DRAFT – Not for distribution or quotation
THE EFFECT OF ECUADORIAN ECONOMIC LIBERALIZATION ON
POVERTY AND INEQUALITY
John Doe1
ABSTRACT. The goal of this paper is to examine the effects of economic openness on
Ecuadorian poverty and income inequality via simulation modeling. Ecuador’s success
at meeting policy recommendations of the Washington Consensus and meeting the
Millennium Development Goals (MDG) in relation to Human Development Indicators
(HDI) is also be reviewed. Macroeconomic simulations, based on a social accounting
matrix calibrated to a base year of 2000 show that liberalization has not been
accompanied by rapid poverty eradication or improvement in the distribution of income
largely due public sector corruption.
I. INTRODUCTION
“Economic openness generates domestic ‘losers’. These losers, whoever they are, will ask for
redistribution and governments, accordingly, will respond by increasing expenditures, social
security transfers,
or
public
consumption
if
they want
to
silent
opposition
to
internationalization.” (Lartey et al. 2008. p. 6). The goal of this paper is to examine the effects of
globalization on Ecuadorian poverty and income inequality through the use of a social
accounting matrix (SAM) calibrated to a base year of 2000. The broad conclusion is that
Ecuadorian liberalization has not been a catalyst for reducing poverty due to widespread
government corruption. Figure 1 and Table 1 below show Ecuador’s “corruption perceptions
index” as calculated by Transparency International.
1
Version: 1.1. December 11, 2010;. I would like to thank..... All remaining errors are my own.
c 2010 Robert Roe.
John Doe
FIGURE 1: 2010 Corruption Perception Index2
Ecuador Corruption
Index:
2005
2006
2007
2008
2009
2010
2.5
2.3
2.1
2
2.2
2.5
Source: Transparency International (2010) and Author’s Calculations
TABLE 1: Ecuadorian Corruption Index (2005-2010)
The paper is organized as follows: the following section reviews some recent economic history
of Ecuador, including time series for openness, inflation, fiscal and foreign deficits as share of
GDP, among other indicators. The third section presents the simulation model. The fourth
section presents the results of the simulations based on a social accounting matrix calibrated to a
2
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
base year of 2000. The final section draws conclusions based on the evidence presented in
section II and the simulations presented in section IV.
II. ECUADORIAN ECONOMY & POLICIES: BRIEF OVERVIEW
III.1: ECUADORIAN LIBERALIZATION: Figure 1 shows the sum of imports, M, plus
exports, E, as a share of GDP as a measure of openness. Note that openness has increased
steadily over the period, rising from less than 30 percent of GDP to more than 70 percent by
2008. By comparison to other Latin American countries, Ecuador is relatively open, although
many smaller countries show openness measures that exceed 100 percent of GDP. The date of
liberalization for the Ecuadorian economy is 1974 based on the ratio of imports plus exports to
GDP as illustrated in Figure 2 below.
FIGURE 2: Ecuador’s economic liberalization as measured by calculating [(E+M) / Y] for Ecuador
(1960-2009)
However, 1974 is an early date of liberalization for Latin America and was Ecuador’s large
increase in [(E+M) / Y] was driven primarily by rising oil prices, making it an artificial date of
3
John Doe
review for this paper. By reviewing foreign direct investment, it appears that capital account
liberalization began in 1993 as seen in Figure 2 below.
FIGURE 3: Foreign Direct Investment, net (BoP, current US) for Ecuador (1976-2009)
FIGURE 4: Tariff Rate for Ecuador (1993-2008)
4
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
Figure 3 above illustrates a reduction in tariffs somewhere between 2000 and 2004, another key
indicator of the liberalization of the Ecuadorian economy. Given the dollarization of the
Ecuadorian economy in 2000 and the reduction in tariffs over the same period, a SAM
calibrated to a base year of 2000 will be utilized to perform counterfactual simulations in which
tariffs are not reduced and exports plus imports over GDP do not continue to rise after 2000. A
Solow economic growth model which takes into account the “law of diminishing returns to
individual factors of production” which “create endogenous changes in the capital-output ratio”
that inhibit growth could be used to forecast GDP/capita growth, but would not assess changes
in poverty or income inequality since it is a one-sector model. (Ray 1998, p. 64-67) For this
project, the SAM will be sufficient for counterfactual modeling.
Expectations are that the richest Latin American countries, which are “better endowed in skilled
labor,” (Lartey et al. 2008, p. 13) are less likely to generate income equality from
internationalization compared to poorer Latin American counties in which there are a greater
“abundance of factors related to lower income groups (unskilled labor).” Considering this
context, it can be presumed that liberalization in Ecuador will “induce greater demands for
redistribution.” Due to large oil and mineral resources in Ecuador and the skilled jobs required
for the extraction of such, Ecuador is “better endowed in skilled labor.” Ecuadorian President
Correa has attempted to offset the economic “losers” of liberalization through a series of social
spending programs while battling rising deficits through austerity measures. The effects of these
policies on poverty and income inequality are unknown given their recent implementation.
III.1: INCOME INEQUALITY IN ECUADOR: With GDP per capita at $1770 in 2009, Ecuador
is considered a lower middle income country. In Ecuador the wealthiest 10% of the population
possess over 43% of the country’s wealth while the poorest 10% hold only 1%.
5
John Doe
FIGURE 5: Ecuadorian Income Distribution for Ecuador (1994-2007)
Two measurements of poverty will be utilized in this paper. The poverty headcount, which
counts the fraction of individuals living below the poverty line, does not take into account the
depth of poverty. The poverty gap “look[s] at the total shortfall of poor incomes from the poverty
line and express[es] this shortfall as a fraction of national income (as in the poverty gap) or as a
fraction of the total income required to bring all the poor to the poverty line” (Ray, 1998, p. 2889) and is a more useful measure of poverty. Issues with both the poverty gap and poverty
headcount are that they do not take into account the “relative deprivation” (Ray, 1998, p. 288-9)
of the poor. In addition, in a household living below the poverty line, the elderly, children, or
women may receive a smaller share of nourishment and other essentials, which is difficult to
track. Figure 6 shows a steady decline in the poverty headcount and poverty gap when measured
at $2/day. At the current rate of decline, Ecuador should meet the MDG goal of halving poverty
as measured by headcount.
The Gini Index, which is calculated from the Lorenz curve, “measures the degree of inequality in
the distribution of family income in a country.” (CIA, 2010) It ranges between 0, which would
indicate that every household in a country possessed an equal share of wealth, to 1, which
indicates a single household possess all of a country’s wealth. Ecuador ranks 31st (worst) in the
6
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
world with a Gini Index of 47.9 (as of 2009), which is the 3rd best in Latin and South America;
only Argentina (45.7) and Uruguay (45.2) have lower Gini indexes. For comparison, the United
States Gini Index is 45. As we can see in Figure 6 below, income inequality is rising (based on
the Gini coefficient) while poverty is falling (based on poverty headcount and gap). This is not
an unusual occurrence in developing economies. In Ecuador, recent government social policies
have focused on reallocating wealth to those living below the poverty line. Redistributing wealth
in this manner raises incomes and consumption in the short run which may inhibit unskilled
workers from gaining the education and training necessary for skilled work in the future, creating
cycles of poverty fueled by government transfers. That is to say, there is a potential trade-off
between greater consumption in the short run for lower consumption in the long run via
government transfers of this kind. (Ray, 1998, p. 288-9)
FIGURE 6: Ecuadorian Poverty Headcount & Gap Compared to the Gini Coefficient for Ecuador
(1987-2007)
In section IV of this paper, I will present non-liberalized model simulations of the Ecuadorian
economy to examine how these three indicators have been affected by liberalization.
7
John Doe
III.2: DOLLARIZATION OF ECUADORIAN ECONOMY: The financial crisis of 1999-2000
was created by “institutional weaknesses in Ecuador” due in part to “exogenous and policyinduced shocks” and during which confidence in the Ecuadorian banking system and currency
declined rapidly. (Jacome et al. 2010. pg. 7) This led to Ecuador replacing the Sucre with the
U.S. dollar as legal tender. “In general, the most important rationale for dollarization has been
the desire to import a tested monetary policy framework that facilitates preserving price stability
and contributes to fostering economic growth.” (Jacome et al. 2010. pgs. 3-4) The Ecuadorian
financial system has enjoyed stable inflation of consumer prices of 2-8% since the financial crisis
and dollarization of the economy with GDP growing at an average of 3.68% since 2000, which is
essentially the same as the US. A benefit of Ecuador’s dollarization is the avoidance of Dutch
Disease. Dutch Disease occurs when a country’s revenues increase due to a reliance on a natural
resource, such as oil, causing the currency to appreciate. This appreciation causes a decline in the
manufacturing sector due to exports becoming more expensive in the global marketplace. Gibson
(Lecture)
III.3: According to data from the WDI (2010), GDP per CAPITA GROWTH: GDP per capita
has risen at an average rate of 2.38% since 1960, with growth of 3.68% since recovering from a
major economic crisis and subsequent dollarization of the economy in 2000. The rise in GDP per
capita rise has created growth in the middle class and is largely driven by the increased output of
oil. For example, in 2004, oil output doubled and Ecuador’s GDP per capita rose by 6.9%. The
effects of liberalization on GDP per capita growth are ambiguous given Ecuador’s reliance on oil
exports.
8
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
FIGURE 7: Price of Oil Compared to GDP per Capita for Ecuador (1960-2009)
Ecuador’s economy relies heavily on the approximately 480,000 barrels of oil produced each
day, making it the 5th largest supplier of oil in Latin and South America. 180,000 barrels are
consumed in Ecuador with 300,000 barrels being exported abroad, primarily to the United States.
The export of oil constitutes approximately ¼ of Ecuador’s public sector revenues and ½ total
export revenue. (CIA, 2010)
Total oil reserves are estimated to be 6.5 billion barrels. “The Andean nation’s ‘persistent
conflicts’ with oil companies have made a recovery in output ‘impossible’ further limiting
government revenue.” (Fertl, 2010) At current production Ecuador will enjoy the benefits of oil
production for approximately 36 years. Without sufficient technological advancements in
petroleum extraction or growth in other sectors of the economy, Ecuador faces income
contraction when production decreases or ceases. While Ecuador exports heavy refined products,
it must import lighter products such as gasoline, diesel, and liquefied petroleum due to limited
9
John Doe
refining capacity. Due to the cost of import petroleum products being greater than export
petroleum products, increases in oil prices (globally) have a lower effect on Ecuadorian income
than they would if refining heavy petroleum products in-country. (EIA, 2010)
Attempts to increase oil output have met with opposition from private firms. The Ecuadorian
government is looking to increase its share of oil revenue by “transforming existing contracts
with foreign oil companies into service agreements” by the end of 2010. In so doing, oil
companies will receive a flat fee, with all oil “considered state property.” The government’s hope
is that their share of oil revenues will increase under this new Hydrocarbon Law. (EIA, 2010)
Privatization, deregulation, and property rights, three of the ten recommendations made by the
economist John Williamson in the Washington Consensus, are seemingly being ignored by
President Correa’s policies, a worrying policy change in Ecuador during a period of strong
GDP/capita growth. (Williamson, 1990)
Overall, according to data from the World Bank (2010), “low private investment remains the
main bottleneck for sustained high economic growth in Ecuador.” The new constitution, poor
investment conditions, and increased state intervention in “’strategic’ areas, such as energy,
banking and telecommunications” continue to limit private investment.
III.4: FOREIGN TRADE: Ecuador is typical of a developing country in that it is an exporter of
raw materials and cash crops and an importer of capital goods and heavily reliant on oil exports,
Ecuadorian income is highly correlated to international oil prices. With Ecuador protected from
the effects of Dutch Dieses by the dollarization of the economy in 2000, entrepreneurs in the
manufacturing sector are able to “compete and learn new technologies on the job rather than in
the abstract” by “exporting to competitive markets [which] may create positive externalities.”
(Ray, 1998. p. 682-683)
10
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
FIGURE 8: Top 10 Export Commodities for Ecuador (2007-2009)
“Ecuador’s most recent constitution, promulgated in October 2008, established broad new
guidelines for trade, giving priority to local production.” (Foreign Trade Information System,
2010) Ray (1998. p. 678) argues that preferential credit and import policies are necessary to
combat high domestic interest rates in order to spur investment and growth. Figure 9 below
illustrates the increased competitiveness of Ecuadorian exports and the lower cost of imports
through a lower exchange rate due to the dollarization of the economy in 2000.
11
John Doe
FIGURE 9: Real Effective Exchange Rate Index (1980-2009)
FIGURE 10: Top 10 Import Commodities for Ecuador (2007-2009)
High interest rates on private capital continue to be a limiting factor in alternative products
reaching world markets. President Correa’s decision in 2008 to default on its $31.6 million
12
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
interest payment for global bonds effectively closed international capital markets to Ecuador.
Considering that President Correa has called Ecuador’s $10 billion in foreign debt “immoral and
illegitimate” (Romero, 2008) future interest payments are in doubt, creating difficulty in
acquiring foreign private capital. Venezuela continues to be a major lender to Ecuador, making
possible such irrational fiscal decisions by government. Ecuador’s constitutional reforms of 2008
are still evolving, but one key change is new trade guidelines which provide priority to local
production. For example, the Foreign Trade Information System (2010) reports “price band total
duties as high as 85.5 percent and 46 percent have been applied to chicken parts and pork,
respectively, restricting those imports.”
Ecuador joined the WTO in 1996, setting tariff rates at 30% or less with the exception of
agricultural products covered by the pre-existing Andean Price Band System (APBS). In 2007
and 2008 Ecuador “reduced tariffs on 3,267 tariff lines and increased them on 1,612 tariff lines.”
(Foreign Trade Information System, 2010) Overall, it appears Ecuadorian trade policies are
focused on protecting the most vulnerable portion of the population from international
competition. However, greater research on this point is not realistic given the scope of this paper.
It is therefore sufficient to say that Ecuadorian foreign trade policies are in keeping with WTO
and Andean trade guidelines while attempting to protect the domestic agricultural sector. This
protectionism coupled to re-imposing capital controls via Ecuador’s 2008 default, implies that
the counterfactual simulation presented in section 4 of this paper may be in-line with current
Ecuadorian policy.
III.5: BALANCE OF PAYMENTS: There have been significant increases in spending for social
services which created a government deficit in 2009 due to low oil prices, lower demand for
exports due to the global economic slowdown, and higher import prices. “Given the country's
13
John Doe
dire financial and capital account situation, we stress that the risks of a broader balance of
payments crisis emerging over the next 18 months remains pronounced… Ecuador will
experience another current account shortfall in 2010, driven in large measure through the
country's burgeoning trade deficit, forecast to come in at 0.11% of GDP (US$262mn).”
(Business Monitor International, 2010) Williamson (1990) argued “that large and sustained fiscal
deficits are a primary source of macroeconomic dislocation in the forms of inflation, payments
deficits, and capital flight,” unless the deficits are being used for infrastructure development.
Unfortunately, infrastructure development is currently limited given Ecuador’s limited access to
foreign credit. Considering that current deficits are being used for social programs focused on the
redistribution of wealth, these policy decisions may not be the best for long term economic
growth. However, from Figure 11 below, it appears the Ecuadorian economy has been moving
towards a positive balance of payments over the prior 32 year period illustrated.
FIGURE 11: Balance of Payments for Ecuador (1976-2008)
14
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
III.6: REMITTANCES: A hidden “benefit” of Ecuadorian economic and political instability was
the waves of emigration prior to and during the 1999-2000 fiscal crisis. Remittances can be an
important element household income for the poorest portion of the population. Household
income is expressed as in equation Yh above with remittances entering the equation as foreign
transfers (Tr*). According to Acosta et al. (2007), “countries that receive remittances have lower
poverty levels.” Furthermore, a 10 percent increase in remittances equates to a 3.5 percent
decline in poverty headcount. As the Ecuadorian economy improves, remittances have fallen to
a little over 4% of GDP from their high of 8.2% in 2000. As supported by the Solow growth
model mentioned in Developmental Economics (Ray, 1998) if emigrants return to the country
with sufficient capital, GDP per capita will remain unchanged or rise, however, if these workers
return with little to no capital, GDP per capita will fall, especially for lower income families.
FIGURE 12: Worker’s Remittances as a Percentage of GDP for Ecuador (1986-2009)
III.6: LABOR FORCE: The Ecuadorian formal sector labor force consists of 8.3% engaged in
agriculture, 21.8% in industry and 69.8% in services.
15
John Doe
Employment in
Employment in
Employment in
AGRICULTURE (% of INDUSTRY (% of total SERVICES (% of total
total employment)
employment)
employment)
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: WDI (2010)
6.4
6.9
7.5
7.9
6.6
7.3
7
6.2
6.6
6.8
7.3
7.5
8.5
7.7
8.6
9.1
9.3
8.3
8.3
25
24.2
25.2
23.7
24.3
24.9
22.8
21.9
21.6
22.3
21.4
23.4
23.9
24.3
22.5
21.7
21.4
21.2
21.8
68.6
68.9
67.3
68.3
69.1
67.7
70.2
71.9
71.8
70.8
71.2
69.1
67.6
67.5
68.9
69.2
69.3
70.4
69.8
TABLE 2: Percent of Labor Force per Sector
This classification of labor into these three sectors does not provide a wide enough view to
ascertain the health of the Ecuadorian economy in that the large services sector could be
“symptomatic of the development of the unorganized or informal sector” due to the service
sector proving a “fallback option for laborers lacking an industrial job” during the urbanization
of the economy. (Ray, 1998.p.38) However, urban population growth has slowed and formal
sector unemployment has remained relatively steady at 8-10% over the prior 10 year period.
From this data it is not possible to ascertain whether Ecuador has reached the Lewis Turning
Point. If wages had continued to rise, given stable unemployment, it may have been possible to
make this conclusion. However, total compensation of employees including remittances is still
16
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
1/5th of its 1988 high of 146% of GDP. When reviewing actual compensation/remittances
amounts versus as a percentage of GDP, the same correlation presents itself.
FIGURE 13: Urban Growth Rate for Ecuador (1960-2009)
The percentage of women working in the formal sector has increased 45% since 1980, a major
driver of economic growth (see Figure 14 below). Coupled to the emergence of women in the
formal sector workforce is a significant reduction in birthrates (see Figure 15 below), which
increases capital per individual worker due to lower population growth, which was 1.5% in
Ecuador in 2009. (U.S. Department of State, 2010) The MDG target of “full and productive
employment and decent work for all, including women and young people” is on-track in
Ecuador. The MDG goals of improving child mortality and improving maternal health seem to
be unaffected by liberalization and continue to decline at a steady rate (see Figure 15 below). In
regards to the MDG goal of “Universal Primary Education,” Ecuador is doing poorly, greatly
reducing its ability to compete in global markets (see Figure 16 below). In addition, the reduction
17
John Doe
of women receiving primary education threatens Ecuador reaching the MDG goal of continued
improvement in labor force participation for women.
FIGURE 14: Labor Participation Rate (Percent Over 15 Years of Age) for Ecuador (1980-2008)
FIGURE 15: Birth & Infant Mortality Rates for Ecuador (1960-2009)
18
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
FIGURE 16: Percent of Labor Force with Primary Education for Ecuador (2001-2006)
III.8: ECONOMIC POLICIES: President Correa’s broad social and constitutional reforms may
create greater income equality due to transfers of capital and land to the poorest of the
population, but they are also acting as inhibitors to foreign investment due to increasingly
autocratic policies. (Fleischman, 2010) Furthermore, without sufficient investment in human
capital education, etc, transfers of income to the poor is a short run boost to consumption. After
passing a wide reform of the constitution in 2008, President Correa now “talks about re-orienting
the private sector, also called the strategic sector, to serve ‘the social interest.’” Furthermore,
“the Ecuadorian constitution– whose enactment and ratification was praised by the contentious
Secretary General of the Organization of American States, Jose Miguel Insulza– is a document
that empowers the government against democracy, individual rights and private property.(
Fleischman, 2010) Austere fiscal policies coupled to large social spending programs and
increasing government control over media outlets and private businesses have weakened
19
John Doe
President Correa’s approval ratings and further hamper international investment. “Ecuador will
seek $1.1 billion in loans from domestic investors and $3.86 billion from foreign lenders to cover
the budget deficit [2010], according to the proposed budget.” (Gill, 2010)
FIGURE 17: GDP Growth and Current Account Balance
A major focus of Correa’s social spending plan is to “expropriate unused and unproductive
agricultural land, or raise taxes on those properties to force its owners to sell.” (Fertl, 2010) This
focus on improving the lives of indigenous peasants may raise consumption in the short run, but
without improvements in education and access to capital, these programs will not prepare the
workforce for the skilled jobs necessary for competition in the global market.
III.9: WASHINGTON CONSENSUS: Besides previously mentioned issues in regards to policies
on foreign direct investment, public expenditure priorities, trade policy, deregulation, and fiscal
deficits, Ecuador is moving in a positive direction in regards to property rights, but is still
significantly lagging most of Latin and South America with only Bolivia and Venezuela scoring
lower. According to the Heritage Foundation, Ecuador scored 20 out of 100 in a Property Rights
20
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
Index compared to the rest of South America. Part of the government’s recent social agenda is to
provide indigenous farmers with titles to land they’ve been farming for generations, however the
results of those policies have yet to be seen and they may infringe upon the property rights of
current large land owners. (Fertl, 2010) Overall, it appears Ecuador is not following the
recommended policies of the Washington Consensus.
IV. SIMULATION MODEL: SOCIAL ACCOUNTING MATRIX (SAM)
The simulation model solves for 12 variables [X, C, I, E, Yh, i, Yd, p, M, er, e(Ms), Y] using 28
fixed parameters, comprising 3 SAM identities and 9 behavioral equations. While this provides
the economist opportunity to run 336 different experiments with the model, it is the goal of this
paper to focus on counterfactual simulations examining the effects of economic openness.
The first SAM identity is aggregate demand (X), which is expressed as:
X = AX + C + I + G + E
where X is the gross value of production, A is value of intermediate goods per unit of output, C is
real consumption of domestic goods and is expressed as:
C = cBar + mpc(Yd)
where cBar is autonomous consumption and mpc is the marginal propensity to consume out of
household disposable income. The SAM identity Yd will be defined below. I is investment and is
expressed as:
I = Ibar – bi
in which Ibar is autonomous investment, b is interest sensitivity of investment, and i is the
domestic interest rate. G is government expenditure on goods produced by local firms, and E is
net exports less competitive imports which is expressed by:
E = E0 [(ep*/p)ε]
21
John Doe
where E0 are SAM competitive imports, e is the nominal exchange rate, ε is the elasticity of net
competitive exports in relation to the real exchange rate, p* is foreign price and p is domestic
price, which is expressed as:
p = (1+tind)(1+τ)(pA+wl+e mf)
where tind is indirect taxes, τ is the markup, w is the wage rate, l is the labor coefficient, and mf is
the non-competitive import coefficient for firms.
The second SAM identity is the income of households (Yh) which is expressed by:
Yh = wlX + (1-sf)rK + Tr + Tr* + Wg + iDg
where the parameter sf is firm’s savings rate, r is the level of international reserves in the central
bank, K is the capital stock, Tr are domestic transfers, Tr* are foreign transfers, Wg are
government wages, and Dg is government debt.
The third SAM identity is disposal income (Yd), which is expressed as:
Yd = Yh(1-t)
where t is the direct tax on households. There are 5 other behavioral equations that require
defining. The first is:
Ms = KmY – Hi
where Ms is the money supply, Km is the transactions coefficient in the demand for money, H is
the speculative coefficient for money and Y is GDP, which is expressed as:
Y = C + I + (G+Wg) + E – M
in which M is expressed as:
M = mfX + mi(I)
where mi is the non-competitive import coefficient for investment.
The fourth behavioral equation is:
∆R = E - erM + F(i-i*)
22
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
where F is the capital flow parameter, which is the sensitivity of foreign investment to the
interest rate differential and in which i* is the foreign interest rate.
The final behavioral equation is:
er = ep*/p
IV. COUNTERFACTUAL SAM MODELING
I calibrate a counterfactual model, which operates as if the Ecuadorian economy had not
liberalized, to GDP, as seen in Figure 18 below. In all Figures listed in Section IV: “Sim” is the
SAM’s simulation of the “Actual” data, “Actual” is the real data for Ecuador, while “CF”
represents the counterfactual result.
GDP was used to calibrate simulations to actual data as shown in Figure 18 below:
FIGURE 18: Actual and Simulated Ecuadorian Incomes (2000-2009)
The per year growth rate changes made to the model to simulate deliberalization are listed in
Table 2 below.
23
John Doe
Parameter /
Variable
Base Simulation
G
0.01
Counterfactual
Simulation
0.1
Tr
0.01
0.03
Tr_star
0.05
0.065
ws
0.05
0.07
wu
0.01
0.02
e_n
0.07
0.02
Ibar
0.03
0.08
Ms
0.03
0.08
ε
3.5
2.5
(dI/I)/di
-3
-3
(dMd/Md)/di
2
2
-0.1
0
t* growth
Source: Author’s calculations
TABLE 2: Counterfactual Simulation Changes to SAM
As we can see from Table 3, aggregate demand (X) growth decreased from 6.5% to 4.5% per
year. The reduction was driven primarily by decreases in consumption (C) and net exports (NX),
as would be expected in closing the economy. However, as illustrated in Table 2 above
government spending (G) was increased by 10% per year in the counterfactual simulation and
the money supply was increased by 8% to drive income growth. Other drivers of income growth
included raising foreign transfers (Tr*) from 5% to 6.5%, and raising autonomous investment
(Ibar) from 3% to 8%. Given historical evidence presented earlier in this paper, greater
emigration and remittances is plausible. Interest rates (i) fell at unrealistic rates, which can in
part be contributed to the 8% growth of the money supply (Ms). Given the dollarization of the
economy, it is questionable whether Ecuador would have the freedom to raise the money supply
by 8% per annum, however, changes to these parameters was necessary to simulate parallel GDP
growth (do you mean even at the slower rate?)
24
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
Macroeconomic
Indicator
X
Liberalized
Growth Rate
0.065
Counterfactual
Growth Rate
0.045
C
0.056
0.045
I
-0.021
0.123
E
0.106
-0.002
M
0.088
0.051
i
0.200
-2.190 unrealistic
e_n*(1+t_star)
0.055
0.020
Source: Author’s Calculations (2010)
TABLE 3: Income Growth Rate Comparison Between Liberalized and
Closed Ecuadorian Economy SAM Simulations
The effects of nonliberalization on Ecuadorian poverty, inflation, and government deficits, are
illustrated in Figures 19-23 below.
FIGURE 19: Actual and Simulated per Year Inflation for Ecuador (2000-2009)
Figure 19 illustrates that counterfactual inflation would increase at approximately the same levels
as in the open economy simulation. Growth rates for ws were increased from 5% per year in the
25
John Doe
open market simulation to 7% per year in the closed economy simulation while wu was increased
from 1% to 2% to achieve this result.
FIGURE 20: Actual and Simulated Fiscal Deficits for Ecuador (2000-2009)
In order to maintain parallel income growth, fiscal deficits rise at an unsustainable rate in the
closed economy model in part due to government spending increasing from 5% to 10% per
annum. Maintaining government spending growth at 5% per year, as modeled in the open
economy simulation, reduces deficit growth, but does not (no contractions in formal writing)
26
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
solve the issue of rising deficits.
FIGURE 20a: Actual and Simulated Fiscal Deficits for Ecuador (2000-2009)
The reduction in government spending has profound impact on poverty growth as measured by
the poverty gap as illustrated in Figure 21 below. The poverty gap rises at 2.97% per year in the
open economy simulation, 2.46% in the closed economy simulation with government spending
set at 10% growth, and with government spending growth reduced to 5% per year, the poverty
gap increases at only 0.4% per year. These results illustrate that increases in government
spending are not the solution to reducing poverty. The Gini coefficient and poverty headcount
are relatively unaffected by the changes in government spending as illustrated in Figures 22 and
23. However, the growth rate of the Gini coefficient slows from 0.55% per year to 0.2% per year
in both closed economy scenarios.
27
John Doe
FIGURE 21: Actual and Simulated Poverty Gap for Ecuador (2000-2009)
FIGURE 21: Actual and Simulated Gini Coefficients for Ecuador (2000-2009)
28
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
FIGURE 22: Actual and Simulated Poverty Head Count for Ecuador (2000-2009)
V. CONCLUSIONS
The growth reduction in the poverty gap and the Gini coefficient were expected as globalization
causes greater income inequality as profits are increased and labor receives a decreasing share.
However, poverty and income inequality were not decreasing in the closed economy simulations,
but rising at slower rates while the poverty headcount grew 0.06% more quickly in both the
closed economy simulations, illustrating that closing the Ecuadorian economy is not the solution
to lowering poverty, but would lower income inequality. While it was possible to create a
counterfactual simulation in which GDP rises at the same rate as in the original simulation, given
Ecuador’s reliance on oil exports for ½ of public sector revenue, oil would continue to be
exported while other sectors of the economy close to globalization. This could account for a
continued rise in poverty.
Current Ecuadorian policies are focused on short-run increases in consumption and agriculture
reform, which will do little to improve Ecuador’s global competitive edge, excluding the
29
John Doe
agricultural sector. With less than 33% of the population having primary education and the
country reliant on oil income, it is the contention of this paper that poverty and income inequality
will continue to rise unless unskilled workers are properly trained.
In the counterfactual
simulation, employment growth slows from 5.8% to 4% per year, a worrying prospect for
Ecuador reaching the Lewis Turning Point, as wages will not rise with less workers being
employed in the formal sector. As evidenced in this paper, closing the Ecuadorian economy is
not the solutions to reducing poverty or income inequality.
V. REFERENCES
Acosta, Pablo & Calderón, Cesar & Fajnzylber, Pablo & Lopez, Humberto. What is the Impact of
International Remittances on Poverty and Inequality in Latin America? The World Bank,
2007.
BBC News: Ecuador declares state of emergency amid 'coup attempt,' 30 September, 2010,
Accessed at: http://www.bbc.co.uk/news/world-latin-america-11447519 on 26 Nov, 2010.
BBC News: Profile: Ecuador's Rafael Correa. 30 September, 2010, Accessed at:
http://www.bbc.co.uk/news/world-latin-america-11449110 on 26 Nov, 2010.
Business Monitor International: Ecuador: Balance Of Payments Dynamics Remains Precarious,
Jun 22 2010. http://store.businessmonitor.com/article/360949. Accessed Nov 24, 2010.
CIA. World Factbook – Ecuador. Available from CIA website:
https://www.cia.gov/library/publications/the-world-factbook/geos/ec.html. Accessed on
November 20, 2010.
Clayton, Jessica Audrey & Warin, Thierry, A Note of Remittances in El Salvador and Ecuador:
An Analysis of Household Survey Data. Cirano, Montreal 2010.
comtrade.un.org. Ecuador- Imports: CIF, by origin; Exports: FOB, by last known
destination. Accessed on 22 November, 2010.
DRDB. Rafael Correa: another Latin American president with an econ Ph.D. 14 Oct, 2006,
http://www.bankresearch.org/economicpolicyblog/2006/10/rafael_correa_a.html, accessed on
Nov 26, 2010.
30
THE EFFECT OF GLOBALIZATION ON INEQUALITY AND POVERTY IN ECUADOR
Fertl, Duroyan. Ecuador: Correa vows to ‘radicalise revolution’. Green Left. October 17, 2010.
Fleischman, Luis. Correa’s Ecuador: Defending An Autocracy. Oct 20th, 2010. Accessed at:
http://bigpeace.com/lfleischman/2010/10/20/correas-ecuador-defending-an-autocracy/ on 20
Nov, 2010.
Foreign Trade Information System: Eucador: Foreign Trade Barriers. Accessed at:
http://www.sice.oas.org/ctyindex/USA/USTR_Reports/ECU_2010.pdf, on Dec 2, 2010.
Gibson, Bill. John Converse Professor of Economics, University of Vermont. Lectures. 2010.
Gill, Nathan. Ecuador’s Correa ‘At Risk’ Without Economic Rebound. Bloomberg, Nov 16,
2010. Accessed at: http://www.bloomberg.com/news/2010-11-16/ecuador-s-correa-is-at-riskif-economy-doesn-t-improve-moody-s-says.html on 26 November, 2010
Heritage Foundation. http://www.heritage.org/index/. Accessed on Dec 8, 2010.
International Human Development Indicators: http://hdrstats.undp.org
Jácome, Luis I and Lönnberg, Åke. Implementing Official Dollarization. International Monetary
Fund. April 2010.
Lartey, Emmanuel K.K. & Mandelman, Federico S. & Acosta, Pablo A. Remittances, Exchange
Rate Regimes and the Dutch Disease: A Panel Data Analysis. February 12, 2008.
Ray, Debraj. Development Economics. Princeton University Press, Princeton, NJ: 1998
Romero, Simon. Ecuador: President Orders Debt Default, December 12, 2008, NY Times.
The World Bank. Data available from the World Bank website: http://www.worldbank.org/. First
accessed in September 2010.
Transparency International: Corruption Perception Index (http://www.transparency.org).
Accessed Dec 10, 2010.
U.S. Department of State. Background Note: Ecuador.
http://www.state.gov/r/pa/ei/bgn/35761.htm Accessed Nov 2010.
U.S. Energy Information Administration, Ecuador Country Analysis Brief, Updated August
2010. Available from: http://www.eia.doe.gov/cabs/Ecuador/Full.html. Accessed on November
18, 2010.
U.N. Data: http://data.un.org
Williamson, John. What Washington Means by Policy Reform, Chapter 2 from Latin American
Adjustment: How Much Has Happened? Published April 1990 by Peterson Institute for
International Economics
31
John Doe
Before showing this to anyone make sure that 1. All references are actually cited in the paper
and 2. The citations in the paper link to a reference in the bib.
Nice job Jeff…
32