Dollars, Oil, and Ecuador’s Strange Economy

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.

Retiring Abroad in Ecuador

As we travel through South America, we are learning all we can about the role that tourism plays in local economies. We sometimes do interviews with local business owners, analyze business models, look for opportunities etc.

In Cuenca, Ecuador we spoke with Michael Berger, a local real estate agent. We asked him about his business and experience, recent industry trends, and the role of retiring Americans in the local economy. The interview was conducted in English. What follows is a summary based on our research, notes, and the highlights of the conversation.

When we began researching our trip to Ecuador, we came across all kinds of information encouraging us to retire there. It turns out there are lots of good reasons to do so, and as many as 10,000 Americans are currently living in Ecuador. This struck us as an interesting market so we decided to look further. At the heart of most “Retire Abroad” arguments is the concern about living an unknown number of years on a fixed amount of private savings and government social security checks. The promise is that you can live better and cheaper outside the US, and it’s not that hard to do.

Ecuador is an ideal place to study this phenomenon, and Cuenca in particular. Cuenca shows up on many lists of top places for Americans to retire, and after spending some time there we could see why. Ecuador uses the dollar, so there is no fluctuating exchange rate to worry about. You can also easily index local prices against those in the states to gauge value.  The weather in Cuenca is mild year-round, no heat waves or shoveling snow. As we discovered, there is a lot to do in there. It has a good variety of cultural events and is full of museums, plazas, and greenbelts. The mountains and the national parks are just outside the city. Streets are clean, driving is fairly calm, crime is minimal.

Most importantly, cost of living is low compared to the US. Gas is 1.5 USD, fresh local fruits and veggies are cheap and available year-round. Seniors get half-price bus tickets, plane tickets, and many other benefits. Medical care seems to be at a high standard and, again, really affordable. We had some dental work done as well as a few other doctor’s visits and had good, affordable treatment.

All this information can be found in glowing detail on the many websites selling the Retire Abroad dream. From the time we spent in Cuenca, we can confirm that the good stuff is as good as they say. But what about the bad stuff? While living in Nicaragua, another growing destination for American retirees, we had seen that it is not always as simple as it seems. So we sought out an American realtor living in Cuenca, Michael Berger, who specializes in helping people from the States make the transition to Cuenca, Ecuador. We asked him some tough questions to try to get the whole story, no sugar coating. Here are the highlights of our conversation:

Property Rights

This was our first concern. The US concept of property rights is not as universal as you might expect. The first thing Michael explained was that rural property can be a lot more complicated than urban. Many rural properties have incompletely or inaccurately registered boundaries which can compromise the title and complicate the purchasing process. He emphasized how important it is to make sure the information on the title is complete, including physical boundaries, road/water access, and third party usage rights. Apparently children can inherit the right to use land owned by their parents, even if they don’t inherit the land itself. Also neighbors who have traditionally walked across your field may maintain the right to do so even after you buy the land.

Fortunately Cuenca has a fairly organized and centralized property registration system, so these things can be checked and recorded. Finally, make sure to take the title down to the office and register it after the purchase. Failing to do this is apparently a common mistake made by locals and foreigners alike. If it doesn’t get registered, it doesn’t count.

Building Costs

Generally speaking Michael says that property in the Cuenca area is not cheap compared to much of the US, but building costs are much lower. This means that the best way to get more for your money is to buy and build. We wanted to get an idea of pricing, so he threw out some general numbers for us based on a few scenarios. These numbers are as of February 2013.

Buying a 100 m2 apartment within the city limits would run between 100k and 120k USD. A 150 m2 house might run around 180k USD. He recommended moving a little outside the city center for better values. Ten to fifteen minutes outside the city center you can buy a 250 m2 house on a 1/4 acre lot for between 200k and 250k.

If you want to buy land and build, he estimated that building costs run from $350 to $450 USD per square meter including cabinetry, kitchen and bathroom finishes. Most expats find themselves at the higher end of the spectrum but do not exceed it.

Living the Dream

This was the big question for us. When people come down here to live, are they happy? Does it really work? On the whole, Michael was positive. When people have the right expectations, coming to live in Cuenca can be a great experience. The biggest problems are budget and isolation. He said that many promoters of retiring abroad under-estimate the true costs of living in Cuenca and this can cause problems for people on a fixed income. Also the difficulties of language, as well as being far from family and friends can cause people to feel more lonely than they might have expected. For this reason he recommends living closer to the city to stay connected and involved with the community.

We want to thank Michael Berger of Cuencas Best Real Estate Properties for the time he spent with us. More information about him and his company can be found at www.cuencasbestproperties.com.

Cuenca – Why would you ever leave?

Cuenca was our first stop in Ecuador and it made a great first impression. We ended up staying there longer than we had anywhere else, for a number of reasons. Most of all, we just liked it and felt comfortable there. It is clean, cheap, safe, and there’s lots to do. What else can you ask for?

As soon as we cross the border from Peru into Ecuador, we noticed some major changes. The streets were cleaner, less trash on the side of the road. There were few or NO street dogs, and people seemed only to let their dogs run around on rooftops. We also noticed that the driving style calmed down a lot, and there were more new model cars on the road than we had seen in Peru. This was especially true in Cuenca, where most cars were late model SUVs or sedans. Ecuador uses the US dollar as currency and this was also a nice point. Not having to do constant mental conversions made things simpler, and there was something strangely comforting about the familiar bills after so many months of traveling. As we learned later, dollarization has its complications for Ecuador, but for the moment we were happy.

Cuenca is a medium sized city with about 350,000 people. It is the southern most major city in Ecuador, and the third largest after Quito and Guayaquil. It sits in the Andes mountains at 2,500 M (8,300 ft) elevation and enjoys a stable, slightly cool climate. The average daily temperature is about 60 F. Four different rivers feed from the surrounding mountains into the city, which is why it is called Cuenca (basin). Here is a panorama taken from a lookout point above the city.

Note the wonderful greenbelt that follows a river through the middle of the city. (lower left corner)

One of our favorite spots in Cuenca was the central market. It was not as big as the market in Arequipa, but they had an amazing array of fruits and vegetables. Ecuador boasted a variety of fruits that we had not seen before in Latin America. The combination of being at the equator allows for tropical fruits like bananas, mangos, and pineapples, but the mountain highlands are cool enough for growing apples, cherries, peaches etc. Really amazing.Apart from the fruit extravaganza, we went back more than once to visit the fantastic food court where chancho (pork) was the highlight of the offerings. For a few dollars we could load up a plate with fried pork, beans, rice, and salad, accompanied by a fresh juice from one of a dozen fruit options, some of which we didn’t even recognize!

Standard vacation tourism did not feel like a major industry in Cuenca, although it is a popular tourist destination. There were options for a city bus tour and trekking trips outside of the city, but we were never mobbed by people selling tours, and didn’t find the endless markets of wollen hats and llama dolls we had seen in some parts of Peru. Somewhat like Arequipa, the city is apparently a regional hub for agricultural and industrial goods. It also has a long traditional of craftsmanship, especially ceramics and pottery.

Touristy knickknacks can be found in Cuenca, but they aren’t on every street corner

This is not to say that foreigners do not play a significant role in Cuenca’s economy. They do, but in a way that we had not seen before. Ecuador, and especially Cuenca, consistently show up in the lists of top expat retirement destinations where money goes a long way and quality of life is high. It is also a top pick for the growing medical tourism industry. We took advantage of our time in Cuenca to look deeper into both areas, and I will be going into greater detail in the next few posts!