Ecuador is F$%ked
How COVID-19 may doom the country’s flagging economy, and why you should care.
By Matthew Carpenter-Arévalo
How F$%ked is Ecuador? The short answer is very.
Last week I wrote about why Ecuador has been so hard hit by COVID-19. In this week’s post, I’m going to attempt to explain some of the challenges Ecuador will have to overcome in order to rebuild its economy post-COVID-19, and why Ecuador’s well-being should matter to the rest of the world.
As I mentioned in my last post, a consequence of Ecuador’s 1999 financial crisis was that in 2000 Ecuador adopted the US dollar as its official currency, replacing the sucre. 20 years later, if there is a third rail in Ecuadorian politics, it’s dollarization.
Despite the fact that half its population was born after dollarization came into effect, Ecuadorians believe strongly that the US dollar is responsible for the country’s modest economic stability.
Older Ecuadorians remember the pain of hyper-inflation. Many lost their life savings when banks collapsed in 1999 and when their sucres were converted to dollars without any warning.
Younger Ecuadorians, on the other hand, have seen the economic chaos wrought by Venezuela’s incompetent rulers. They credit dollarization with Ecuador’s comparative relative well-being.
Most importantly though, Ecuadorians trust dollarization because they distrust their political leaders’ ability to manage a sovereign fiat currency.
Whenever I point out to people that countries such as Haiti, Bolivia, and Paraguay manage their own currencies, people usually respond by saying “Yes, but our politicians have proven they can’t be trusted.”
One fear is that politicians will be too incompetent to manage a sovereign currency.
The other fear is that they’re too corrupt to not want to manipulate the currency for their own gain.
Indeed, just prior to dollarization, many well-connected Ecuadorians were tipped off as to the new exchange rate and managed to either get their money out of the country or exchange their currency at the more-favorable rates. Most Ecuadorians were not so lucky.
In the present, in order to manage the fallout from the economic collapse brought about by the measures required to contain the spread of COVID-19, advanced economies are using a combination of fiscal and monetary policies to keep people and businesses afloat.
The US-Government, for example, is able to fund its bailout programs by emitting sovereign debt. That debt is purchased by both private investors looking for a safe place to park their money as well as the US Federal Reserve.
Ecuador has no such recourse.
To understand why, we need a brief overview of recent history.
Prior to becoming President in 2007, Rafael Correa had a brief spell as Ecuador’s finance minister during the transitional government of Alfredo Palacio (2005–2007).
Correa’s tenure was cut short due to an argument with the IMF regarding the use of oil reserves to either service the country’s foreign debt or to invest in social programs, as Correa would have preferred. Correa advocated for correcting what he referred to as the country’s social debt. Correa refused to cede the point to the IMF, resigned, and used the standoff as the basis for his successful Presidential campaign.
During its 10 years in power (2007–2017) the Correa administration benefited from record-high oil prices. Flush with cash, the left-leaning government no longer needed the IMF for emergency loans.
Instead, the government embarked on a 10-year oil-fueled spending spree in which government investment became the primary driver of economic growth. When oil prices started dropping, Correa supplemented oil revenues with sketchy debt from China as well as pre-selling oil to countries like Thailand. The full-scale of Correa’s opaque debt deals were not fully understood until he left office.
When he left office in 2017, oil was around $50 a barrel, down from the record-high $160 he oversaw in 2008.
Because a rising oil tide lifted all boats, the Correa administration never felt compelled to create a more competitive private sector landscape. The best way to imagine Ecuador’s private sector is to think of a race around a track in which none of the runners wants to overtake anyone else. There’s little innovation, little investment, and little movement between players. Over-regulation protects entrenched firms from the few existing mid-sized firms, while abundant small businesses and a substantial informal economy battle for whatever falls off the table. Prices stay high due to the lack of competition and innovation.
As a result, when the state was no longer able to maintain the type of spending that sustained growth during the previous 10 years, the private sector was not equipped to take over as the primary driver of economic growth, nor was Ecuador an attractive destination for foreign investment. When the oil party was over Ecuadorians had the worst of two worlds: neither a climate favorable to business and investment, nor a strong social safety net.
In addition, as often happens in developing countries, oil-fueled government spending sprees produce two toxic residues: white elephants and corruption.
Many of the projects that were funded by loans from China, for example, including billion-dollar hydro-electric plants, are white elephants.
Two massive corruption scandals, including one involving the Brazilian firm Odebrecht, and another called arroz verde (green rice), for which Correa and numerous close collaborators were recently convicted and sentenced, have shown that billions were wasted and stolen.
When Correa left office, he famously stated that he was leaving “the table served” for his successor. What ended up being on the plate was a shit sandwich. In truth, Correa bailed after the plane had stalled but before it had started to descend. He landed in Belgium. His parachute, as he himself has admitted, has been paid for by the Venezuelan government.
After inheriting unsustainable levels of spending, nebulous debt obligations and a low price of oil, Ecuador’s new government had no choice but to return to bond markets and the IMF to avoid economic collapse as well as to shore up government services including health, education, and security.
Initially loyal to his predecessor, the new President, Lenin Moreno, promised to tackle corruption caiga quien caiga, regardless of who falls. Moreno quickly became Carol Baskin to Rafael Correa’s Tiger King. Now they both fulfill important roles in each others’ narratives: Lenin’s so-called betrayal has allowed Rafael Correa to revitalize his fledgling movement by providing a common enemy, the traitor. He’s a traitor supposedly because he refused to cover-up the past government’s corruption. Correa, for his part, is Lenin’s favorite excuse for everything that has gone wrong and is going wrong during his presidency. They hate each other. They need each other.
The IMF of 2020 is not the IMF of 1999. The ideologically driven structural re-adjustment programs that focus on austerity at all costs have been discredited. Nonetheless, the IMF does not write blank checks, and governments that do turn to the IMF because they have no more sources of revenue or alternative financiers do need to make progress against targets in order to ensure repayment.
In 2019 Ecuador decided to meet its goals by focusing on reducing fuel subsidies, which the government claims mostly serve wealthy people who consume more fuel as well as drug traffickers who depend on cheap diesel to transform coca leaf into cocaine in drug laboratories along the Colombian-Ecuadorian border. Most economists agree that blanket fuel subsidies are regressive.
Despite the opinion of economists, other powerful groups disagree that fuel subsidies are regressive. In fact, wide-scale protests in October 2019 organized by trade unions, transportation unions, and indigenous groups shut down Ecuador for 11 days, forcing the government to retreat on its plan to replace fuel subsidies with cash transfers to the poor. The government promised a new proposal, and aside from some basic tax reform, we’ve yet to see a full proposal.
Prior to COVID-19’s arrival in Ecuador, the government was struggling to meet the IMF’s targets. Rumours circulated that the multi-lateral organization was unlikely to make further disbursements into Ecuador’s account.
Though left-wing opposition has rallied around anti-IMF sentiment since the protests, it’s not exactly clear what alternative financing they foresee. Recent history suggests Chinese imperialism is not that much better than American imperialism. Russia’s slow withdrawal from Venezuela hints that Putin’s Latin America ambitions may have their limits. So long as Ecuador appears to be a financial basketcase, global bond markets aren’t likely to provide favorable conditions for the serial defaulting nation (Ecuador has defaulted on its debt 8 times).
When COVID-19 hit, the Ecuadorian government needed to choose from two options: service past debt, or use those same funds to pay for medical supplies. If the government defaulted on its foreign debt, Ecuador would eliminate bond markets as a source of funding for rebuilding. If, on the other hand, Ecuador fails to properly equip the country’s already overwhelmed and underperforming health system to tackle COVID-19, the government would likely pay a high political price.
Though Lenin Moreno has already announced he won't seek re-election, he is clearly positioning his Vice-President Otto Sonnenholzner, the third vice-President of this administration after the first two were removed due to corruption allegations, to lead the rag-tag remnants of Correa’s former party Alianza País into elections less than one year from now (Feb 2021).
What makes matters worse, Ecuador depends on oil as its primary source of revenue. Still reeling from October’s protests, the Ecuadorian government was already unprepared for $30 barrel oil (the state budget anticipated a $60 barrel) when two pipelines that carry oil from the Amazon to the coast burst, preventing Ecuador from meeting its export targets and obligations. Ecuador is in deep.
With no clear source of financing available, the government has announced a new series of taxes aimed at wealthy businesses and individuals to help guarantee the basic needs of the country’s most needy. While the sentiment of taxes may be well-intended, business owners under quarantine entering their second month without sales wonder aloud how they’ll manage to pay a tax based on last year’s earnings if the average business has only 37 days of reserves, as per a study by a local university. To be clear, while in the rest of the world governments are injecting liquidity into companies to help keep them afloat, in Ecuador the opposite is happening.
Here we see the bind dollarization leaves Ecuador in. With no fiscal resources available, a government might turn to monetary levers which, because of dollarization, Ecuador does not have. Exporters have long complained that dollarization places Ecuador at a disadvantage. When neighbours Colombia and Peru devalue their currencies, Ecuador becomes instantly less competitive as all three countries sell more or less the same products. Economists in favor of dollarization claim that no country has become rich through constantly devaluing its currency. To get out ahead, Ecuador should become more efficient, cut red tape, and diversify its economy.
Diversifying one’s economy after 500 years of living off of what one can pull out of the ground is no easy task. As the Latin American economists Ricardo Hausman and Cesar Hidalgo have shown, transitioning from resource-based economies to knowledge-based economies is hard, requiring not only the acquisition of information but also the creation of human networks and new organic product and service eco-systems, not to mention a regulatory framework that helps businesses succeed rather than works against them. Furthermore, so long as oil continues to be in demand, Ecuadorian politicians will be tempted to fuel growth through oil booms without much care for the inevitable busts.
COVID-19 didn’t destroy the Ecuadorian economy. 500 years of pursuing a single-minded growth strategy at the cost of adopting more sustainable economic policies and models have placed Ecuador in its current predicament. Events surrounding COVID-19 have hastened the country’s demise, and it’s not entirely clear how the country will plow forward with a dollarized economy and no plan to adjust to a dollarized economy.
Because the Ecuadorian state has constant liquidity problems (which it then passes on to businesses, as I’ve written about here in Spanish), one alternative may be to launch a parallel digital currency, an initiative floated by the past administration and more or less abandoned by the current. Such a move would allow the government to create liquidity and meet domestic obligations, though it wouldn’t be without controversy. Having failed to foresee the protests that would follow the elimination of fuel subsidies, the government may be reluctant to seemingly backtrack on dollarization, the only policy most Ecuadorians can agree on. Furthermore, leaving dollarization would mean contracting future debt in USD and then having to pay it back in a currency that could easily lose its value, such as the case in Argentina. Nonetheless, the choice may not be theirs. As one executive said to me in private, “you don’t decide to leave the dollarization party. You get kicked out.”
So why should you care if the Ecuadorian economy collapses? Allow me to make an analogy: one of the consequences of inequality in Ecuador is that the Ecuadorian dream is not to rise from rags to riches, as is the American dream. Instead, the Ecuadorian dream is to escape the public realm and live entirely in the private realm. Your kids go to private schools and universities. When you’re sick, you go to private hospitals. You live in a guarded private neighborhood. Success in a place like Ecuador means you can disassociate from your poor brethren.
With COVID-19, the foundation of that dream has proven to not sustain the weight of a pandemic. Pandemics don’t pay attention to the walls and barbed wire that surround compounds. When the health system collapses, it collapses for everyone, public and private. When the need for ventilators outpaces the availability of ventilators, it doesn’t matter what private insurance you have. The escape from the public ream was, like Narnia, always an illusion.
Similarly, the idea that rich countries can live divorced from poor countries is equally delusional.
So long as the world doesn’t have a vaccine for COVID-19, the inhabitants of North America will be threatened by the failing healthcare systems in Ecuador, Ethiopia, and Estonia.
Lockdowns won’t help and are not sustainable. We shouldn’t forget that there were pandemics long before there were mass transit systems. Indeed, a big part of the reason why we refer to Latin America and not say, Incan America and Mayan America is because Colombus and Pizarro were aided by diseases that traveled faster than they did. In other words, no-one will be safe from this particular pandemic until everyone is safe.
So how do we move forward?
Countries like Ecuador probably need some sort of debt relief, but it should be accompanied by international assistance in tackling corruption. It’s hard to overstate the negative impact of corruption. Corruption is not a bug in the system; corruption is the system.
Just as we depend on the international Red Cross for humanitarian assistance and the United Nations to facilitate dialogue amongst nations, so too do we need technical assistance to battle the plague of corruption and to help ensure our future looks far different than our past.
Lastly, rather than handouts, countries like Ecuador need access to markets to sell goods and services.
COVID-19 presents an opportunity for the world to re-discover its interconnectedness and to re-imagine the global community. Furthermore, we are also learning how to flex a new muscle, the global response muscle, which requires not only assistance and cooperation by governments but also an effort by citizens around the world to do their part to help stop the spread of a disease.
The process of trying to defeat COVID-19 has revealed many shortfalls and vulnerabilities in our global order. We’ve learned that the individual cannot be safe outside the confines of the collective. The lessons are ours to learn: not only do we need to react appropriately to prevent another pandemic, but we also need to begin to understand that threats such as climate change can have similarly impactful consequences.
The cost of inaction will be far higher than the cost of action. The cost of inequality will eventually be spread out evenly. Ecuador’s error was to not understand that. The world’s error would be to continue to live under a similar deception.d
