Understand Ecuador’s economic adjustment in eight key points

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With oil prices falling every day, Rafael Correa’s Government is forced to bet on the dirty word of neoliberalism: adjustment. In fact, the economic adjustment will be of sufficient magnitude to cause unemployment and layoffs. Pablo Dávalos, economist and professor at the Catholic University of Quito explains the details.

Artículo original en español:
Plan V

1. The Government has seven times less oil revenue
The difficulty of the economic situation in Ecuador is evident. Between January and June 2014, the treasury received $1.4 billion in oil revenues. During the same period in 2015, the State received only $200 million, i.e., seven times less than last year. This, says Dávalos, makes it impossible for the Government to expand its social investment programs and public works, which will affect the public income. “There will be stores that sell less because there are fewer people with consumer capacity,” he explains. The impact on trade will also create unemployment and impoverishment.

2. Layoffs in the public sector
In order to adjust State finances to its new income, Dávalos predicts that the Government will make redundancies in the public sector. “The Government is adjusting the economy, taking into account its expenditure versus its income”. Although the first adjustments have been made in the area of public investment, which has come to double the total private investment in the country, one cannot rule out that the next adjustments will be made to current expenditures. “In the coming weeks they will merge several ministries and institutions. This will mean layoffs”. Dávalos notes that in 2007, with the arrival of Correa-ism, spending on bureaucracy stood at $3.3 billion. In 2014, however, the budgeted amount had almost tripled to $9.4 billion.

3. Oil production is committed and expensive
The crisis has exposed the Government’s contracts for oil production at high costs. According to Dávalos, oil companies should be paid between $8 and $12 per barrel, but in Ecuador they receive over $40 per barrel. Due to the falling price of Ecuadorian oil and these high costs, Ecuador is producing oil at a loss. To this, Dávalos adds that large volumes of oil have already been pledged, i.e. presold, to countries such as China and Thailand, which means that the Government will receive no new funds from that oil. “In the coming years, there will be no money from oil revenues, which is why there are only two variables: taxes and borrowing, which are both limited variables”. This will mean that the Government will move towards a gradual adjustment: “where society hears efficiency, there will only be adjustment”.

4. The Government has squandered resources, but savings funds aren’t the solution
Pablo Dávalos agrees that there has been State squandering (as an example, he cites the Government’s failure to make important investments in sectors such as agriculture) but, unlike other analysts, he does not believe in the creation of savings funds. Rather, he argues that the Ecuadorian economy has many needs that must be addressed as a higher priority. “Liquid savings funds cause distortions in the economy,” says the analyst. What should be generated is investment in key sectors, which would allow the economy to recover from the crisis. “When a country has met its basic needs, such as Norway, savings funds make sense, but when there is so much poverty and lack of infrastructure, countries cannot have funds like these”. The infrastructure in which the Government has invested, such as roads and hydroelectric power plants, has no impact on the development of agriculture. Dávalos also believes that the industrial sector has been neglected, as the Government has failed to create lines of credit for small and medium enterprises. Even the $7.7 billion spend on roads does not represent a significant investment, considering State income, which the analyst estimates to be at least $300 billion over the eight years of Rafael Correa’s Government. “Never before in history has a Government had so many resources. It’s too much money and their results are very poor”.

5. The private sector cannot revive the economy, even if it wanted to
Dávalos does not believe that investment from the Ecuadorian private sector can revive the economy. Firstly, because the profit motive is a priority and the sector will not render a social service. Secondly, he believes that the domestic private sector is pre-modern, with rent-seeking behavior. “Whilst an entrepreneur in Colombia, with the national currency, has a profit rate of 20 to 30%, an entrepreneur in Ecuador may make profits of 300 or 400%. The Ecuadorian entrepreneur tends towards profiteering. This can be seen, for example, in the price differences with Colombia; the same goods cost 300 or 400% more in Ecuador and this is not only due to the safeguards”. Therefore, Dávalos believes that the solution will not come from the private sector, as has been suggested by some sectors of the opposition.

6. The prices in Ecuador are too high and this is not only due to safeguards
For Dávalos, the controversy over shopping in Ipiales (a town just across the Colombian border) is evidence that the price difference between the Ecuadorian market and other countries in the region is too large.  Dávalos refutes that this is due to taxes alone, asserting that the price differences between Ecuador and Colombia and Panama, for example, were too large even before the Government established safeguards. This is explained by distortions in the dollarization model. “The 12% VAT in Ecuador is too high in dollars; it’s the same as we paid in sucres, when we were compensating for devaluation and inflation. This tax distorts the economy. There are values such as the intermediation of credit cards, which has remained at 9%, the same as when we had sucres”. The basic food basket has risen to more than $660, when in 2000 it cost only $250. Dávalos believes that Ecuadorians do not appreciate the value of cents, even after 15 years of dolarization.

7. Low prices in Ipiales can indeed affect national trade
Dávalos believes that high prices in Ecuador will affect local traders, as the liquidity of consumers is siphoned off to stores in neighboring countries. For this reason, the Government should not rule out a closure of the border with Colombia, a measure similar measure to that taken by Venezuela. “This would have a great political cost, but it would be a desperate measure to avoid liquidity from leaving”.

8. The budget should set a realistic price of oil
Public investment, with the oil price at $30, will be frozen. But Dávalos believes this price will not cause such a shortage of money to jeopardize the salaries of public employees. “They will seek liquidity, either through debt or electronic money”, he concludes.

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