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Ecuador
Binding Constraints to Growth
IDB LAC Competitiveness & Growth Seminar
Simon Cueva
Vicente Albornoz
Leopoldo Avellán
September 2007
Applying GDM methodology to Ecuador
•Assessing underlying constraints to growth
•Examining diverse potential tree branches explaining low growth
•Judgment calls on the relative importance of the branches
•Use of factual & perception indicators with international comparisons,
surveys, databases on enterprises and micro businesses
-1%
-1%
-3%
-2%
-2%
-4%
-3%
-3%
3%
1980-89
Average
-1%
-2%
Source: ECLAC
5%
2%
4%
1%
3%
0%
2%
1960-69
Average
4%
2%
1%
0%
1990-99
Average
0%
8%
-2%
-2%
-2%
-4%
-4%
4%
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
6%
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
3%
1951-59
Average
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
-1%
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
4%
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Ecuador
ElSalvador
Guatemala
Haiti
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Dom. Rep.
Uruguay
Venezuela
An intermediate growth performer in the region
1970-79
Average
6%
2%
4%
0%
2%
0%
2000-05
Average
3%
2%
1%
1%
0%
•Above-average results in the 1970s (oil boom) and the early 2000s (oil + post
crisis recovery)
•Below-average results in the other periods, particularly 1980s, 1990s (financial
crisis) and currently
A volatile and commodity-oriented economy
•2.4% average per capita growth over 1951-2005
•Growth accounting: TFP shortfalls for the income level; much more negative
growth than other LAC countries
•Economic booms led by a few export commodities despite some growth of
industrial exports since the 1990s
•Phases of growth with significant changes in average growth performance: high
volatility, even for LAC standards
•Relatively high investment levels and capital stock on a regional basis
•Oil dependence: mixed evidence suggesting some Dutch disease; fiscal revenues
and procyclical fiscal policies 450
400
350
300
250
200
150
100
50
Chile
Dominican Republic
Ecuador
Venezuela
Source: Center for International Comparisons of Production, Income and Prices, University of Pennsylvania
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
1970
1967
1964
1961
1958
1955
0
GDM decision tree
Low levels of private investment and entrepreneurship
Low return to economic activity
High cost of finance
Costly international
financing - High
country risk
Low
appropriability
Low social returns
Costly domestic
financing
Low domestic savings:
1. Financial system
weaknesses
2. Inappropriate savingsboosting framework
Geographical or
natural resources
impediments
Bad
infrastructure
Low human capital
Government
failures
Macro risks:
Financial,
monetary &
fiscal stability
Government
failures
Poor intermediation:
1.Weak regulation
2. Weak enforcement of
creditor rights
3. Asymmetric information
4. Thin domestic capital
markets
Market failures
Micro risks:
Property rights &
Legal stability;
Corruption; Taxes;
Inefficient public invt
decisions
Information externalities
Coordination externalities
Access to finance: a major business complaint
•Private sector surveys (World Bank Investment Climate 453 firms; Proyecto Salto
for 17,626 micro businesses): access & cost of finance are major complaints,
either for working capital or investment purposes
•Statistical consistency: access to finance matters; firms highlighting financing
constraints actual perceive them in their business decisions, use of bank loans and
allocation of internal funds (not true for other mentioned constraints)
•More sensitive for small & micro businesses:
•Credit seen by far as the most important requirement for success
•Cumbersome procedures; collateral requirements; high interest rates
60%
Most important requirement for success
50%
40%
30%
20%
10%
Source: Enterprise Surveys, the World Bank
Electricity
Tax admin.
Legal
system/conflict
resolution
Tax rates
Anticompetitive or
informal
Cost of
Financing
Corruption
Access to
Financing
Macroeconomic
Instability
Economic and
Regulatory
Policy
0%
Transport
Promotions, sellers
Pay off debt
More or better equipment
More or better workforce
More space
Improve processing technology
Improve product presentation/ packaging
Better access to raw materials or products
More product to sell
Credit for inputs or merchandise
Credit for equipment, machinery, facilities
Training
Technical asistance/ Advisory
332
208
176
1,196
40
1,655
63
130
480
2,492
5,621
1,718
124
48
0
Source: Proyecto Salto survey
1000
2000
3000
4000
5000
6000
Access to finance and underlying reasons
•Weak credit history, macro instability: high costs of international finance, highest
EMBI+ country risk (more than 500bp above LAC average)
•Actual impact on domestic creditors limited for now: growing private foreign debt,
(incl. back-to-back); limited banks’ foreign financial liabilities (6% of total)
•Significant credit growth in recent years, in line with a recovery of depositor
confidence after the 1999 financial crisis and the benign international environment
•Ecuador macro crisis have traditionally included problems of access to intl finance
•Low real lending rates by LAC standards but significant hidden costs: 22.5%
implicit rate
•Market segmentation, with widely variable real cost of credit; more acute
transparency and competition problems for micro businesses / informal sector
•Despite dollarization, lack of modern and comprehensive legal & regulatory
environment on financial resolution & depositor’s protection => excessive
precautionary liquid assets affecting financing costs?
•Low levels of financial intermediation: creditor rights, weak judicial system,
appropriability issues
Natural resources & human capital
•Diverse and abundant natural resources: oil, mining, productive land, forests,
water, biodiversity, geographical position
•Some geographical constraints arising from physical fragmentation: transportation
and infrastructure costs; cultural and regional antagonism; decentralization trends
and related risks
•Human capital: mixed indicators and regional rankings:
•Favorable for primary education coverage, alphabetization, training for firms’
employees
•Less favorable for secondary & tertiary education, standardized quality tests
•Poorly for R&D spending, publications, patents
•Large returns to schooling in the country but poor comparisons with other migrants in
the US human capital in short supply, poor education quality
•Waves of recent migration, particularly for segments with higher primary and
secondary education coverage
•Business surveys do not place workers skills as a critical issue
Infrastructure: some critical areas
•Mixed rankings with some relative strengths (water coverage, fixed and mobile
phone lines) and weaknesses (paved roads, airport usage)
•Progress on transportation and telecommunications (road concessions, large port &
airport projects), not perceived as critical obstacles by businesses
•Weakest links: oil and electricity
600
Oil Production
Energy Transmission and Distribution Losses
45
40
500
35
400
30
300
25
20
200
15
10
100
5
Private companies
Total
* Excluding the impact of the decision to rescind Occidental contract in April
Ecuador
Argentina
Brazil
Colombia
Peru
Average
Source: World Bank’s WDI, average includes Argentina, Bolivia,
Brazil, Chile, Colombia, Ecuador, Panama, Peru and Uruguay.
Chile
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
Ene-00
May-00
Sep-00
Ene-01
May-01
Sep-01
Ene-02
May-02
Sep-02
Ene-03
May-03
Sep-03
Ene-04
May-04
Sep-04
Ene-05
May-05
Sep-05
Ene-06
May-06
Sep-06
Ene-07
Petroecuador
1971
0
0
Oil: weak institutions, low investment
•Oil sector critical for export proceeds, GDP, fiscal revenues + subsidies
•Steady decline in state-controlled oil production since 1994 (except Oxy, 4.5%
average annual decline) vs. moderate growth in private production
•Constraints not related to oil reserves (covering 23 years of current production);
transportation capacity (since 2004, capacity usage of existing pipelines close to
59%) or world demand or prices
•Institutional limitations:
•Limited attractiveness to foreign investors, legal limitations for public-private
partnerships, shared-management contracts and risk-sharing
•Petroecuador: under investment and technological obsolescence in the context of weak
governance, transparency or institutional stability
•Political interference: Petroecuador decisions and leadership, heavy and regressive oil
subsidies (fiscal costs close to 6% of GDP + lack of competition)
•Need for investments and transparent markets (exploration, refineries,
commercialization)
•Vested interests related to unions’ role and to beneficiaries of existing subsidies and
related businesses (derivative imports, unloading and domestic transportation,
smuggling)
Electricity: weak institutions, low investment
•High final electricity prices by LAC standards: constant threat of power outages;
severe obstacle for businesses, recurrent issue
•Highest energy losses in the region (more than 40% of transmitted and distributed
energy) reflecting technical issues but also smuggling, obsolescence & management
•Expensive and growing thermal generation; postponement of several large hydro
projects despite natural generating potential: growing imports
•State dominated sector (lowest private investment in LAC); clear segmentation by
efficiency of distribution utilities; tariff subsidy magnifies the problem
•Very low investment levels (0.16% of GDP over 1996-2000)
•Vested interests play a role: weak management & collection help large debtors with
some influence over managers’ nomination; legal calls for open nomination
procedures nor implemented; political interference and governance issues
•Regulatory framework on energy pricing + instability exacerbate existing problems
and incentives for thermal vs. hydro projects
•Hippos and camels - overall impact on growth: sectors where electricity is at least
2% of intermediate production add up to 47% of GDP; most (79% v.a.) grew below
the national average since 2000
Macro vulnerability is still alive
•History of macroeconomic crisis episodes related to fiscal, external accounts &
financial weaknesses – role of low oil prices & limited access to external financing
•Recent macroeconomic performance largely reflects benign external environment
•Dollarization cushions the economic impact of political uncertainty but reduces
policy room of maneuver
•Fiscal policy is largely procyclical: more than 80% of inflows to oil-related funds
have been used since 2000 ; fiscal dependence on oil has grown
•Elusive political consensus on sustainable fiscal management: significant budget
rigidities arising from large eamarking of fiscal revenues: is this a second best
alternative to limit fiscal procyclicality?
•Earmarking has constrained investment in key energy sectors, affecting long term
growth
•Budget implementation is highly discretionary, enhancing strong political actors and
sidelining long-term poverty reducing projects
•Procyclical fiscal policies are one of the reasons behind the pressures for earmarking
protection
•Chilean-style structural fiscal budget scheme could potentially help
Micro risks & appropriability: the weakest link
Political Stability
0,50
20
05
20
04
20
03
20
02
20
00
19
98
19
96
0,00
-0,50
-1,00
-1,50
Latin America Average
Ecuador
-0,50
-0,50
-1,00
-1,00
-1,50
20
05
20
04
20
03
20
02
19
96
20
05
20
04
20
03
20
02
20
00
19
98
0,00
19
96
0,00
20
00
Regulatory Quality
0,50
19
98
Government Effectiveness
0,50
-1,50
Ecuador
Latin America Average
-0,50
-0,50
-1,00
-1,00
-1,50
-1,50
Latin America Average
Ecuador
Latin America Average
Ecuador
20
05
20
04
20
03
20
02
19
96
20
05
20
04
20
03
0,00
20
02
0,00
20
00
0,50
19
98
0,50
19
96
Ecuador
Control of Corruption
19
98
Rule of Law
20
00
Latin America Average
Micro risks & appropriability: the weakest link
•Every survey or competitiveness assessment point to Ecuador’s weak institutions
and governance problems; Ecuador performs poorly, even within LAC, on political
stability, government effectiveness, regulatory quality, rule of law, corruption
•Exception: rather developed individual liberties– potential threats?
•Recurrent problems, widely perceived as a weakness for business environment;
close to last in Transparency International corruption perception index; corruption in
the top 3 reasons inhibiting private investment
•Growing lags with LAC on property rights & enforcement; after Argentina,
Ecuador faces the largest number of FDI international arbitration procedures
•Appropriability issues are clearly a binding constraint for Ecuador
•Answers are uneasy; no quick fixes
•Addressing social inequality and transparency may be the first steps
•Fixing some specific areas to foster business environment may help
Business environment weaknesses
•Market concentration:
•In the context of weak institutions, concentration could reflect overdue protection of
inefficient sectors but is not necessarily hampering growth
•Firm-level date show significant market concentration, particularly for state-controlled
or heavily regulated sectors
•Concentration correlated with more profitable sectors but not with high-investing ones
(measured by net fixed assets growth)
•No clear correlation with effective tariff protection; neither effective tariff protection is
correlated with strategic value sectors
•Trade openness shrunk from 68.1% of GDP in 2000 to 55.4% of GDP in 2004,
with limited new trade agreements signed compared to the region
•Some taxation issues (red tape, tax rate structure, VAT drawback process) viewed
as moderately problematic for doing business
•Business costs: starting a business is relatively fast and inexpensive, hiring costs
are among the lowest in LA while firing costs are particularly high
Industrial base and export diversification
•A weak industrial base for innovation and product sophistication:
•One of the lowest indexes for manufacturing value added and exports in LAC despite
recent growth
•Limited technological complexity (medium and high-technology 15% of total v.a.; very
low manufacturing v.a.; industrial competitiveness index weak)
• Limited export diversification:
•Some recent diversification by product (5 non-oil exports share down from 79% in
1990 to 59% in 2006); number (exported items grew from 281 to 858); and destination
(5 largest destinations fell from 78% to 62%)
•Manufacturing exports remain largely concentrated by product (5 items - 51% exports)
and geographically (East Asia – only 1,5%)
Product space and strategic value
•Hausmann and Klinger/UTEPI strategic value approach:
• Ecuador’s productive capabilities in sparse parts of the product space; some movement
in oil, forest and tropical agriculture but no high sophistication areas
•Specialized in sectors wit limited global trade growth, value added & technological
diffusion – not global star products
•Open forest has increased since 1975, as for LAC average, and remains low by regional
standards: moving toward high strategic value goods—far from existing products—
would require effort and adaptation
•Ecuador appears to have products with higher strategic value but farther away: high
growth potential but harder to reach
10121416 182022
ECU
Ecuador and other LAC countries: Open Forest
2,000,000
1,800,000
1,600,000
4 6 8
1,400,000
1,200,000
1,000,000
.5
1.5
2.5
Density (inverse)
Petroleum
Forest
Animal Prods
L Intensive
Machinery
3.5
Raw Materials
Tropical Ag
Cereals
K Intensive
Chemicals
4.5
800,000
600,000
400,000
200,000
0
1975
Ecuador
1980
1985
Colombia
1990
Chile
1995
Brazil
2000
2005
Argentina
Industrial policy?
• Some successful cases of product development (bananas, shrimps, strawberries,
palm heart, broccoli) but also poorly designed or failed industrial policy experiences
•Main lessons: key role of well-educated entrepreneurs, key market information
trade agreements, combined public-private initiatives in some cases
•Supporting policies: well-targeted and controlled credit access for small producers,
public leadership to overcome perceived low appropriability of private returns,
human capital policies, FDI attractiveness, some real exchange rate depreciation
•Potential usefulness of public policies to address some coordination failures and
technical expertise needs
•However, bad experiences with strong state presence in some areas must always be
reminded for caution
Policy recommendations
•Access to finance:
•Access to international financing may become important beyond the current
favorable situation, as highlighted by Ecuador’s experience and crises –
contingent credit lines
•Underlying factors are critical: legal stability, creditor rights, informality.
Some role for public-private partnerships to foster well-designed access to
small producers
•Buttress efficient mechanisms for banking regulation, early prevention and
resolution procedures, depositor protection
•Enhanced attractiveness to foreign banks & banking transparency
•Macro stability:
•Foster consensus over sustainable fiscal policies
•Politically difficult but potential areas: budget transparency, prioritization of
public investment and integrating planning and budget, protecting fiscal
revenues to some sectors in bad times (structural fiscal balance?)
Policy recommendations
•Infrastructure:
•Prioritize in oil and energy without hampering fiscal stability – role of oilrelated funds, reducing oil subsidies
•Increased transparency and governance for public controlled companies;
business-oriented and professional management
•Appropriability:
•The hardest to address – long term and comprehensive efforts
•Institutional reforms for the Judiciary, Customs
•Transparency and accountability (understandable budget objectives in terms of
the coverage of social needs, financial management system, rules for public
market attribution)