing countries, was using some of its and control inflation by once again pegging money for capital investment and some for the sucre to the dollar. They adopted what is current spending. Though the lenders were called a crawling peg. This means that the unhappy about this, it was hard for the devaluations are planned and in small Ecuadorian government to justify building and increments. The Ecuadorian government buying capital and infrastructure while its understood that they could not defend the population was hungry. Before the sucre for a very long period oftime, otherwise aforementioned drop in oil prices hit in 1986, the entire crisis of the 19805 would reoccur. 14% of Ecuador's entire GNP was from oil While the current devaluations are still painful, sales (Ecuador, 1991). Oil accounted for over they are not nearly as lethal as the devaluations 60% of all of Ecuador's exports (Ecuador, of the 1980s. The government is not 1991). In 1987, after the price" drop and spending huge sums of foreign reserves on despite an increase in production, oil was only defending the sucre; the central government 8% of GNP. This loss in export revenue, simply devalues soon after it is apparent that a coupled with skyrocketing world inflation that devaluation is needed. This causes inflation, forced the interest rates to rise on Ecuador's but it is planned and stable inflation. With a international loans, caused the net present more stable economy, the Ecuadorian value of their external debt to be SOOA» of the government has started to tighten money

50 Cunningham

Year

Figure 3: Annual Percent Change in GNP supply and reign in inflation (see the last 3 manufacturing subset in parentheses, was 38% years on Figure 1). The hope is that with (1 8%) in 1980 and, similarly, 38% (21%) in more controllable inflation, the "real" value of 1994 (World Development Report, 1996). the sucre will stabii and the international More industry must be developed and less debt will diminish. Ecuador has also dependence on oil must transpire for stable restructured its loans so that debt servicing is growth to occur. Not that GNP has declined. not such a burden on the economy. Debt Overall the GNP is higher now than it was 20 servicing fell fiom 35% of exports in 1980 to years ago. The problem is that the last 20 years 22% in 1994 (World Development Re*, have been marred by violent swings in the 19%). It is fhr too early to tell if these policies GNP, as shown in Figure 3. W1th this much will-work, but they appear to be successful in volatility, it was impossible for anyone in the the short run. Fmadorian government to accurately plan for Of course there are other economic the kture. problems facing Ecuador. Ecuador needs to To end this section on an upbeat note, the divers@ in order to grow. As stated earlier, government of Ecuador by 1994 has managed Ecuador is basically a monocrop economy. to balance its budget. It has increased the Oil fbeled the growth up to this point, but this amount of non-tax revenue fiom .6 biion sole dependence on oil has created several in 1980 to 2.0 billion dollars in 1994 problems and has taken Ecuador as far as one (World Development Report, 1996). The crop can take a country. The economic mix of government of Ecuador has also increased the GNP in Ecuador has changed little since capital expenditures by over 50% fiom 1980 the boom days of the early 1980s. In Ecuador, to 1994 (World Development Report, 1996). agriculture accounted for 12% of GNP in both This will help the country industrialize more 1980 and 1994. Industry, with the and reduce Ecuador's dependence on oil. The Park Place ECOllOmist, v. 5

B. Social Issues rates in all of Latin America. While The social problems that Ecuador faces researching several sources, not a single stem mainly from the current economic mention of public policy concerning instability and the past political turmoil. Some population control was found. Ecuador must of the problems that face Ecuador are health get this problem under control soon. care, sanitation, education, and distribution of Another societal.success in Ecuador is the wealth discrepancies. fact that the Ecuadorian government has Until very recently health care was mostly established mandatory primary education for limited to people in the cities. People in the all ofits citizens and that roughly halfofall of countIy had to travel long distances to receive the population of Ecuador goes on to treatment for even the most minor problems. secondary school (WorldDevelopment Report, This was such a problem because as recently 1996). This solid education has resulted in as 1980 52% ofEcuador's population lived in only 9OA» ofthe males and 12% ofthe females rural areas (World Development Report, being illiterate as of 1995 (World Development 1996). Only in the last 15 years has Ecuador Report, 1996). been able to establish clinics in its rural Though distribution of wealth might regions. The government has established a technically be an economic issue, it reflects on four tier health care system. The lowest levels the development of society. In Ecuador, are in the countryside and are orlly equipped 5.4% of the income went to the lowest fifth, for minor emergencies, immunizations, and 8.9 going to the next fifth, 13.2 goes to the other family practice type procedures. The middle fifth, 19.9 to the fourth 2OOA», while higher the tier, the larger the facility and the 52.6 ofthe income goes to the rest. This gives more complicated the procedures that occur a Gini coefficient of46.6. With over halfthe there. The benefits of improved health care wealth going to only 200A. of the population are already visible in certain areas. The infant and no clear middle class defined, it is obvious mortality rate has dropped 45% from 67 that Ecuador has not yet reached the apex of deaths per 1()()() in 1980 to 37 deaths per 1000 Kumet's inverted U. More needs to be done in 1994 (World Development Report, 1996). to share the wealth ofEcuador. Concerning other social measures, Ecuador understands that old adage "an ounce of m. POLICY RECOMMENDATIONS prevention is worth a pound of cure." The Ecuadorian government knows that if its The most. obvious recommendation that population has access to clean water and good could be made to Ecuador would be to sanitation then people will not be as sick and diversify. Ecuador is a monocrop economy, will not have to visit the government­ which makes the entire country a slave to the sponsored clinics as much. Access to international price ofoil. Industrialization and sanitation rose from 43% ofthe population in the development of linkages to primary 1980 to 54% in 1994 (World Development products are the keys for improving the Report, 1996). economic situation of Ecuador. This would One area where the government is grossly ease the pain during periods of low oil prices lacking is the area of population control. in the world. Oil income would be considered Between 1990 and 1994 Ecuador experienced more transitory and would not be depended on an annual population growth rate of 2.2% so heavily. This extra, hopefully more stable (World Development Report, 1996). This income from industry would help ease all three means that the population will double in just of the major economic problems facing 32 years. This is one of the highest growth Ecuador that were mentioned earlier: inflation,

52 Cunningham

weak currency, and international debt. Therefore, income distribution becomes more If industries were established that had a equal, and the Gini coefficient improves. comparative advantage to other countries in 'This infonnation looks great on paper, but the world then the Ecuadorian products would how is Ecuador supposed to achieve this in the be sought on the global markets. Along with real world? By following the example ofthe the increase in demand for Ecuadorian Japanese, Ecuador may achieve its goals. The products would be the increase in demand for Japanese used a government-controlled, the sucre. This higher demand would make it export-led growth. This means that Ecuador much easier for the country to defend its must find an industry that it can establish a currency. In time, Ecuador might even be able comparative advantage in. An industry that let the market establish the exchange rate. The utilizes the strengths' of the country and government would not have to constantly sell compliments the existing economy. At this foreign auTency to artificially inflate the value time, the Ecuadorian government would of the sucre; its (the sucre's) value would subsidize these indllstries so as to make them naturally rise. For foreign companies to buy more competitive on the world market. These sucres, they must pay in hard such subsidies should not come easily to the as the US dollar, the German mark, British budding Ecuadorian industry. These industries pound, etc. This helps the debt because must prove that they are achieving their goal Ecuador would now have the foreign currency ofbecoming competitive on the world market. needed to whittle away at that huge The government must have the self discipline international debt. With a smaller debt comes to pull the subsidies if the industry is not smaller debt service; this means that more performing up to standard. Basically, the money can go back into capital expenditures company must either succeed or die. Another or can be spent on social programs. Programs problem is the following: how is Ecuador such as better sanitation, more accessible going to pay for the huge initial start up fees drinking water, better-funded health care, and associated with industry? Japan had the luxury more education would be natural ofa high national savings rate. Ecuador does consequences of the added revenue. not have a very high savings rate, therefore Hopefully the problem of unequal income this is not a viable option. Ecuador could distribution would lesson due to the overall borrow, but it does not want to go any further increase in GNP. The Fei-Ranis two-sector in international debt. Ecuador could try to growth model theorizes that in the early stage attract Foreign Direct Investment (FOI), but of a country's industrial development there is given Ecuador's record of political and a pool of labor surplus this is attracted from economic instability it is unlikely that many rural areas to cities by marginally higher companies would flock to Ecuador in the near wages. The only people really profiting from future. The Ecuadorian government could try this are the elite classes that own the factories. to receive foreign aid that is earmarked for As the surplus labor pool empties and industry industrialization. This would be great, but expands, the demand for labor increases and Ecuador would be naive to depend too heavily the price paid for labor increases. As more on "free" money. Unfortunately, an and more people move away from agriculture international loan is probably the only way to and mineral production to work in the cities, receive enough foreign currency to buy the the demand for rural and mineral labor needed capital. increases and so does the wage paid to the A potential industry for Ecuador to rural and mineral labor. If labor is making explore would be plastics. Most plastics are more, the elite classes would be making less. made from petroleum. Everything from

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frisbees to artificial hearts is created from exact ending date is crucial because industries various plastics. Ecuador would already have in developing countries come to rely too the petroleum and could import the capital it heavily on the protection given by tariffs. The needed to convert oil into plastic. Ecuador new domestic companies never become might want to start on the low end of the efficient enough to compete on the world market (e.g. frisbees) and gradually try to markets, yet are profitable at home because of break into the high end (e.g. artificial hearts). tariffs. If the Ecuadorian never became This would have several advantages for competitive in the world, then the goal of Ecuador. Ecuador could buy used equipment export-led development would be thwarted. from other countries. This would be less Despite all of the pitfalls that come with expensive, thus not as much would have to be trying to industrialize, Ecuador can and must borrowed. Also, the older the equipment is, continue to strive forward. With good the more labor-intensive it probably is. This management and a little good fortune, benefits Ecuador because the demand for labor Ecuador can emerge from its economic would rise, causing wages to rise. quagmire. While the industry is young and not very efficient, tariffs could be placed on whatever REFERENCES plastic products Ecuadorian industry produces. This would protect the new industry from Ecuador: A Country Study. Federal Research foreign competition because the prices ofthe Division, Library ofCongress. 1991. foreign plastic products would be artificially raised above the price ofthe domestic plastic Internet. Ecuadorian Homepage. products. The country would also benefit from the added revenue from the tariffs. Low Internet. National Geographic Homepage. or non-existent tariffs would be placed on whatever inputs are needed for the plastic Internet. Smithsonian Homepage. industry, so as not to hamper the efforts ofthe . new industry. The revenue that could have Internet. United Nations Homepage: . been made by having tariffs on the inputs Developing Countries Link, Latin would hopefully be offset by quicker American link, World Bank Link. industQalization of the country. Despite the tariffs this is definitely an export-led growth World Development Report. New York: strategy, not an import-substitution strategy. Oxford University Press, Inc, 1996. The tariffs are only there to raise a little revenue and giVe the industries a break in the World Tables. Baltimore: Johns Hopkins domestic market. These tariffs would only be University Press, 1995. temporary, with a definite ending time. The

Jeremy Cunningham ('97) graduated in December with a major in Business and is interested in international business. He wrote this paper for Dr. Lowry's class, The Economics of Developing Countries.

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