Warning: This post gets a little heavy with the econ. So, I’ve included some of my favorite Ecuadorian street art to liven things up!
Cuenca, Ecuador
The more we get to know Ecuador, the more of a fascinating puzzle it becomes for us. For example, why is gas so cheap and liquor so expensive? In searching for the answers to our questions we talked to locals and foreigners, combed online news and forums, and dragged dusty economics terms out of the mental closet.
Oil Economy
Gas is really cheap in Ecuador. Like $1.50 USD per gallon cheap. This must be because Ecuador has a lot of oil, right? It’s not quite that simple. Although Ecuador is an oil producing nation, the government also spends about 2 billion USD annually subsidizing fuel domestically. This explains all the late model SUVs we saw in Cuenca. But why does Ecuador subsidize fuel? Why does the US government subsidize corn? It’s complicated.The subsidies go back many years and there are a lot of vested interests.
By international standards Ecuador doesn’t really have a lot of oil. It is the smallest member of OPEC, 30th in the world for production and 20th in the world for proven reserves. But even if Ecuador is not a major source of oil for the world, oil exports are a major source of revenue for Ecuador. At present, the oil sector typically accounts for 50%-60% of the country’s export earnings, 15%-20% of GDP, and 30%-40% of government revenues.
Ecuador’s Exports. Wikipedia Image- Click to Enlarge
While there’s no doubt that the money from the oil trade has helped Ecuador grow economically, it is not an unmitigated benefit. Because Ecuador is so dependent on the oil money, changes in the price have a huge impact on Ecuador’s financial state. Several of the major economic crisis in the country’s recent past have been tied to fluctuations in the international oil market.
Yasuni National Park in Ecuador – Wikipedia Image
There is also the environmental impact to take into consideration. Ecuador is home to some very special natural spaces, as well as several uncontacted Amazon tribes. Specifically, the Yasuni National Park is considered to be one of the most biologically diverse places in the world. It also happens to sit on about 8 billion dollars of oil reserves. Oil drilling has a messy history in Ecuador, so there are a lot of activist groups (domestic and international) pushing back against further exploitation.
Good government wants to balance the long term and short term needs of the country. Rarely do you get to have your cake and eat it too, but in this instance Ecuador is certainly trying. We first heard about this story from our much-beloved Planet Money podcast back in February. “In 2007, Ecuador’s president proposed a way around the dilemma: Ecuador would promise to leave the forest untouched if countries in the developed world would promise to give Ecuador half the value of the oil — $3.6 billion.” This way, they would get some money for the near term economic growth and development and be able keep the park for the long term tourism and scientific value. The jury is still out on whether this is brilliant or just a brilliant scam, but individuals, governments, and NGOs have collectively donated over 300 million dollars.
Can the dollar save the day?
The rise and fall of oil prices, combined with natural disasters and governmental mismanagement, created a cycle of booms and busts in the Ecuadorian economy over the past 40 years. Huge debts were incurred during the good times, leading to inflation, and then devaluation during the bad times. The instability reached a breaking point in the late 1990s and the decision was made to dollarize. Basically this means that the government of Ecuador decided that they couldn’t manage their own money supply, so they would use the US dollar instead.
Ecuadorian coins – Wikipedia Image
Dollarization comes with a lot of advantages. The government doesn’t have to print any money (although Ecuador makes its own coins, which circulate along with US coins). The dollar’s value is relatively quite stable and this creates confidence, for both citizens of the country and foreign investors. Since the Ecuadorian government can no longer just print money whenever it wants to, this is supposed to lead to fiscal discipline and greater economic stability. Can that ever be a bad thing? It depends on who you ask.
A highly cyclical economy (like oil-dependant Ecuador) with an inflexible monetary policy (like dollarized Ecuador) is a tough combination. During the bad times, when oil prices fall, the Ecuadorian government would like to print more currency. In fact, that’s what it used to do, and how it got into trouble. Now they can’t. So when oil prices fall below what was expected and budgeted, Ecuador has trouble covering its expenses. The government gets behind on debt payments and funding of social and infrastructure programs. The current account balance becomes negative. That means that as a country, Ecuador is spending more than it is earning. All this, even though they haven’t done anything different. It’s not as if everyone decided to stop going to work, or the government spent all the money on yachts. It’s a cycle they have little control over, but which has a lot of control over them. So what’s a girl to do?
Quito, Ecuador
How to Get Out Of An Economic Straight Jacket
The Ecuadorian government does still have some control over its economy, in the form of taxation. Last year it levied a high import tax on luxury goods such as cars, cell phones, appliances, and hard alcohol. The official rationalizations for these taxes were environmental and health based, but not everyone is convinced. The more widely accepted explanation is that it is an attempt to raise some revenue and keep the current account balance from becoming too negative (a dubious goal).
Consumers and business owners have felt the consequences of the tax as prices rise. We spoke to a bar owner who told us that this is the most recent of many taxes on hard alcohol (most of which is imported). He said prices had more than doubled since he got into the business about 5 years ago. We were shocked at the prices we saw in the liquor isle at the grocery store. A fifth of Jack Daniels cost $55 USD, whereas it might be $20 USD in the States. A 1.75L bottle of Bacardi Light cost $85 USD, and in the States that would also be about $20 USD.
Canoa, Ecuador
Import taxes are a common tool for developing economies trying to raise government revenue. Collecting internal sales tax or income tax is complicated and requires a lot of manpower and organization. Also, those systems are not effective in places where many (most) transactions happen informally. In contrast, an import tax is easier to impose. Watch the borders, check the stuff coming in, collect the tax. But obviously these taxes have a dampening effect on international trade. If Ecuador wants to balance out its economic profile and develop industries beyond oil, heavily taxing other forms of commerce is not the way to do it. It discourages current business owners and makes potential investors wary of what might come next.
Campana Project 