Ecuador - dollarization, trade liberalization and poverty

Abstract:

Ecuador engaged in drastic economic reforms in the early 1990s. In the decade that followed there is a tale of great economic and political turmoil. In the process, the country's dependence on primary exports (oil, shrimps and bananas) has not been reduced, while the economy is likely to have become even more sensitive to terms-of-trade shocks following its decision to adopt the dollar as official means of payments thereby fully giving up independence of monetary policy. The early 1990s began with fairly successful economic stabilization helped by debt reduction under the Brady deal, use of the exchange rate as nominal anchor and a rise in trade and capital inflows following import liberalization and capital account opening. In the first half of the 1990s, modest growth was achieved and real wages were up fostering a substantial decline in (urban) poverty. Things start to breakdown after 1995 following political turmoil and several external shocks. A full-blown currency and financial crises emerged in 1999 as the domestic currency could no longer be defended. A shift towards a flexible exchange-rate regime and rise in interest rates did not evade, but rather accelerated the banking crisis as it revealed the currency mismatch and large share of bad debts in the system. Per capita income fell by 9 per cent in 1 year and poverty increased substantially during 1998-9. The crisis eventually led to the decision to dollarize the economy. Inflation hit at an unprecedented height in the first months following dollarization, but the inflation rate has gradually decelerated since and the economy has slowly recovered. Inflation has been higher though than that of the major trading partners leading to an appreciation of the hypothetical real exchange rate. Real wages have been able to recover alongside the real appreciation alike in the early 1990s. Workers remittances have become a major new source of household income following massive emigration after the economic crisis of 1999. These factors have helped reduce (urban) poverty in 2001-2. Factors associated with the structural reforms, however, seem to have pushed up income inequality. This trend has been visible throughout the 1990s, particularly due to a rise in skill-intensity of production in most traded and non-traded goods sectors pushing up the wage gap between skilled and unskilled workers. Employment growth has been as volatile as aggregate output growth, but on balance more workers have been pushed in the informal sector and a widening gap between formal and informal sector workers has further contributed to rising inequality. These trends may be associated to a large extent with the process of trade liberalization in Ecuador as shown by the CGE simulations. The simulation results indicate that the trade opening in Ecuador induced mild aggregate welfare gains, but rising income inequality due to rising wage differentials between skilled and unskilled workers implies that at the end of the day trade liberalization had no poverty-reducing impact. Scenarios of deepened trade integration, such as under the Free Trade Agreement for the Americas and a WTO scenario of free trade and no export subsidies only exacerbate these trends. Under the WTO scenario rising inequality and unfavourable relative prices for agricultural exports would even lead to a rise in poverty. To reap the benefits of trade, Ecuador's stabilization and growth strategy should thus give priority to investment in human and physical infrastructure to foster productivity growth and reduce the shortage of skilled workers.

Año de publicación:

2006

Keywords:

Fuente:

scopus