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DIRECTIONS IN DEVELOPMENT
Crisis and Dollarization
in Ecuador
Stability, Growth, and Social Equity
Paul Beckerman and Andr6s Solimano
Editors
THE WORLD BANK
Washington, D.C.


@ 2002 The International Bank for Reconstruction
and Development/THE WORLD BANK
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First printing June 2002
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Contents
Preface  ...........................................................................................................  ix
Abbreviations  .................................................................................................. xi
1. Crisis and Dollarization: An Overview   .................................................1
Andr6s Solimano
Introduction                 ............................... .........1
Historical and Structural Features of Ecuadoran Economy and
Society ..........................................4
Dollarization: Lessons and Challenges Ahead ................................ 6
Social Impact of Economic Crisis and Dollarization ........................12
Organization  of This Book  .................................................................. 13
Notes ............................................13
References           .............................................14
2. Longer-Term Origins of Ecuador's "Predollarization" Crisis ..........17
Paul Beckerman
1. Introduction          .............................     ........17
2. Historical Background of Ecuador's Predollarization Crisis .........19
3. Ecuador's Economic Structure Going into the Predollarization
Crisis ..........................................34
4. Ecuador's Predollarization Crisis  ......................51
.5. Conclusion: Underlying Causes of Ecuador's Predollarization
Crisis ..........................................59
Notes ................................................76
Bibliography  ......     ..... ............................... ............................ 78
3. Ecuador under Dollarization: Opportunities and Risks ..............81
Paul Beckerman and Herndn Corts-Douglas
1. Introduction                               .....................................81
2. Evidence and Theory from the Literature on Dollarization ...........83
3. Lessons from Panama's Dollarization ...................86
iii


iv                              CRISIS AND DOLLARIZATION IN ECUADOR
4. Lessons from Argentina's Currency-board Experience ........90
5. Ecuador's Dollarization System                   ....................95
6. Transition Issues: Deposit Unfreezing and Price Adjustment .....100
7. Ecuador's Macroeconomic Performance under Dollarization in
2000 and 2001        .......................................108
8. The Longer Term under Dollarization ..................117
9. Conclusions        ........................................120
Notes ...........................                      ....................121
Bibliography           ..............................................123
4. Ecuador: Crisis, Poverty, and Social Protection ................................127
Suhas Parandekar, Rob Vos, and Donald Winkler
1. Introduction        ....................................................127
2. Inequality and Poverty................................130
3. Vulnerable Groups...................................134
4. Human Development..............................138
5. Targeted Poverty Programs............................146
6. Future Prospects.....................................162
7. Strategic Options................................................170
Notes.                                  ...............................................174
References.         .......................................175
5. Gender Dimensions of Vulnerability to Exogenous Shocks:
The  Case  of Ecuador ...............................................................................177
Maria Correia
1. Introduction           ...............................   .....177
2. Assessing Vulnerability to Exogenous Shocks: A Framework .....179
3. Gender and Household Vulnerability in Ecuador .........................181
4. Institutional Context    ........ ..... .................... ....................203
5. Conclusions and Recommendations ......................................204
N otes  ............................    ...............................................207
References          ...........................................211
Tables
2.1    Ecuador: Governments, 1979-2001 ............................................29
2.2    Ecuador: Dollarization Indicators   ...............    ........47
2A.1   Ecuador: Selected Annual Macroeconomic Indicators,
1991-2000  ...............................................62
2A.2a Ecuador: Selected Monthly Macroeconomic Indicators, 1998 .....64
2A.2b Ecuador: Selected Monthly Macroeconomic Indicators, 1999 .....66
2A.3   Ecuador: National-Income Accounts     .......................68
2A.4   Ecuador: Nonfinancial Public-Sector Accounts (Percentage of
G D P)  ................................................................................................ 70


CONTENTS                                                         v
2A.5 Ecuador: Balance-of-Payments Accounts (US$ Million) ............72
2A.6 Ecuador: Year-End External Debt Outstanding and Disbursed
(US$ Million)       .......................... ...........73
2A.7 Ecuador: Year-End Monetary and Commercial-Bank Aggregates
(Percentage of GDP), 1987-1999  ..............     .........74
3.1  Panama: Selected Macroecononic Indicators, 1970-99 .............87
3.2  Argentina: Selected Macroeconomic Indicators, 1989-2000 ...........92
3.3  Ecuador: The Central Bank's Four Balance Sheets, March 10,
2000-December 31, 2001      .....................   ........97
3.4  Ecuador: Exchange Rate (Sucres per U.S. Dollar), Consumer
Prices, and Real-effective Exchange Rate,
December 1998-December 2001     .................................105
4.1  Extreme Poverty in Ecuador                   ................ .........132
4.2  Consumption-based Comparison of Poverty in Ecuador .............133
4.3  Ecuador: Household Characteristics by
Consumption Quintile                            ...............135
4.4  Ecuador: Correlates of Poverty  .......................137
4.5  Ecuador: Composition of Social Spending, 1995-2001 .................149
4.6  Public Expenditure Incidence of Social Spending by Type of
Program and Per-capita Expenditure Quintiles, 1999 ........150
4.7  Vulnerable Groups Among the Poor and Ecuador's Social-
Protection Programs      ...............................151
4.8  Ecuador: Targeting Errors of the Bono Solidario by
Eligibility Criteria, 1999  ............................153
4.9  Ecuador: Eligible Population and Actual Recipients of the
Bono Solidario, 1999                     ........................ ........153
4.10 Ecuador: Coverage and Targeting: Programs for Children
under Six Years                         ............................ ......157
4.11 Ecuador: Coverage and Targeting: Programs for
School-Age Children        .........................   .....159
4.12 Ecuador: The Annual Cost of Alternative Coverage, Level,
and Targeting Changes in the Bono Solidario (in US$) ...................165
4.13 Strategies for Social Protection  .           .......................171
5.1  Structure of Employment by Sex and Status (Quito,
Guayaquil, and Cuenca Averages from March 1998 to
March 2000)         .............................................195
5.2  Average Level of Education of the Labor Force by Sex and Labor
Market/Unemployment Segment (Quito, Guayaquil, and Cuenca
Averages from March 1998 to March 2000) ..........    .......195
5.3  Unemployed, According to Education and Sex (Quito, Guayaquil,
and Cuenca Averages from March 1998 to March 2000) ..............196
5.4  Labor-market Segmentation by-Sex (Quito, Guayaquil, and
Cuenca Averages from March 1998 to March 2000) ......................196


vi                              CRISIS AND DOLLARIZATION IN ECUADOR
5.5  Unemployed Population by Relationship with Household Head
(Quito, Guayaquil, and Cuenca Averages from March 1998 to
M arch  2000)  ..........................................................................................198
5.6  Indicators of Land Ownership in Ecuador ....................................202
Figures
2.1   Ecuador: Year-end Public and Publicly Guaranteed External Debt
(US$ million), 1970-2000 ...................       .......................27
2.2   Ecuador: Per-capita Real GDP, Real Private Consumption, and
Year-End Per-capita Public External Debt in 1999 U.S. Dollars
and  Prices, 1972-2000  .................................................................... 31
2.3   Ecuador: Gross Domestic Capital Formation (at 1975 Prices,
1975  GDP  =  100), 1965-2000  ........................................................... 32
2.4   Ecuador: Gross Fixed Capital Formation, Gross Domestic Saving,
and Net Imports of Goods and Nonfactor Services (Percent of
G D P , 1971-2000. .............................................................................. 33
2.5   Ecuador: Exchange Rate (Sucres per U.S. Dollar); Trade-Weighted -
Real-Effective Exchange Rate (+ = Depreciation; 1990 = 100), June
1970-Septem  ber 2001  ....................................................................... 33
2.6   Ecuador: Per-Capita Nonfinancial Public-Sector Revenue
(in 1998 U.S. Dollars at 1998 Prices), 1990-2000 ..........................37
2.7   Ecuador: Monthly Average Crude Oil-Export Price,
June  1995-September 2001  ............................................................. 38
2.8   Ecuador: Per-Capita Central Government Expenditure
(in 1998 U.S. Dollars at 1998 Prices), 1990-2000 .........................39
2.9   Ecuador: Nonfinancial Public-Sector Overall and Primary
Surplus (US$ Million at 1998 Prices and Exchange Rate),
1990-2000. .......................................................................................... 42
2.10 Ecuador: Onshore Commercial-Bank Deposits (US$ Million) .......48
2.11 Ecuador: Onshore Commercial-Bank Loans Performing
N orm ally  and  in  Arrears  ................................................................49
2.12 Ecuador: Indicators of Macroeconomic Imbalance, 1988-2000 ......52
2.13 Ecuador: Consumer Prices, 1995-2000 .........................................55
3.1   Ecuador: Monthly Trade-weighted Exchange-rate Competitive-
ness, December 1994-December 2001...............................................103
3.2   Ecuador: Monthly Increases in Consumer Prices, January
1999-Decem  ber 2001....................      ..............................103
3.3   Ecuador: Consumer Prices and Weighted
Trading-partner Prices at the Current Exchange Rate,
December 1997-December 2001      ......................................................104
3.4   Ecuador: Quarterly Real GDP (1998 average =100),
1997.4-2001.4.........................................................................................109


CONTENTS                                                        Vn
3.5  Ecuador: Quarterly Nonfinancial Public-sector Revenue
(US$ million), 1998.2-2001.4  .........................110
3.6  Ecuador: Quarterly Nonfinancial Public-sector Expenditure
(US$ million), 1998.2-2001.4 ........................111
3.7  Ecuador: Quarterly Performance of the Main Components of
the Current Account of the Balance of Payments (US$ million),
1998.1-2001.4       ....................................113
3.8  Ecuador: Monthly Merchandise Trade and Real-effective
Exchange Rate (December 1996-October 2001) ...................117
4.1  Ecuador: Real Wage and Urban Poverty Trends
(index, 1990 = 100)      ........................... ......134
4.2  Malnutrition Rates in Latin America ................ ...........139
4.3  Malnutrition in Ecuador: Stunting (%) by Consumption
Quintiles, 1998 and 1999   ........................................139
4.4  Malnutrition in Ecuador: Stunting (%) by Area and Region,
1998-2000  ..................           ........... ....................140
4.5  Ecuador, Jamaica, Honduras: Years of Educational Attainment
by Age Cohort         .......................................141
4.6  Ecuador: Educational Attainment by Rural and Urban Areas
(persons over 24 years old )   .....................  ....143
4.7  Ecuador: Gender Gap in Education   ..............    ......144
4.8  Ecuador: Percentage of 18-Year-Olds Completing School ............145
4.9  Ecuador: Percent of Children Working, 1999 ..................................146
4.10 Ecuador: Social Spending per Capita, 1995-2001 (in US$) ...........148
5.1  Factors Affecting Vulnerability to Exogenous Shocks....................181



Preface
Understanding the nature of deep economic crises and social disarray
and formulating adequate exchange rate and other policies for stabiliza-
tion, growth, and social equity are topics of great importance in develop-
ing countries and emerging economies in the turbulent world of the early
21st century.
The experience of Ecuador in the late 1990s and the early 21st century
showcases a country with structural problems of low growth, regional
divides, and social and ethnic fragmentation made more acute by a
severe currency and banking crisis in the late 1990s. Ecuador's response
to the crisis centered on the adoption of foreign money-dollarization-
as a last-resort measure to cope with total distrust in the national cur-
rency and domestic institutions after repeated cycles of failed
stabilization and crisis. This book assesses several aspects of the Ecuado-
ran experience, including a historical analysis of the main features of the
country's economic development and the main political economy fea-
tures that set the background for the most recent cycle of crisis and stabi-
lization. The book analyzes in detail the characteristics of the economic
crisis of 1998-99 and the subsequent experiment with dollarization and
its initial results. Then the book turns to the impact of the crisis and sub-
sequent stabilization through dollarizaton. on poverty, inequality, mar-
ginalization, gender, and the Ecuadoran family. The book also assesses
the ability of existing social-protection institutions to cope with a severe
economic crisis and subsequent stabilization.
Most of the material for this book was initiated when several of the
authors belonged to what was then the World Bank's Country Depart-
ment for Ecuador, Colombia, and Venezuela. The work benefited from
first-hand involvement-at times at the highest political level-in
Ecuador until mid-2000.
We want to acknowledge several people and former colleagues who
made this book possible. David de Ferranti, World Bank Vice President
for Latin America and the Caribbean, provided generous financial sup-
port to fund this publication and encouraged a free analysis of events and
lx


x                           CRISIS AND DOLLARIZATION IN ECUADOR
policies in Ecuador. David Yuravlivker, Vicente Fretes-Cibils, and
Eduardo Wallentin also provided useful insights based on their knowl-
edge of Ecuadoran economy and society. Luis Jacome, former governor
of the Central Bank of Ecuador, provided helpful comments on chapters
2 and 3. Diana Cortijo, Mario Aventino, and Hazel Vargas gave important
logistic support, and Paola Scalabrin was instrumental in publishing this
project. We also appreciate efficient editorial work by Thea Clarke. Book
design, editing, production, and dissemination were coordinated by the
World Bank Publications team. As ever, the authors alone are responsible
for any errors of fact or judgment this book may contain.


Abbreviations
AGD          Agencia de Garantia de Dep6sitos (Deposit Insurance
Agency, Ecuador)
CAF          Andean Development Corporation
CAN          Andean Community of Nations
CDC          Centers for Disease Control, U.S.
CEPLAES      Centro de Planificaci6n y Estudios Sociales (World Bank
Poverty Group)
CONAMU       el Consejo de las Mujeres del Ecuador (National Council
of Ecuadoran Women)
DDSR         debt-and-debt-service reduction
DINAMU       Direcci6n Nacional de la Mujer (National Directory for
Women, Ecuador)
ECD          early childhood development
ECV          Encuesta de Condiciones de Vida (Ecuador LSMS
survey)
EAP          economically active population
EU           European Union
FISE         Fondo de Inversi6n Social de Emergencia (Emergency
Social Investment Fund, Ecuador)
GDP          gross domestic product
IDB          Inter-American Development Bank
IESS         Instituto Ecuatoriano de Seguro Social (Ecuadoran
Social Security Institute)
IMF          International Monetary Fund
INEC         Instituto Nacional de Estadistica y Censo (National
Institute of Statistics and Census, Ecuador)
INNFA        Instituto Nacional del Niflo y de la Familia (National
Institute of the Child and the Family, Ecuador)
LIBOR        London interbank offered rate
LSMS         Living Standards Measurement Study
MERCOSUR     Mercado Comin del Sur (Southern Common Market)
NCHS         National Center for Health Statistics, U.S.
NGO          nongovernmental organization
OECD         Organisation for Economic Co-operation and
Development
xi


xii                         CRISIS AND DOLLARIZATION IN ECUADOR
OPEC          Organization of Petroleum Exporting Countries
ORI           Operaci6n Rescate Infantil (Child Rescue Program,
Ecuador)
PACMI         Programa de Alimentaci6n Complementaria
Materno-Infantil (Maternal-Infant Nutrition Program,
Ecuador)
PAHO          Pan American Health Organization
PANN          Programa Nacional de Alimentaci6n y Nutrici6n (Food
and Nutrition Program that replaces PACMI in Ecuador)
PDI           Programa de Desarrollo Infantil (Child Development
Program, Ecuador)
PRONEPE       Alternativo Programa Nacional de la Educaci6n
Prescolar (National Alternative Preschool Education
Program, Ecuador)
SIISE         Sistema Integrado de Indicadores Sociales del Ecuador
(Integrated System of Social Indicators of Ecuador)
SIMUJER       Situation of Women and Gender Inequality Indicators
database, Ecuador
STFS          Secretaria T6cnica del Frente Social (Technical Secretariat
of the Social Front, Ecuador)
VAT           value added tax
WHO           World Health Organization


Crisis and Dollarization:
An Overview
Andr6s Solimano
Introduction
On January 9, 2000, Ecuador decided to adopt the U.S. dollar as its
national currency, its domestic medium of exchange, and its unit of
account,1 thus becoming the first country to officially dollarize its econ-
omy in the 21st century. The purpose of this book is to analyze the con-
text within which dollarization took place in Ecuador and some of its
economic consequences. It describes the initial conditions, accompanying
policies, and response of the economy to the official adoption of a foreign
currency as the legal tender and the issues the still-new Ecuadoran expe-
rience with dollarization suggests for other countries considering the
adoption of a new monetary regime. Another important theme of the
book is the social impact of the crisis of the late 1990s and of subsequent
dollarization.
The end of the 20th century caught Ecuador in one of the more serious
economic crises-compounded by a governance crisis-in its Republican
history. The country was on the verge of hyperinflation in late 1999 with
the price level increasing at a rate of near 30 percent per month. The
national currency, the sucre, was in free fall. The government had inter-
vened in the banking system, and a large part of the deposits of the pub-
lic was frozen. Internationally, in late 1999 the country was in partial
arrears with private creditors and bondholders and, for various reasons,
the International Monetary Fund (IMF) had withheld for nearly a year a
crucial loan to support the balance of payments. This, in turn, forced the
World Bank and the Inter-American Development Bank (IDB) to post-
pone their own policy-based lending to Ecuador in 1999, attendant to the
The author was Country Director of the World Bank for Ecuador, Colombia, and
Rep6blica Bolivariana de Venezuela between 1997 and 2000. He is currently
Regional Advisor for the United Nations Economic Commission for Latin
America and the Caribbean. Comments on this chapter by Paul Beckerman are
appreciated.
1


2                            CRISIS AND DOLLARIZATION IN ECUADOR
stalemate with the loan by the IMF. At a time when hyperinflation had
abated in Latin America, the Ecuadoran case of extreme monetary insta-
bility was clearly a regional anomaly for the late 1990s.
Most of the ingredients of.high inflation and acute monetary instabil-
ity were present: (a) a flight from national money and de-facto dollariza-
tion2 as nationals and foreigners in Ecuador lost all confidence in the
capacity of the sucre to serve its store-of-value function, (b) large fiscal
deficits, (c) a sharp contraction in real economic activity, and (d) a severe
banking crisis.3 The increasingly cornered government, led by President
Jamil Mahuad, a highly educated and intellectually sophisticated social-
democrat, could not gather congressional support for passing crucial tax
legislation and other measures to stabilize the economy..This situation,
combined with the near paralysis of the international financial institu-
tions based in Washington, helped bring about an economic meltdown
manifested in very high inflation, a banking-crisis, economic depression,
and social disarray during most of 1999. It is important to recognize that
the Ecuadoran crisis took place in a delicate situation of security within
the Andean region. On the one hand, Ecuador and Peru were tiying to
consolidate an historic peace agreement signed by Ecuadoran President
Jamil Mahuad and Peruvian President Alberto Fujimori in October of
1998. On the other hand, Ecuador was exposed to the potentially desta-
bilizing effects of acute intensification of the armed conflict in Colombia,
a country that shares a long border with Ecuador.
In this setting, and in one of the more dramatic experiments in recent
monetary history, the Ecuadoran government decided, in January of
2000, to adopt, de facto, unilaterally, and apparently.without much exter-
nal consultation, the U.S. dollar as its national currency. This was a "pol-
icy of last resort," an almost desperate move to restore some degree of
monetary and price stability in a country that needed an urgent monetary
anchor to stabilize expectations, avoid hyperinflation, stop uncontrolled
currency depreciation, and enable resumption of normal economic and
financial activity.
Official dollarization had a political motivation as well. In late 1999,
constitutionally elected President Mahuad was facing a sharp plunge in
his popularity. His presidency was being challenged by a particularly
adverse set of events: a severe economic crisis, an active and militant
indigenous movement with radical political and economic demands, a
badly divided and fragmented parliament, and a restive army. In these
circumstances, a radical change in the monetary regime toward dollar-
ization was seen by President Mahuad as a way to regain the initiative
for his government, by changing the focus of the national debate away
from purely political issues toward much needed economic stabiliza-
tion. In spite of the announcement of official dollarization, President


CRISIS AND DOLLARIZATION: AN OVERVIEW                            3
Mahuad was deposed on January 21, 2000, following an indigenous
uprising that seized the parliament building with support from units of
the army. After late-night negotiations involving rebellious colonels,
members of the political class, the U.S. Embassy in Quito, and the Orga-
nization of American States, the rebels stood down and Vice President
Gustavo Noboa was sworn in as the new President of Ecuador in the
Ministry of Defense with the support of the army. The "constitutional
order" was restored.
The new government of Gustavo Noboa ratified the change of monetary
regime initiated by President Mahuad, and official dollarization was
adopted, in haste, and under very fragile conditions. At this stage, consul-
tations were initiated with the U.S. government, whose currency was to be
adopted. The reluctant IMF, which had distanced itself from the Mahuad
administration, resumed lending in April 2000, and entered into full col-
laboration to ensure the success of the change in the monetary regime.4
The mechanics and economic effects of dollarization are important
subjects of this book. Supportive economic and financial legislation-the
Law of Economic Transformation-was approved in March 2000. This
legislation included a number of structural changes in several areas. In
August 2000 Ecuador successfully carried out a bond exchange, which
reduced its massive Brady debt by roughly a third, and its bilateral exter-
nal debt was rescheduled in September 2000 by the Paris Club. The econ-
omy benefited from an increase in the international price of oil, which
helped to improve the fiscal accounts and the balance of payments. At the
same time, important efforts to improve tax collection were undertaken.
The income tax, which had been suspended in January 1999, was rein-
stated. The fiscal accounts improved sharply, passing from a fiscal deficit
of near 5 percent of gross domestic product (GDP) in 1999 to a small sur-
plus in 2000.
The balance of payments also improved, as a result of a combination
of favorable oil prices, the repatriation of flight capital helped by the lib-
eralization of dollar deposits in the banking system associated with offi-
cial dollarization and, very importantly, by a surge in foreign remittances
of Ecuadorans following massive emigration after the crisis that began in
1998-99.5 As a consequence of all these factors, the current account of the
balance of payments registered a surplus of nearly 10 percent of GDP in
2000 compared with a deficit of roughly the same,magnitude in 1999.
The progress in solving the banking system crisis was slower than in
other areas. In spite of intensive work to rationalize, dispose the assets of
nonviable banks, privatize intervened banks, and other measures, as of
2001 a considerable segment of the Ecuadoran banking system still
remained in the hands of the Deposit Insurance Agency (Agencia de


4                            CRISIS AND DOLLARIZATION IN ECUADOR
Garantia de Dep6sitos, AGD), which underwent several changes in its
management structure in 2000 and 2001.
Dollarization succeeded in stabilizing expectations, as reflected in
declining interest rates and induced capital repatriation. Banks registered
an increase in their deposits from the public. Dollarization did not stop
inflation immediately, because adjustment to a new equilibrium level for
the real exchange rate, undervalued when dollarization was launched,
was reached through inflation. In addition, GDP started to recover fol-
lowing official dollarization, helped by a gradual recovery of confidence
and favorable external shocks. In turn, unemployment has slowly
declined and real wages have become more stable, although real wage
levels are rather depressed in dollar terms.
Historical and Structural Features of Ecuadoran
Economy and Society
The deep economic crisis of the late 1990s that preceded dollarization in
Ecuador was, as argued in this book (see chapters 2 and 3), the culmina-
tion, in dramatic overtones, of an economic and governance crisis associ-
ated with several structural characteristics of Ecuadoran economy and
society. Historically, the emergence of Ecuador as an independent state
from the the Confederation of Gran Colombia in 1830 created a country
with two main competing regions: a coastal area (Costa) centered around
the city of Guayaquil and the Sierra or highlands around the capital city
of Quito. The two regions have different social, economic, cultural, and
ethnic characteristics. Regional disputes have been an important source
of social and political instability in Ecuador throughout the 19th and 20th
centuries. Ecuador's main political parties are formed along regional
lines, weakening central authority and forcing a style of policymaking
that allocates resources, taxes, and quotas of political power in an effort
to maintain regional balance.6 Economy-wide objectives such as eco-
nomic growth and monetary stability are often displaced by the needs of
regional balancing, redistribution, and rent-seeking. In turn, Ecuador, like
most Latin American countries, is a highly socially stratified country.
Wealthy people, elite landowners, and financial and industrial entrepre-
neurs coexist with a population that is mostly poor (see chapter 4) and
with a large (at times politically active) indigenous population. This
social structure superimposed on the regional divide often hampers the
capacity of governments to undertake national policies that garner wide
social consensus. During the 20th century the country endured repeated
constitutional reforms, presidential crises, and cycles of military govern-
ments followed by civilian rule (see Solimano 2002), both trying to ensure
stable governance and economic development but with often disappoint-


CRISIS AND DOLLARIZATION: AN OVERVIEW                            5
ing results.
The difficulties of building stable governing coalitions were exacer-
bated in the late 1990s. In fact, since 1996 Ecuador has had four different
Presidents: Abdald Bucaram, Fabian Alarc6n, Jamil Mahuad, and Gus-
tavo Noboa.' Over the same period there were about 10 finance ministers
plus a frequent rotation of the technocracy working in government. Many
of the most able and qualified people left the country.
A common feature of the Ecuadoran economy in the 20th century
has been the dependence of real economic activity, the fiscal accounts,
and the balance of payments on exports of a few commodities, such as
cacao, bananas, shrimp, and oil. This dependence has made the econ-
omy prone to volatility associated with cycles in the international
prices of commodities and climatic changes. This dependence on com-
modity prices was accentuated in the 1970s with the oil price boom.
Although the oil boom allowed a doubling of the yearly real growth
rate of GDP of previous decades, from an annual rate of growth of 4.7
percent per year in 1950-60 to 9.4 percent in the 1970s, this dynamism
was ultimately short-lived. In the 1980s and 1990s the economy
reverted to average GDP growth rates on the order of 2 percent, lower
than the historic average of the past 50 years,in Ecuador and in Latin
America.
In the 1980s Ecuador, like other Latin American economies, suffered
a foreign debt crisis after the windfall of oil revenues of the 1970s, and
the cycle of foreign overborrowing of that decade. As a consequence,
GDP growth declined to around 2 percent in the 1980s, down from
more than 9 percent in the previous decade. In the 1990s, Ecuador
started reforms that were never completed, suffered several large
external shocks and natural disasters, and then culminated the decade
with the disruptive economic and financial crisis we have already dis-
cussed and which is analyzed in further detail in the next chapter of
this book.
An important cause of Ecuador's unsatisfactory economic perfor-
mance is weak institutions. The fiscal structure has traditionally been
very dependent on the revenues of oil and taxes on other commodities
and, until recently, has suffered from the widespread practice of tax eva-
sion. Public expenditure is far from efficient and well directed. In turn,
the crisis of the banking system that started in 1998 also revealed serious
shortcomings in the regulatory structure of the system, a pattern of loan
concentration, and the vulnerability of the bank's portfolios to high real
interest rates and overall economic decline.
Still, there is room for (cautious) optimism. Ecuador is a country with
significant economic potential. It has a strong natural resource base and
talented people, its geographical proximity to major international mar-


6                             CRISIS AND DOLLARIZATION IN ECUADOR
kets in the "center" makes it a favorable location for international trade
and foreign investment, and, in spite of its complex social and regional
structure, it is generally a country of social peace.
Dollarization: Lessons and Challenges Ahead
The experience of Ecuador with dollarization is of interest for the rest of
Latin America and other emerging economies wrestling with the adop-
tion of the adequate exchange-rate regime in a world of increased finan-
cial integration but also of volatility and instability. We can highlight six
important areas in which the Ecuadoran experience is relevant for other
nations.
Dollarization under Fragile Initial Conditions
The choice of a monetary regime by a country is a far-reaching decision
that, under normal circumstances, must be preceded by a period of inter-
nal discussion of the merits and possible disadvantages of possible alter-
natives. Moreover, the introduction of a foreign currency to replace the
national currency needs to be accompanied by adequate preparation and
by legal reforms in several areas of the economy. A solid banking system,
a sustainable fiscal position, and wage and price flexibility are all eco-
nomic preconditions for successful dollarization. On the legal side, basic
legislation must be introduced to legally sanction the new currency and
allow contracts (wages, rents, and so on) to be made in foreign currency
(now also the national currency). Also, the accounting systems of banks
and corporations have to adopt new practices and conventions in line
with the fact that a foreign currency is the legal tender after official dol-
larization is adopted.
The decision of when to dollarize (for example, its timing and sequenc-
ing) is, however, a matter of debate. Some people adopt the position that
dollarization need not wait on these other reforms to be in place and
believe, on the contrary, that dollarization can accelerate the overall
process of reform.8
As shown earlier, adequate fiscal, financial conditions, and accounting
practices were not present when Ecuador announced dollarization in Jan-
uary 2000. It is apparent that dollarization was not a decision made under
controlled conditions to ensure its success. Rather, it was a bold move to
reverse a situation of near hyperinflation and massive flight away from
domestic currency, debased after a long period of monetary instability.
Also, as already mentioned, the fiscal budget was in a sizable deficit dur-
ing the year preceding dollarization and the state intervened in a large


CRISIS AND DOLLARIZATION: AN OVERVIEW                            7
part of the banking system, with several important banks having nega-
tive net worth.
Important pieces of legislation regarding the banking system, the new
accounting systems, the conversion of contracts from sucres to dollars,
labor laws, and other laws were passed after dollarization was launched.
In fact, the legal approval of dollarization came in March 2000 and it was
fully implemented in September 2000. The degree of public support for
dollarization was mixed. Various groups, such as the indigenous people's
movement and left-wing political parties, opposed dollarization, in part
on nationalistic grounds. The middle class, industrialists, and bankers,
however, supported dollarization both in Guayaquil and Quito. Very
importantly, Congress ultimately supported dollarization. The United
States was initially very cautious in supporting the measure taken by
Ecuador. In the end dollarization was launched, implemented, and as of
early 2002 consolidated. In a metaphoric sense, dollarization was a revo-
lutionary regime change in the monetary system of the country and, like
many revolutions, starting from dramatically deteriorated conditions, it
still succeeded in holding. Of course, other countries considering dollar-
izing would certainly benefit from more stable and balanced initial con-
ditions. This was, indeed, the case of El Salvador, which decided to
dollarize in January 2001 in far more comfortable fiscal and financial con-
ditions than those of Ecuador just a year before. Indeed, El Salvador had
maintained a fixed exchange-rate regime for almost a decade, and dollar-
ization was seen as a "natural" consequence of a long period of a fixed
exchange rate, low domestic inflation, and a largely dollarized banking
system. A more distant case of dollarization is, Panama, which adopted
the system in 1903 and has nearly a century of economic history with a
foreign currency as the national currency.9
The Dynamics of Inflation, the Real Exchange Rate,
and Output
Dollarization was adopted in Ecuador mainly to stop very high infla-
tion.10 In the last quarter of 1999 the consumer price index rose by 60 per-
cent; the wholesale price index rose by 187 percent. However, the
domestic price level continued to rise rapidly after dollarization was
adopted, following a sharp depreciation of the currency from 18,000 to
25,000 sucres per dollar." There were two main reasons for the large
depreciation of the currency preceding dollarization that was fueled by
wild expectations of Ecuador's financial markets: (1) the intent to avoid a
real appreciation after dollarization on account of "residual inflation"
and (2) the need to increase the purchasing power of a limited level of
international reserves (dollars) to buy (cheaply) the monetary base in


8                            CRISIS AND DOLLARIZATION IN ECUADOR
sucres at a more depreciated exchange rate. This latter factor was impor-
tant since Ecuador had a very low level of international reserves at the
time dollarization was implemented. Domestic prices nearly doubled
over 2000. For 2001, however, inflation was only about 25 percent.
Clearly, after official dollarization the speed of convergence of the domes-
tic price level to a new international parity was gradual and spread over
at least two years after the new currency was introduced.
A similar speed of inflation convergence was observed in Estonia, a
country that introduced a currency board in 1992. In Estonia inflation
converged to moderately low levels, only two years later, in 1994.12
The real exchange rate in Ecuador depreciated mildly in 1998 (about
3.5 percent), but depreciated about 40 percent in 1999. After an additional
real depreciation in January of 2000 following the "last" maxi-deprecia7
tion of the sucre, the real exchange rate (a somewhat peculiar concept in
a dollarized economy) began steadily appreciating in February 2000 and
afterwards as a consequence of the slow process of convergence of the
domestic price level already noted above (see chapter 3 for a more
detailed analysis of these trends).
This pattern of rapid real depreciation of the national currency before
the change in the monetary regime followed by a real appreciation of the
currency was observed in three countries that adopted currency boards
in the early 1990s: Argentina in 1991, Estonia in 1992, and Lithuania in
1994. As the acute crisis of Argentina in late 2001 and early 2002 is show-
ing rather dramatically, the failure to correct the real appreciation of the
currency through domestic deflation, cuts in nominal wages, and unem-
ployment can be so costly as to generate an economic and political crisis
of large proportions leading, among other things, to abandonment of the
seemingly irreversible currency board regime.
The growth cycle before and after official dollarization in Ecuador was the
following: real GDP contracted sharply in 1999, falling by 7.3 percent that
year, with unemployment rising from 11 to 15 percent. As chapters 2 and 3
of this book document, this situation was the combined effect of several fac-
tors: external shocks (a decline in oil prices in 1998/99), natural disasters (the
El Nifio phenomena in 1997/98), domestic instability, and a severe banking
crisis. The latter clearly amplified the contractionary effects of the other
shocks. GDP grew by 2.3 percent in 2000, as a consequence of an improve-
ment in domestic confidence following dollarization (domestic interest rates
fell) and by a recovery in international oil prices. Real growth reached 5.4
percent in 2001 as the gradual stabilization in inflation consolidated, confi-
dence recovered, and construction of the second Transandean oil-pipeline
generated employment and income. However, social conditions in Ecuador
postdollarization still remain precarious (see chapters 4 and 5).


CRISIS AND DOLLARIZATION: AN OVERVIEW                            9
Dollarization in Ecuador and Exchange-Rate Regimes
in the Andean Area
Ecuador is a member of the Andean Community of Nations (CAN), a
free-trade area. Although exchange-rate regime harmonization among its
member countries is not practiced in the CAN, and monetary integration
is still not on their agenda, the fact is that Ecuador's new monetary sys-
tem adds to the already large variety of exchange-regimes in the Andean
region. At present (mid-2002) we have floating exchange-rate regimes in
Peru, Colombia, and Rep6blica Bolivariana de Venezuela, a crawling peg
system in Bolivia, and a foreign-currency regime in Ecuador. The fact that
two trade partners (and neighboring countries) of Ecuador-Peru and
Colombia-are in a floating exchange-rate regime while Ecuador is dol-
larized creates the potential for Ecuador to lose regional competitiveness,
should these countries depreciate their currencies, an option unavailable
to Ecuador. In the context of MERCOSUR (Mercado Comin del Sur)
countries, this is what exactly happened to Argentina when Brazil
sharply devalued its national currency, the real, in early 1999, causing
Argentina to suffer an important loss of competitiveness. Argentina, with
its currency board system, could not adjust its exchange-rate parity to
maintain competitiveness. A similar situation is starting to face Ecuador,
so this can be considered a vulnerability of the new system. A more gen-
eral lesson here is that decisions made by one country on its exchange-
rate regime should consider the interdependences with the exchange-rate
regimes of other member countries of the same integration bloc. The
CAN and MERCOSUR are just starting to put in place mechanisms of
consultation on monetary and fiscal policy among their member coun-
tries. Such consultations are still far behind experiences of macroeco-
nomic coordination and harmonization such as that of the European
Union (EU), in which the exchange-rate regimes were defined in a collec-
tive way. Of course, the degree of integration in goods, capital, and labor
markets in the EU is far higher than in the CAN (or MERCOSUR).13 Still,
the development of practices of mutual consultation in monetary and
exchange-rate matters among member countries is worth pursuing.
Seigniorage and Lender of Last Resort
A classic argument in the case for national money'4 is that, by giving up
the use of national money and adopting a foreign currency, a country loses
a source of revenue, given by the difference between the real command of
resources that the creation of money entails and the low cost of producing
(paper) money. This difference is called seigniorage. For ranges of low to
moderate inflation and with "normal" demand for money, seigniorage can


10                            CRISIS AND DOLLARIZATION IN ECUADOR
represent several points of GDP. By adopting the U.S. dollar as its national
currency, Ecuador loses this source of revenue and transfers seigniorage to
the Federal Reserve Bank of the United States: However, the quantitative
importance of the loss of seigniorage in Ecuador is bound to be modest, as
the economy was already highly demonetized and de-facto dollarized
before the U.S. dollar was officially adopted. In any case, it should not be
ruled out that in the future some arrangement could be made for the
seigniorage to be shared with Ecuador.
Another feature of a dollarized system is the apparent absence of a
lender of last resort. Because the Central Bank, still in existence in
Ecuador, cannot create money any more, banks will be unable, unlike in
the past, to resort to bailouts and credits from the Central Bank. In the
absence of national money, the Central Bank ceases to play the role of
lender of last resort. However, as the commercial banking system was in
such a fragile condition in Ecuador at the time of dollarization, a special
contingency fund for banks in distress was created following official dol-
larization. From this perspective, this fund can be viewed something like
a lender of last resort in the event of a banking crisis. Moreover, as has
been the case in history, for example in the United States during episodes
of banking crisis before 1913, the year the Federal Reserve System was
created, the resolution of banking crisis or liquidity shocks was arranged
by private financiers such as J. P. Morgan. In other cases, the resources for
performing the functions of lender of last resort can come from the fiscal
budget or from foreign borrowing.
The Adjustment Mechanism of the Dollarized Economy
An economy operating with a foreign currency as the legal tender works
in several respects like the economies under the gold standard of the pre-
1913 world. The so-called price-specie flow mechanism of David Hume
described such a system as one in which balance of payments disequilib-
ria had a domestic monetary counterpart (money expands when there is
a balance of payments surplus and contracts when there is a deficit).
These changes in the money supply affect domestic prices relative to
world prices, thereby automatically correcting the balance of payments
disequilibria and, in this way, restoring macroeconomic balance. This sys-
tem rests on a combination of policy rules and price and wage flexibility.
A critical point of the mechanism is that it requires both downward as
well as upward wage and price flexibility. In- particular, when there is a
loss of external competitiveness a deflation of prices and salaries is needed
to correct external and internal imbalances.
By adopting official dollarization, Ecuador entered into the world of
tight rules in economic policy. As mentioned before, in the new system,


CRISIS AND DOLLARIZATION: AN OVERVIEW                            11
the Central Bank can neither print money nor adjust the exchange parity
between a national and foreign currency since the national currency was
abolished. Fiscal deficits cannot be monetized, and commercial banks
cannot receive credit from the Central Bank in national currency to
resolve financial difficulties. The new system also puts strong require-
ments on fiscal solvency and domestic financial stability. This, needless to
say, implies a strong departure from previous practices in the conduct of
monetary, fiscal, and exchange-rate policies in Ecuador.
The other component of David Hume's price-specie flow mechanism is
wage and price flexibility. Certainly Ecuador has had a lot of upward price
flexibility in the recent past. The point, however, is to what extent there is
also downward wage and price flexibility in Ecuador to correct relative
prices in the wake of external shocks and natural disasters, to which the
Ecuadoran economy has been quite prone in the recent past (see chapter
2). A subtle point is that although in Argentina there was some downward
wage and price flexibility, but this was still not enough to reverse a real
appreciation of the currency. In addition, cutting nominal wages, as antic-
ipated by Keynes long ago, can be very unpopular and practically costly
in a modem contractual economy. Thus it is not a recommendable course
of action on which to rely to correct currency misalignments.
Dollarization and Hard Pegs
In the recent discussion of exchange-rate regimes a "bi-polar". view
emerged. According to this view, for a financially integrated economy,
two regimes are bound to be viable: "hard pegs" (currency boards, dol-
larization, or currency union) or exchange-rate flexibility.15 "Intermedi-
ate" exchange-rate regimes such as (soft) fixed-exchange rates, crawling
pegs, and others are bound to be susceptible to crisis and failure in a con-
text of high capital mobility. Only hard pegs and flexible rates would
endure according to the bi-polar view. After the current Argentine crisis,
this view is severely challenged.
Several emerging economies have been in the hard peg group:
Argentina (until December 2001), Bulgaria, and Hong Kong, China, all
have had currency boards; Panama, Ecuador, and El Salvador are coun-
tries that use the U.S. dollar as their national currency. In turn, for devel-
oped economies, the countries of the EU have decided to adopt a common
currency, the euro, another form of hard peg from the perspective of each
member country. Argentina and Bulgaria are cases of countries that
adopted currency boards after experiencing periods of very high inflation
or hyperinflation. The other countries entered into a hard-peg currency
arrangement in more gradual fashion and after a preparation period.
Ecuador shares with Argentina and Bulgaria the fact that it adopted a


12                            CRISIS AND DOLLARIZATION IN ECUADOR
hard-peg regime because of the urgent need to restore credibility after
experiencing extreme monetary instability.16
Although the recent experience with hard pegs suggests that they
were mostly successful in stopping high inflation, often in a gradual
way, and helped to restore stability, an important issue is the capacity of
the system to last over long periods of time. This leads us to the com-
plex problem of the "exiting option." As the events of early 2002 in
Argentina show, the exiting from a currency board, if not well prepared
and anticipated, can be extremely traumatic, possibly involving an
implosion of the economy. In general, once a country has adopted a
hard peg it is not expected to exit. The recent abandonment by
Argentina of its currency board is starting to shatter this long-held view.
The adoption of a hard peg is a kind of open-ended choice, almost irre-
versible. In fact, hard pegs are conceived to side step the main weakness
of "soft pegs" (fixed exchange rates, crawling pegs), namely, that fre-
quent exits from the fixed system are often unanticipated and disrup-
tive and often entail credibility loss for the monetary authorities.
However, loss of the exit option should ultimately be considered a lim-
itation of hard pegs if exiting is needed in extremis.
Social Impact of Economic Crisis and Dollarization
Economic crisis can have very adverse social consequences. In the late
1990s Ecuador suffered a sharp recession and a large increase in unem-
ployment. Output contraction and job losses reduced economic welfare of
the citizens, particularly that of the unemployed. In addition, as the eco-
nomic crisis came with instability, continuous currency depreciation, and
high and volatile inflation, there was a reduction in real wages, affecting
workers and their families as well as other low-income groups and classes
whose incomes grow (if at all) at a slower pace than the exchange rate and
average prices. In the case of Ecuador, as documented in chapter 4, unem-
ployment, poverty, and inequality all worsened in this period. From a
longer-term perspective, the low (and volatile) rate of GDP growth of the
1980s and 1990s implied almost stagnant income per capita for a long
period, with minimal poverty reduction, persistent inequality, and social
marginalization of minorities. This social situation worsened further
because of the economic crisis of the late 1990s. The social impact of dol-
larization has to be evaluated against this background. Gender biases, in
turn, seem to make crises affect women more adversely (see chapter 5).
Dollarization, as we document in this book, has not been costless in
Ecuador. The exchange rate chosen for conversion of the money supply
in sucres to dollars (25 sucres per dollar) was a very undervalued rate. As
a consequence, there was a sharp reduction in real wages in dollars. As


CRISIS AND DOLLARIZATION: AN OVERVIEW                           13
inflation continued at a significant (although declining) pace after dollar-
ization, real wages suffered from continuous inflation and slack in the
labor market. However, as of early 2002, about two years after dollariza-
tion was adopted, the real exchange rate has started to appreciate and
real wages to recover. In addition, following the pattern of other
exchange-rate-based stabilization plans, a recovery of consumption and
an increase in relative prices of nontradable goods and assets accompa-
nied a recovery in economic activity, with declining unemployment and
some improvement in deteriorated social conditions. Still, the medium-
term effects on the external competitiveness of Ecuador of currency
appreciation must not be neglected.
In retrospect, the social impact of dollarization was affected by the pre-
carious nature of social safety nets in Ecuador that were unable to shield
vulnerable groups, the poor, women, and the unemployed from the social
costs associated with both the economic crisis of 1998-99 and the stabi-
lization efforts afterwards.
Organization of This Book
This volume comprises four other chapters. In chapter 2, Paul Beckerman
presents a broad analysis of long-term characteristics of the Ecuadoran
economy covering several dimensions: economic structure, geography,
social structure, and regional divides; frequency of governance crisis;
dependence on volatile commodity prices; fiscal and financial structure;
and exposure to natural disasters. The chapter places the late 1990s eco-
nomic crisis that preceded official dollarization in historical perspective.
Chapter 3, by Paul Beckerman and Hernan Cort6s-Douglas, provides an in-
depth analysis and documentation of the Ecuadoran experience following
dollarization. It analyzes in detail the workings of the new monetary sys-
tem, the behavior of the fiscal and banking systems, the adjustment in
prices and the real exchange rate, and real economic activity after official
dollarization in 2000 and 2001. Chapter 4, by Suhas Parandekar, Rob Vos,
and Donald Winkler, elaborates and carefully documents the effects of the
crisis on unemployment, real wages, and income distribution as well as the
effects and limitations of policies to counteract these adverse social effects.
Finally, chapter 5 by Maria Correia discusses the gender and family dimen-
sions of Ecuador's severe economic crisis of the late 1990s.
Notes
1. The old national currency, the sucre, retained de jure legal status under the
Constitution, essentially because the government believed it would simply have
been too complicated to change the Constitution.


14                              CRISIS AND DOLLARIZATION IN ECUADOR
2. By December of 1999, around 66 percent of total deposits in the Ecuadoran
financial system were in U.S. dollars and nearly 90 percent of the credit was in
dollars.
3. Historically, not all experiences with very high inflation and hyperinflation
came along with a banking crisis; see Solimano (1990a, 1991).
4. See Fischer (2001b) for an account of the relationship between Ecuador and
the IMF, from the perspective of the latter.
5. It is estimated that around 1 million Ecuadorans left the country between
1998 and 2001.
6. See Hurtado (1993) for a thorough analysis of Ecuador's economic, social,
and political structure in both the colonial period and in the Republican era.
7. See Arteta and Hurtado (2002) for a recent political economy analysis of
Ecuador.
8. See Eichengreen (2002) for analysis of alternative views on the timing and
sequencing of dollarization. Berg and Borenztein (2000) and Calvo (1999) review
several pros and cons of dollarization as an exchange-rate regime.
9. See Moreno-Villalaz (1999) for an analysis of the Panama experience as a dol-
lar economy.
10. A more acute situation of near hyperinflation before adopting a hard peg
regime was observed in Bulgaria in the 1990s. That country adopted a currency
board in July of 1997. Preceding the currency board, inflation reached 500 percent
in January 1997 and more than 2,000 percent in March of that year; see Gulde
(1999). For an early analysis of inflation dynamics in post-Communist Bulgaria,
see Solimano (1990b).
11. See Arteta (2001) for an analysis of that period.
12. See Baliiio and Enoch (1997).
13. See Scandizzo (2001).
14. See Fischer (1982 and 1993) for an assessment of the arguments for national
money and their empirical significance.
15. See Fischer (2001a) for an interesting discussion of the bi-polar view of
exchange-rate regimes.
16. See Calcagno, Manuelito, and Titelman (2001) for a comparison of Ecuador's
dollarization with Argentina's currency board.
References
The word processed describes informally reproduced works that may not
be commonly available through libraries.
Arteta, Gustavo. 2001. "Dollarization in Ecuador: Experiences,
Challenges, and Lessons." Americas' Insights, September.


CRISIS AND DOLLARIZATION: AN OVERVIEW                         15
Arteta, Gustavo, and Osvaldo Hurtado. 2002. "The Political Economy of
Ecuador." Project Political Economy of Andean Region. ECLAC.
Processed.
Baliflo, Tomds, J.T., and Charles Enoch. 1997. "Currency Boards
Arrangements. Issues and Experiences." Occasional Paper 151.
International Monetary Fund, Washington, D.C.
Berg, Andrew, and Eduardo Borenzstein. 2000. "The Pros and Cons of
Full - Dollarization." International Monetary Fund Working Paper,
WP/00/50.
Calcagno, Alfredo, Sandra Manbelito, and Daniel Titelman. 2001.
"Dollarization in Ecuador: A Parallel with Argentine Convertibility."
Economic Commission for Latin America and the Caribbean. Processed.
Calvo, Guillermo. 1999. "On Dollarization." University of Maryland.
Processed.
Eichengreen, Barry. 2002. "When to Dollarize." Journal of Money, Credit
and Banking 34(1):1-24.
Fischer, Stanley. 1982. "Seigniorage and the Case for National Money."
Journal of Political Economy 90(April):295-313.
-. 1993. "Seigniorage and Official Dollarization." In Nissan
Liviatan, ed., Proceedings of a Conference on Currency Substitution and
Currency Boards, pp. 6-10. World Bank Discussion Paper 207. World
Bank, Washington, D.C.
2001a. "Exchange Rate Regimes: Is the Bi-Polar View Correct?"
Distinguished Lecture on Economics in Government, American
Economic Association and Society of Government Economists.
-. 2001b. "Ecuador and the IMF." Hoover Institution Conference on
Currency Unions, Palo Alto, California.
Gulde, Anne-Marie. 1999. "The Role of Currency Board in Bulgaria's
Stabilization." International Monetary Fund Policy Discussion Paper,
PDP/99/3.
Hurtado, Osvaldo. 1993. El Poder Politico en Ecuador. Editorial Planeta,
Quito.


16                           CRISIS AND DOLLARIZATION IN ECUADOR
Moreno-Villalaz, Juan Luis. 1999. "Lessons from the Monetary
Experience of Panama: A Dollar Economy with Financial Integration."
Cato Journal 18(3).
Scandizzo, Stefania. 2001. "Options for Monetary Integration in the
Andean Community." Andean Development Corporation, Caracas,
Reptiblica Bolivariana de Venezuela. Processed.
Solimano, Andr6s. 1990a. "Inflation and the Costs of Stabilization:
Historical and Recent Experiences and Policy Lessons." World Bank
Research Observer 5(2):167-85.
-. 1990b. "Inflation and Growth in the Transition from Socialism:
The Case of Bulgaria." World Bank Policy Research Working Paper
Series # 659.
. 1991. "The Economies of Central and Eastern Europe: An
Historical and International Perspective." In Vittorio Corbo, Fabrizio
Coricelli, and Jan Bossak, eds., Reforming Central and Eastern European
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-. 2002. "Crisis in the Andean Region: A Political Economy
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Nations Economic Commission for Latin America and the Caribbean,
Santiago, Chile. Processed.


2
Longer-Term Origins of
Ecuador's "Predollarization"
Crisis
Paul Beckerman
1. Introduction
On January 9, 2000, Ecuador's government fixed its exchange rate, which
had been floating for nearly 11 months, and announced that it would sub-
mit legislation to the Congress to fully dollarize the economy. At that
moment, Ecuador's sucre was in apparent free fall, having lost two-thirds
of its U.S.-dollar value during 1999 and a quarter during the first week of
the new year alone. Real GDP had fallen 7.3 percent in 1999, and the
recession was apparently still deepening. Commercial banks were in
deep crisis: several large ones had failed, and credit operations were vir-
tually suspended. A liquidity crisis loomed as banks prepared for March
2000, when release of time deposits, frozen for a year in March 1999, was
to commence.
On January 21, President Jamil Mahuad, who had been elected to a
five-year term in mid-1998, was forced from office, mainly because of dis-
satisfaction with the economy and opposition by some people to dollar-
ization. After an unsuccessful coup attempt by some military officers and
leaders of Ecuador's indigenous people, the vice president assumed the
presidency, just barely maintaining constitutional normality. Seeing no
alternative, the new government pressed forward with dollarization. In
early February it submitted the necessary legislation to the Congress,
which approved it after rapid debate. Some left-of-center parties
expressed their opposition by not participating. Once the president
The writer is an independent consultant. The writer thanks Herndn Cort6s
Douglas, Luis JAcome, and Andr6s Solimano for valuable comments on earlier
drafts. The writer alone is responsible for any errors of fact and judgment. Views
expressed here do not necessarily reflect views of the World Bank or any other
institutions with which the writer has been associated. Please do not cite this
work without the writer's authorization.
17


18                            CRISIS AND DOLLARIZATION IN ECUADOR
approved the law in early March, the Central Bank began purchasing
sucres from circulation, and the country adopted the U.S. dollar as its cur-
rency. The conversion was complete well before the year's end.
The crisis that precipitated the move to dollarization was triggered in
late 1997 and 1998 by a combination of exogenous external and climatic
shocks. These shocks included (a) plunging oil-export prices, (b) heavy
damage from El Nifto rains, and (c) various effects of the East Asian,
Russian, and Brazilian financial crises. The shocks widened the 1998 cur-
rent-account deficit and made the pre-announced crawling-band
exchange-rate policy unsustainable, forcing the authorities to float the
sucre in early 1999. By reducing revenue, increasing the domestic-cur-
rency equivalent of the public-debt service, and forcing increased expen-
diture to cope with the El Nifho disaster, the shocks widened the 1998
fiscal deficit. In addition, the shocks damaged commercial banks' loan
portfolios. The exchange-rate depreciation was especially hard on the
banks, because their balance sheets were partially dollarized. Although
they had made a point of keeping dollar assets matched with dollar lia-
bilities, many of the banks' dollar borrowers were themselves
unmatched, with sucre earnings backing dollar liabilities. Exchange-rate
depreciation therefore increased banks' nonperforming assets and
reduced cash repayments. Depositors, fearing for banks' safety, began
withdrawing, intensifying banks' illiquidity, even as the depreciation
swelled the dollar deposit stocks in sucre terms.
The authorities tried to deal with the banking crisis in late 1998 by
fully guaranteeing all bank deposits, and then, in March 1999, by freez-
ing deposits. The deposit freeze threw the economy into disarray, how-
ever, and the authorities found they had no choice but to unfreeze
checking and savings accounts gradually. Withdrawals intensified, how-
ever, and the Central Bank found it had little choice but to provide the
banks credit to prevent a payments-system collapse. This domestic-credit
creation more than doubled the monetary base during 1999, inducing a
sharp exchange-rate slide toward the year's end. If the authorities had
not dollarized when they did, hyperinflation was pretty much inevitable.
This chapter examines the underlying causes of this "predollarization"
crisis -that is, the reasons why the 1998 shocks produced a crisis of such
magnitude. Similar shocks had serious consequences in neighboring
economies at the same time, but in no case so devastating as in Ecuador.
The main thesis is that a combination of specific characteristics of
Ecuador's economic and political systems accounted for the severity of
the crisis. These characteristics included (a) the heavy dependence of
public revenue on volatile oil earnings, (b) the banking system's exposure
to Ecuador's volatile and risky activities, (c) inadequate banking super-
vision, (d) political fragmentation, (e) weak public administration, (f) the


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS        19
political system's tendency to maintain energy subsidization, and-par-
ticularly important-(g) the financial system's partial dollarization.
These characteristics were in turn the consequences of deeper geographic
and historical realities, including (a) rivalry between Ecuador's coastal
and highland regions, (b) the volatility of Ecuador's commodity export
markets, and (c) the country's exposure to natural disasters, including
earthquakes, volcanic eruptions, episodes of excessive rainfall, and
drought. In addition, since the 1970s, the economy has suffered from the
interrelated consequences of (d) excessive public-debt accumulation, (e)
lagging and uneven structural reform in the public and financial sectors,
and (f) the exchange-rate instability deriving from the need to cope with
the external debt.
This chapter will first set out the longer-term background to the
predollarization crisis and then show how the characteristics of the econ-
omy and society affected the evolution of the crisis in 1998 and 1999. Part
2 describes the deep historical origins of the crisis. Its sections discuss (A)
the historical background of Ecuador's regionalism, political fragmenta-
tibn, and administrative weakness; (B) the economy's unusual vulnera-
bility to "contingencies"; and (C) the ways in which the structural
changes carried out by the military government during the 1970s oil
boom led to heavy external-debt accumulation and to many of the struc-
tural problems that still awaited reform when the crisis began.' Part 3
describes the state of structural reform going into the crisis. Its sections
focus on (A) the public sector; (B) the financial system and the crucial
problem of its partial dollarization; and (C) certain additional areas in
which structural-reform agendas remain-formal labor markets and
trade policy. With this background, Part 4 recounts the evolution of the
1998-99 crisis. Part 5 then presenis summary conclusions regarding the
underlying causes of the crisis.
2. Historical Background of Ecuador's
Predollarization Crisis
The root causes of the crisis that preceded Ecuador's move to dollariza-
tion were the country's deeper historical and geographical circumstances.
The political and administrative weakness of Ecuador's government
helps explain its inability to act rapidly and forcefully to deal with the
combination of contingencies that thrust the economy into crisis. The
essential conditions of the crisis, however, were (a) the structural depen-
dence on oil exports beginning in the 1970s, (b) the massive accumulation
of public debt that resulted, and (c) the need to generate an export sur-
plus to service the debt, which, together, led to .(d) the partial dollariza-
tion of the financial system.


20                            CRISIS AND DOLLARIZATION IN ECUADOR
A. Historical Roots of Ecuador's Governance Problems
Complex governance problems, including regional rivalry, political frag-
mentation, weak public administration, and pervasive corruption, figure
centrally among the reasons for Ecuador's poor growth performance, par-
ticularly during the past two decades. These problems derive in large mea-
sure from the peculiar nature of Ecuador's historical formative process.2
Rivalry between the "Sierra" (mountain highlands), centered on the
capital, Quito, and the "Costa" (coastal lowlands), centered on the port
city of Guayaquil, has been a standing theme of Ecuador's history. The
two regions have always been culturally and economically distinct. The
balancing of regional interests has imparted a marked style to political
and administrative structures and decisionmaking. One consequence of
the regional rivalry is that the central government's political and admin-
istrative powers and capacities have been limited. Even at moments of
national crisis, government policies and actions have often had to subor-
dinate broader national interests to reconciliation of regional interests.
The 1998 banking crisis (see Part 4) is a clear example of this: The worst-
affected banks were Guayaquil-based, but regional sensitivities and polit-
ical interference prevented the banking supervisors from taking timely,
effective action.
Before the Republic's creation in 1830, what are now its two main regions
had been quite separate from one another. The present Sierra region was an
important part of the Inca Empire; in contrast, the Incas subjugated the pre-
sent coastal areas only a few decades before the Spanish arrived in 1532, and
had not yet integrated them into their empire.3 During the three centuries of
Spanish rule, Quito and surrounding areas developed in isolation from the
coastal lowlands, which consisted largely of self-governing indigenous
communities. Guayaquil developed as a center for intracolonial sea trade
(mostly illegal under Spanish mercantilist rule). Although many crucial
events in the continental independence campaign of the early 1800s took
place in what is now Ecuador, events in the highlands and on the coast were
basically unrelated.4 Quito's and Guayaquil's initial uprisings, for example,
were uncoordinated. In their July 1822 meeting in Guayaquil, Bolivar
apparently persuaded San Martin to permit Guayaquil to join Quito in a
"District of the South" within the Gran Colombia confederation (compris-
ing modern Colombia, Panama, the Repfiblica Boliviariana de Venezuela,
and Ecuador), rather than Peru. Guayaquil's inhabitants were fearful of
Lima's dominance. In 1830, when Gran Colombia disintegrated, this District
of the South constituted itself as the "Republic of the Equator."
The new republic underwent decades of internal struggle to determine
how it would be governed. During the republic's first century, ideologi-
cal and regional interests coincided: proclerical, centralizing, landowning


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS       21
"Conservatives" were based in Quito, while anticlerical, decentralizing,
commercial "Liberals" were based in Guayaquil. From 1860 until 1895 the
Conservatives were generally dominant. Between 1860 and 1875 Ecuador
achieved some material progress under Gabriel Garcia Moreno's procler-
ical, centralizing dictatorship, but this government engendered regional
resentment. From 1895 until 1925 the Liberals generally dominated the
country, largely on the basis of the rise of the coastal cacao economy. The
Liberals' own factional conflicts subjected the country to instability, how-
ever. Over the course of its first century, Ecuador repeatedly changed its
constitution and governmental structure, introducing and removing an
upper legislative chamber, changing the role of the Church, extending the
suffrage, and so on.5
The regional rivalry has led, first, to a set of standing compromises
limiting central political and administrative powers, and, second, to the
political prioritization of regional balance. Fearful that an administration
largely from one region might impose its will on the other, the writers of
Ecuador's constitutions tended to limit central political and administra-
tive power, in particular, executive power. Twentieth-century constitu-
tions made it relatively easy for the Congress to impeach and remove
cabinet ministers, for example, even on purely political grounds. Legal
intimidation-prosecuting or suing public officials, for example-has
often been used to limit political and administrative power. Administra-
tive institutions have been kept weak, both in mandates and capabilities.
The determination of the regions to protect their positions and interests
manifests itself in many other ways. For example, the country's long-
standing practice of tax earmarking ensures, among other things, that
particular localities and interest groups receive "fair shares" of national
resources, at the cost of complicating expenditure programming, and the
traditional cross-party regional caucuses of the Congress work together
to advance regional interests.
Since July 1925, when the Conservatives and Liberals gave way to new
political groupings in the wake of the Revoluci6n Juliana (see section B
below), Ecuador's political parties have been fragmented and unstable.
As of mid-2001, representatives of 10 parties sit in the (unicameral)
national Congress. The parties are difficult to classify ideologically. Pop-
ulism figures heavily in their styles and substance. Of the four largest,
two are relatively, if inconsistently, center-right and center-left parties
based mainly in the Sierra and two are relatively center-right and center-
left parties based mainly in the Costa.6 Another party (Pachakutik) claims
exclusively to represent indigenous ethnic minorities. During 1998 and
1999, party fragmentation made it difficult to pass emergency legislation
that was essential precisely because of the limitations of the central gov-
ernment's executive and administrative powers (see Part 4).


22                           CRISIS AND DOLLARIZATION IN ECUADOR
A paradoxical consequence of Ecuador's regionalism has been a long-
stafiding failure to develop effective subnational, governments. While
regional interests have sought to limit central political and administrative
power since Independence, they have also generally sought -to limit
regional autonomy, for fear that it could break the country apart. As a
consequence, provincial administrations have simply not had the powers
and the resources they needed for full governmental effectiveness. Some
municipal administrations have proved more effective, but in general
they have suffered from inadequate resources. Although Ecuador is small
by comparison with its neighbors, it has a large territory with diverse
populations. Proper application of the subsidiarity principle would
undoubtedly improve administrative efficiency and enhance political
participation and accountability. In recent years, Ecuadorans have been
formulating and debating proposals for regional autonomy and decen-
tralization. It remains to be seen, however, whether these proposals can
be implemented in ways that would be politically, administratively, and
financially feasible.
B. Ecuador's Vulnerability to Economic Shocks and
Natural Contingences
Just as its deeper political history helps explain its political fragmentation
and administrative weakness, geography and topography are funda-
mental to explain the "contingency" to which Ecuador is subject. Ecuador
has always depended heavily on volatile commodity export earnings and
has always been especially vulnerable to seismic and climatic disasters.
This section reviews the historical processes leading up to the oil boom of
the 1970s, discusses Ecuador's exposure to natural contingencies and
shocks, and briefly discusses the more recent instability of external finan-
cial flows, which has become an additional dimension of vulnerability.
DEPENDENCE ON CoMmoDrrY ExPoRTs. Throughout its history, reliance-on
primary commodity exports has subjected Ecuador, like many other
Latin American economies, to debilitating boom-and-bust cycles. During
the 20th century, three commodity exports-cacao, bananas, and oil-
played crucial roles in the country's economic and political development.
Cacao, produced in coastal agricultural areas, gradually became
Ecuador's first large-scale commodity export during the latter part of the
19th century. Cacao exporters' growing wealth powered the Liberal
Party's rise. During the first two decades of the 20th century, the Liberal
Party fell under the sway of a group of Guayaquil cacao producers and
the trading firms and banks associated with them.7 The party's control of
the government enabled some business figures to divert revenue flows to


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      23
themselves or their supporters, while the banks extended profitable loans
to cover a growing public deficit. The banks created money (there was
neither a central bank nor a banking supervisor), causing an inflation
problem. This "system" collapsed in the 1920s when a series of external
shocks struck the cacao economy. Fungal disease sharply reduced output,
while growing cacao exports by British colonies (and later, the onset of
the world Depression) drove dowi world prices. As a result, real wages
and incomes fell sharply, and deflation set in. In the early 1920s
Guayaquil workers carried out a general strike, while in the Sierra peas-
ants organized protest movements. The government repressed these vio-
lently.
In July 1925 a "League of Young Army Officers" seized power (the Rev-
oluci6n Juliana). Its stated objective was to end the Conservatives' and Lib-
erals' dominance and to begin carrying out modernizing reforms. It
organized a provisional government, naming Isidro Ayora, a wealthy
opponent of the Liberals from Guayaquil, to serve as president. His gov-
ernment's accomplishments included drafting a new constitution
(Ecuador's 13th), which enhanced the power of the legislature and
diminished the power of the executive; wide-ranging fiscal and monetary
reforms (recommended by an advisory mission headed by Edwin Kem-
merer of Princeton University), including establishment of the Central
Bank; and progressive social reforms, including establishment of the state
pension system. The collapse of the cacao economy prevented economic
recovery, however: Cacao exports fell from US$15 million in 1928 to US$7
million in 1931 and US$5 million in 1932. The government could not deal
effectively with the economy, and in 1931 another military coup removed
Ayora from office.
From the standpoint of export-commodity dependence, the half-cen-
tury between the Revoluci6n Juliana and the rise of the "oil economy" in
the 1970s can be divided roughly into three periods. In the first period,
from approximately 1925 until the late 1940s, Ecuador's economy contin-
ued to stagnate in the aftermath of the cacao collapse. A populist move-
ment emerged in the early 1930s, under the personalist, charismatic
leadership of Jos6 Maria Velasco, who served as president five times
between 1934 and 1972. The 1930s and 1940s were a period of political
instability, during which the government alternated among (a) represen-
tatives of the Quito and Guayaquil elites; (b) Velasco and his supporters,
who sought generally to implement expansionary public-expenditure
policies; and (c) the military, who intervened several times to change gov-
ernments but did not themselves retain power over extended periods.
The second period, from 1948 to 1958, was characterized by political sta-
bility, mainly because it coincided with the rise of Ecuador's banana
economy. During the 1940s, after disease devastated Central American


24                          CRISIS AND DOLLARIZATION IN ECUADOR
banana plantations, Ecuador began producing and exporting heavily.
Banana exports grew from US$2 million to US$20 million between 1948
and 1952 as volumes and prices rose. Three presidents, including Velasco,
served full four-year constitutional terms between 1948 and 1960. Until
the late 1950s the favorable effects of the banana boom on the economy
and hence on government revenue enabled all three presidents to govern
without having to confront serious economic crises.8
Renewed economic instability characterized the third period, begin-
ning in the late 1950s. Falling banana prices brought about recession,
unemployment, and intensified social protest. In 1960 Velasco was
elected to his fourth term as president, promising to confront the eco-
nomic downturn. Declining government revenue made it impossible for
him to make good on his electoral promises, however, and he was forced
to resign just over halfway through his term. Soon afterwards the military
took power themselves, announcing that this time they intended to retain
power long enough to carry out modernizing reforms. In 1964 this gov-
ernment enacted a land reform that significantly changed land tenancy in
the Sierra, although it preserved commercial holdings in the Costa. Per-
sisting low commodity-export prices, however, made it no less difficult
for the military government to manage the economy and the fiscal
accounts effectively. Unable to agree on a policy program to confront the
economic malaise, and increasingly unpopular because of political
repression, the military decided to step down in 1966. Following an
interim government, which produced a new constitution, new elections
were held in 1968.
Velasco was then elected President for the fifth time, winning a plural-
ity of votes cast among five candidates. For three years, his government
struggled in the face of inadequate legislative support and low banana
export receipts to maintain a populist spending program. In June 1970 he
assumed dictatorial powers, dissolving the Congress and dismissing the
Supreme Court. Two months later he devalued the sucre from 18 to 25 per
dollar (the rate of 18 had stood for nearly a decade), instituted capital
controls, and decreed tax and tariff increases. In February 1972, however,
largely to head off the election of a populist candidate for president they
disliked, the military removed Velasco and assumed power. Earlier, in
1964, the government had granted prospecting and development conces-
sions for the Amazon basin to several foreign oil companies, several of
which made significant discoveries within several years. By the early
1970s, following construction of an oil pipeline from the producing fields
over the Andes Mountains to the coast, sizable revenue flows seemed
likely. Upon taking power in 1972, the military declared that they would
retain power long enough to ensure that the oil earnings were applied to
national development and social reform.9 Unfortunately, oil turned out to


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      25
be yet another volatile export commodity (section C below takes up the
themes of oil-based growth and external debt since 1970).
EXPOSURE TO FORCES OF NATURE. Along with world commodity markets,
forces of nature have been another standing source of contingency for
Ecuador's economy. Ecuador is. prone to earthquakes, landslides, vol-
canic eruptions, and extended periods of. both drought and excessive
rain. The record during the past 20 years indicates the nature of the prob-
lem. In 1975 and 1983, Ecuador experienced damaging El Niflo episodes,
with severe rain damage to coastal agricultural output and transport
infrastructure and a substantial decline in fishing production. A new
round of the phenomenon in 1998 was one of the shocks contributing to
the predollarization crisis. Infrastructure accumulation and population
growth imply that, as time passes, the consequences of any particular nat-
ural disaster increase. Drought has been a recurring problem, affecting
agricultural production and electricity generation in several recent years.
A drought in 1995, for example, affected export and domestic food crops
as well as electrical power supplies. Earthquakes are a standing hazard.
In 1987, an earthquake tore apart 40 kilometers of the Transandean
Pipeline, stopping oil production for five months (see section C follow-
ing). Volcanoes are another hazard. During 1999, in the midst of the eco-
nomic crisis, two eruptions-one (Guagua Pichincha) on the outskirts of
Quito, the other (Tungurahua) near a rich agricultural and resort area-
further disrupted economic activity and created uncertainty. Relatively
few lives were lost, but property damage was considerable and tourism
was affected. Many countries face standing risks from natural phenom-
ena. Still, were one to list the world's economies according to the fre-
quency and. variety of their natural disasters, Ecuador would surely rank
relatively high. The likelihood of the occurrence of natural disasters dis-
courages many kinds of investment, and the disasters themselves tend to
have significant consequences for economic growth and stability.
EXPOSURE TO SHIFTS IN CROSS-BORDER FINANCIAL FLOws. More recently, inte-
gration with world financial markets has exposed Ecuador to another
dimension of volatility. Wealth-holders have been able to move resources
with increasing ease between on- and offshore placements, as perceptions
and realities of relative rates of return and bank safety evolve. As in other
economies, this activity has imparted an additional dimension of vulner-
ability to financial activities. In 1994 and 1995, Ecuador experienced a
round of inflows followed by outflows (see section C below), which
intensified the business cycle. Meanwhile, Ecuadoran financial institu-
tions have continued to do business with foreign banks, coming to rely
heavily on external funds for trade and working-capital credit. During


26                           CRISIS AND DOLLARIZATION IN ECUADOR
1998 many' of these. lines were withdrawn-again, at a moment when
their withdrawal was especially inconvenient.both for banks and for the
balance of payments (see Part 4). The benefits and drawbacks of cross-
border financial-capital flows have been a subject of worldwide contro-
versy. While presumably. beneficial for developing economies, since they
augment the resource base for capital formation, in Ecuador as elsewhere
they are an additional source of economic vulnerability.
C. Oil, External Debt, and Ecuador's Exchange-rate Instability
Ecuador's present external-debt problem can be traced back to the 1970s,
when the start of large-scale oil exports generated a growth spurt and the
private and public sectors began borrowing heavily. No less important, a
large part of the present unfinished structural-adjustment agenda
involves reversing changes the military government made in the 1970s.
This section reviews Ecuador's macroeconomic evolution from the mid-
1970s up to the start of the predollarization crisis. The essential argument
is that the need to service- the external debt reduced economic growth and
sustained the exchange-rate instability.
The start of large-scale oil exports came at just the moment that the
Organization of Petroleum Exporting Countries (OPEC) succeeded in rais-
ing world oil prices. In 1972, soon after taking power, the military renego-
tiated some of the concession contracts to increase the nation's share of the
proceeds.l0 In 1973 they took Ecuador into OPEC. On the basis of the surge
in oil revenue, the military government increased public-sector employ-
ment and capital formation rapidly, raising overall government expendi-
ture by about two-thirds between 1972 and 1975. It reduced domestic
taxation: non-oil public-sector revenue fell from 18.7- percent of GDP in
1972 to 13.8 percent in 1975, while oil revenue rose from 2 to 8.4 percent.
The government applied part of the oil earnings to subsidize domestic elec-
tricity and oil derivatives. From 1970 to 1977 'annual real GDP growth
exceeded 9 percent" (compared with just below 6 percent in the 1960s).
As the economy grew, Ecuador's private sector-mainly commercial
banks-began borrowing from foreign banks engaged in "recycling"
OPEC surpluses. During 1974 and 1975, however,' rising aggregate
demand induced inflationary pressure. Oil revenue slipped as world
recession drove down world oil prices. The 1975 El Nifto episode affected
coastal agriculture and fishing, reducing government revenue. To avoid
raising non-oil taxes or reducing expenditure and subsidies, the govern-
ment began borrowing externally to finance its deficit. At the end of 1979
the overall public external-debt stock reached US$4.5 billion (about 28
percent of GDP), compared with US$324 million (20 percent of GDP) at
the end of 1970 (see figure 2.1).


LONGER-TERM ORIGINS OF ECUADOR'S "PR.EDOLLARIZATION" CRISIS      27
Figure 2.1 Ecuador: Year-end Public and Publicly Guaranteed
External Debt (US$ million), 1970-2000
US$
million
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
1970-2000
n Multilateral @ Bilateral a Bonds e Other private sources
Source: World Bank.
In 1976 the military government, its support eroded by inflation and
internal disputes, decided to restore constitutional government. In 1979,
after a lengthy process including the elaboration of a new constitution, a
popular Guayaquil political figure, Jaime Rold6s, was elected president.
His government faced deepening economic problems. Some were of its
own .making: Soon after taking office, the government raised the mini-
mum wage and other wage benefits, which had significant fiscal conse-
quences. The larger problem, however, was an external shock. Following
the U.S. Federal Reserve's monetary tightening and the onset of world
recession, rising interest rates and diminished oil and other commodity
prices thrust Ecuador, like most other South American economies, into
debt crisis. Higher interest rates on floating-rate debt led to a sharp dete-
rioration in both private- and public-sector financial positions. President
Rold6s' death in a May 1981 air disaster further complicated the govern-
ment's problems. The vice president, Osvaldo Hurtado, immediately
assumed the presidency and began steering the economy into adjustment
to the new macroeconomic realities.


28                           CRISIS AND DOLLARIZATION IN ECUADOR
In 1982, under the pressure of surging interest rates on its external debt
and recession induced by declining terms of trade, Ecuador's overall
public-sector deficit reached 7.5 percent of GDP and its current-account
deficit widened to nearly 8.5 percent of GDP. In May of that year, as part
of an IMF-supported program, the government devalued the exchange
rate, which had been fixed at 25 sucres per dollar since 1970, by 25 per-
cent against the dollar. It also raised the (controlled) banking-system
interest rates and raised the prices of a broad range of public-sector goods
and services. In March 1983 the authorities devalued again and then com-
menced mini-devaluations to keep the exchange rate from slipping
behind the price level. Consumer prices rose 63.4 percent over 1983 prices
while real GDP declined 2.8 percent, largely because of that year's severe
El Nifo episode. On the basis of the IMF program (which succeeded in
the sense that Ecuador met its conditionality and it was disbursed fully),
foreign commercial banks reached agreement with Ecuador on debt
rescheduling, and in July 1983 the Paris Club agreed to reschedule amor-
tization due between June 1983 and May 1984.
Repeated exchange-rate depreciation was a fundamental change for
Ecuador, with at least two lasting consequences. First, it sharply
increased the private sector's-in particular, commercial banks'-exter-
nal debt-service obligations. Beginning in 1983, the Central Bank
assumed the bulk of the private external debt (about US$1.5 billion, 11
percent of 1982 GDP) in exchange for sucre debt, under its sucretizaci6n
policy12 (see Bayas and Somensatto 1994). Sucretizaci6n not only added
significantly to the public debt stock, it also angered many citizens, who
believed it was inappropriate to use public resources to bail out private
borrowers and foreign creditors. The second consequence of the sliding
exchange rate was that it set an incentive to move private wealth into dol-
lars. At first this meant offshore placements, since until the 1990s bank
operations in dollars were closely restricted. "Spontaneous" dollarization
of informal contracts, real-estate valuations, professional services, and so
on, also became increasingly widespread.
Throughout the 1980s and 1990s, policymakers struggled to set an
exchange rate that was both stable and set the incentives for the net
export flow required to service the external debt. They never succeeded
in doing so permanently, however. Real growth, inflation, exchange-rate
depreciation, and the public deficit remained highly unstable. Under
Le6n Febres Cordero's liberalizing government, which took office in
August 1984, real GDP rebounded, growing 4.2 and 4.3 percent in 1984
and 1985, respectively, while inflation moderated to around 20 percent. In
1986, however, at the same time it began liberalizing commercial-bank
interest rates, the government began a floating exchange rate for private-
sector imports. Oil-export prices fell by more than half that year, how-


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS       29
Table 2.1 Ecuador: Governments, 1979-2001
Acceded to        Departure
Period           President       office through     from office
Aug 79-May 81 Jaime Rold6s         Election        Accidental death
May 81-Aug 84 Osvaldo Hurtado      Vice President,  Term concluded
assumed office
Aug 84-Aug 88 Le6n Febres Cordero                 Term concluded
Aug 88-Aug 92 Rodrigo Borja        Election       Term concluded
Aug 92-Aug 96 Sixto DurAn Ball6n   Election       Term concluded
Aug 96-Feb 97  Abdal6 Bucaram      Election        Removed by
Congress
Feb 97-Aug 98  Fabian Alarc6n      Designation by  Term concluded
Congress
Aug 98-Jan 00  Jamil Mahuad        Election        Resigned
Jan 00-        Gustavo Noboa       Vice President,
assumed office
ever, and in January 1987 the government suspended debt service to com-
mercial banks. The March 1987 earthquake interrupted oil exports, and
international reserves declined precipitously. The Central Bank tightened
monetary policy to head off exchange-rate depreciation, but then finally
stopped the float when the exchange rate came under speculative attack.
Real GDP fell 6 percent in 1987 while consumer prices rose nearly 100
percent. Oil exports resumed in August 1987 after the pipeline was
repaired, but with continuing high expenditure and subsidies the public
deficit surged to more than 12 percent of GDP. The debt-service suspen-
sion continued for seven years.
Resumption of oil exports at somewhat higher prices led to a 10.5-per-
cent GDP-growth rebound in 1988, but the public deficit remained mas-
sive, on the order of 10 percent of GDP. The external-debt stock, now
accumulating mainly through interest arrears, grew more slowly. In mid-
1988, soon after taking office following elections, a center-left government
under President Rodrigo Borja announced a new policy package, including
yet another large devaluation and introduction of a new exchange-auction
system, with differentiated rates for private and public exporters and pri-
vate importers. It then carried out mini-devaluations consistent with antic-
ipated inflation of 30 percent. Consumer prices rose 54 and 50 percent in
1989 and 1990, respectively, however, and real growth slid to 0.3 percent in
1989. Over the next three years, real growth recovered to between 3 and 5
percent. Inflation persisted in the range of 50 to 60 percent, and the non-
financial public-sector deficit remained around 6 to 7 percent of GDP,
despite higher oil prices at the time of the Persian Gulf War. Building on the
Cordero Government's reforms, the Borja Government undertook several


30                           CRISIS AND DOLLARIZATION IN ECUADOR
significant structural-adjustment initiatives, including a partial tax reform,
trade liberalization, and progress toward financial-sector liberalization. In
the run-up to the mid-1992 elections, however, government expenditure
rose sharply, and, although the authorities maintained a relatively appreci-
ated exchange rate, inflation persisted at high rates.
In mid-1992, Sixto Durin Ball6n was elected president on a platform of
stabilization, liberalization, and structural reform. Soon after taking
office, his government announced another large policy package, encom-
passing a devaluation of 20 percent against the dollar and various fiscal
measures, including increases in motor-fuel prices and electricity rates, a
company-assets tax, expenditure cuts, and a public-employment freeze.
These actions cut the 1993 public deficit nearly to zero. In August 1993 the
authorities unified the foreign-exchange market and began a new policy
of floating within a pre-announced crawling band. The idea was to set a
nominal anchor that-would help gradually to reduce the inflation rate.
This exchange-rate policy continued until 1998 (see Part 4). Meanwhile,
the Durdn Ball6n Government began developing and implementing a
substantial structural-reform program (see Part 3, section A).
In late 1993 and 1994, following the introduction of the float-within-a-
crawling-band exchange-rate policy, Ecuador experienced a short-term,
financial-capital inflow (see Jaramillo 1994). Unlike other economies,
where capital flows tended primarily.to go to the stock markets, these
inflows went mostly to short-term, fixed-income applications, since high,
short-term interest rates were now available on sucre deposits. The place-
ments were made mostly by Ecuadoran nationals, repatriating holdings
taken abroad in the 1980s. The inflows themselves increased foreign-
exchange reserves and so seemed to reduce exchange-rate risk, encour-
aging further inflows. The high interest rates on short-term sucre
deposits were a standing source of instability, however: Capitalization of
rates on the order of 30 percent into deposit balances meant that this
became a basic growth rate for these monetary stocks, helping to sustain
this rate as the economy's "inertial" inflation rate during the 1990s.
The period of arrears accumulation that commenced in January 1987
concluded in 1994, when, with IMF, World Bank, and IDB support, the
authorities secured a debt-and-debt-service reduction (DDSR) deal with
commercial-bank creditors, leaving Ecuador owing Brady bonds totaling
just under US$6 billion (see figure 2.1). (The multilateral agencies
financed the collateral for the Brady bonds.) Even so, by the end of 1998
total public and publicly guaranteed external debt outstanding stood at
just over US$13 billion, about two-thirds of 1998 GDP-the heaviest bur-
den by far among Latin America's 10 largest economies.13 (In September
1999 Ecuador would become the first nation to suspend servicing of
Brady debt. See Part 4.)


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS        31
The national-accounts data suggest that in the mid-1980s, under the
stress of its adjustment to the debt crisis, Ecuador's macroeconomy
shifted to a lower-growth mode. Figure 2.2 shows that Fier-capita real
GDP and real consumption grew relatively rapidly until the early 1980s,
along with the external debt, but then leveled off, remaining nearly
unchanged over the past two decades. (The years 1987 and 1988 were
exceptional because of the earthquake damage to the oil pipeline and the
subsequent recovery.)
Figure 2.3 shows that the gross capital-formation rate rose through the
late 1960s to relatively high levels. It remained high through the 1970s,
but then declined abruptly in 1983, and has remained since then at lower
levels. In 1999 and 2000 it fell precipitously on account of the economic
crisis. (Capital formation surged in 1998,'the first year of the'crisis, largely
because of reconstruction of infrastructure damaged by El NifAo rains.)
Figure 2.4 shows that when per-capita real GDP leveled 6ff in the early
1980s, the resource balance (net exports of goods and nonfactor services)
Figure 2.2 Ecuadoi- Per-capita Real GDP, Real Private
Consumption, and Year-End Per-capita Public External Debt in
1999 U.S. Dollars and Prices, 1972-2000
1,400
1,2001
1,000,
800
600
400
200
0(
.Per-capita real GDP    =Per-capita real private consumption
-Per-capita public external term debt (1999 U.S. dollars)
Note: Data are reflated using the GDP deflator.
Sources: International Monetary Fund, World Bank.


32                           CRISIS AND DOLLARIZATION IN ECUADOR
Figure 2.3 Ecuador: Gross Domestic Capital Formation (at 1975
Prices, 1975 GDP = 100), 1965-2000
1975
GDP= 100
30.0
25.0
20.0
15.0 
10.0
1965-2000
U Nongovernment  U Government
Source: National accounts of Ecuador.
shifted from deficit to surplus: Gross domestic saving (the difference
between gross investment and the resource deficit) generally exceeded
gross investment after the early 1980s-that is, Ecuador was carrying out
external dissaving to limit growth of external liabilities.
Chronic exchange-rate instability (see figure 2.5) helped set the price
incentive for this dissaving: Beginning in 1982, the various policy pack-
ages and mini-devaluations left the real-effective exchange rate at a con-
sistently more depreciated value than it had maintained over the 1970s
and 1980s.
This part has summarized a complex history, but several patterns seem
clear. The oil euphoria of the 1970s not only failed to lead to sustained
economic growth, it also left Ecuador with an overwhelming external-
debt "overhang." Moreover, by using oil proceeds to increase public
expenditure and subsidization and reduce non-oil taxes, the government
of the 1970s set in place revenue and expenditure structures that deep-
ened the economy's vulnerability to shocks. During the 1980s and 1990s,
the need to generate a net-export surplus reduced the resources available


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS           33
Figure 2.4 Ecuador: Gross Fixed Capital Formation, Gross
Domestic Saving, and Net Imports of Goods and Nonfactor
Services (Percent of GDP), 1971-2000.
Percent of GDP
35.0
30.0
.0                 Gross fixed capital formation
20.0 1      .                         ,--/                       -
15.0     Gross domestic savin \p.'.  '               .......
10.0     Ip
10. - Imports less exports of goods and nonfactor services
5.0
0.0
5.0
-10.0
-15.0
1971-2000
Source: National accounts of Ecuador.
Figure 2.5 Ecuador: Exchange Rate (Sucres per U.S. Dollar);
Trade-Weighted Real-Effective Exchange Rate (+ =
Depreciation; 1990 = 100), June 1970-September 2001
Real-effective exchange rate
Nominal exchange rate (log)                          (+ = depreciation; 1990  100)
100,000   ------         -------    ------         --------      -- 200
175
10,000
150
1,000                                                             125
100                                                              100
75
5
Monthly from June 1970
Source: International Monetary Fund.


34                            CRISIS AND DOLLARIZATION IN ECUADOR
for capital formation. Moreover, to set the incentives to bring about the
export surplus, policymakers had to sustain a real-effective exchange-rate
depreciation. Doing so subjected the exchange rate to instability and
uncertainty, encouraging the spontaneous dollarization that would help
make the 1998 crisis so devastating.
3. Ecuador's Economic Structure Going into -the
Predollarization Crisis
As it went into the predollarization crisis in 1998, Ecuador still had a large
pending structural-reform agenda. Oil dependence, the large size of the
public sector, and heavy external debt made the public finances particu-
larly vulnerable. But the most immediately dangerous structural problem
turned out to be that, because the authorities had relied so heavily on
exchange-rate depreciation to maintain the export surplus and external-
debt surplus, the economy's spontaneous dollarization was advancing
inexorably. Partial dollarization left the financial system singularly vul-
nerable to the exchange-rate depreciation. This part considers the public
sector, financial system, and other sectors in turn.
A. Public-sector Structure and Vulnerability
As policymakers struggled to cope with the debt-problem during the
1980s, it became increasingly clear that the public-sector structure they
had inherited from the 1970s was an obstacle to growth. The elected gov-
ernments that followed the military regime found it difficult to limit pub-
lic employment, target subsidies, and taxation sufficiently and efficiently.
Public-sector management-in particular, tax administration, budget
planning, and day-to-day expenditure administration-remained out-
moded. The key oil, electricity, and telecommunications sectors were
inefficient public monopolies, and the government owned and managed
smaller enterprises in many other sectors. The reliance of public revenue
on volatile oil earnings rather than on more stable revenue sources,
together with the expenditure commitments deriving from the public-
debt burden, the essentially tenured public-sector labor force, and man-
dated transfers (required in many instances by revenue earmarking),
made the fiscal accounts inherently vulnerable to exogenous shocks.
The elected 'governments of the 1980s and 1990s differed ideologically,
but all were persuaded of the practical need for public-sector reform. The
Cordero and Borja Governments made significant advances in financial
liberalization and trade liberalization, but found substantive public-sector
reform difficult to achieve. The Durtin Balln Government made some-
what more progress. Its 1992 Public Budgets Law set a legal basis for mod-


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      35
ernization of the systems of formulating and implementing public bud-
gets. The Modernization of the State Law (1993) established a ministerial-
level "Modernization of the State Council" (CONAM) to plan and help
bring about modernization and privatization. The Durin Ball6n Govern-
ment succeeded in divesting most of the smaller enterprises that had come
under public control, and submitted legislation to the Congress to permit
reorganization and eventual privatization of the telecommunications and
electricity monopolies. During its first two years in office the Durdn Bal-
16n Government also made substantial progress in controlling public
finances. It reduced noninterest public expenditure, in part through a pro-
gram that reduced public-sector staffing by nearly 10 percent. This action,
combined with forceful Central Bank policy management and implemen-
tation of the pre-announced crawling-peg exchange rate, helped reduce
annual inflation to around 20 to 30 percent from the 40 to 50 percent pre-
vailing in the early 1990s. These were hard-won reforms, secured in the
face of broad political opposition. Even so, they were short of the compre-
hensive public-sector overhaul that Ecuador needed. The revenue base
was still heavily dependent on oil; non-oil taxes were inefficient and
widely evaded; and the public-sector payroll remained larger than
Ecuador could afford (averaging 7.3 percent of GDP over the 1990s).
In 1995, the Durin Ball6n Government's structural-reform effort fal-
tered on account of unanticipated events, including (a) a border conflict
with Peru in January; (b) extended drought in the middle part of the year;
and (c) the resignation of the vice president, who had been managing eco-
nomic policy, under corruption allegations. Under pressure from interest
groups, the Congress held up progress on reorganization of the electricity
and telecommunications sectors. The failure of two relatively large banks
in 1995 and 1996 deepened the government's difficulties. The Central
Bank provided liquidity credit to keep the banks, open and took direct
ownership of one.14 Real growth slowed in 1995. No further disburse-
ments were provided by the IMF under its 1994 program after the first,
and disbursements of the World Bank and IDB structural-adjustment
loans were postponed on account of the failure to meet the conditionality.
Ecuador relapsed into political instability after the Durin Ball6n Gov-
ernment left office in mid-1996. The government elected that year, under
President Abdali Bucaram, was forced from office by the Congress after
only six months because growing alarm over corruption, the President's
unusual personal style, and, finally, in January 1997, sharp increases in
gasoline prices following relatively high exchange-rate depreciation led
to widespread protests. The Congress then installed an 18-month interim
government under President FabiAn Alarc6n, an anti-Bucaram leader in
the Congress. This government had inadequate political support for any-
thing more than caretaking. It made vigorous efforts to persuade the Con-


36                           CRISIS AND DOLLARIZATION IN ECUADOR
gress to enact tax reform and to advance privatization, but these efforts
were largely fruitless. To increase revenue it enacted a tariff surcharge,
reversing the long process of trade liberalization. Moreover, in early 1998,
with the conclusion of its term close, this government had to deal with
the El Nifio rains and declining oil-export prices that turned out to be the
onset of the predollarization crisis.
The core of Ecuador's public-finance problem was (and indeed
remains) that revenue depended too heavily on volatile oil earnings,
while inadequate non-oil revenue and overwhelming debt-service and
payroll commitments narrowed the scope for developmental expendi-
ture. The incomplete public-sector reform agenda encompassed (a)
reform of tax policy and administration, both to increase revenue and
mitigate the effects of taxation for allocative efficiency; (b) implementa-
tion of oil-revenue stabilization mechanisms; (c) limitation and targeting
of public subsidies; (d) reduction and improved management of public-
sector staff; steps to ensure the efficiency and quality of (e) education,
health, and social-welfare expenditure and of (f) public capital formation
and maintenance; (g) modernization of legal and technical systems of
budget planning and execution; (h) completion of privatization processes
and regulatory development in the telecommunications, electric power,
and hydrocarbons sectors; (i) modernization of the social-security sys-
tem; and (j) implementation of politically, administratively, and fiscally
viable public-sector decentralization.
Figure 2.6 shows how heavily Ecuador's public revenue has depended
on crude-oil exports and domestic sales of oil derivatives. Revenue from
these sources has been remarkably variable. In the four years 1996 to
1999, overall public-sector oil revenue, including domestic sales, was 8.2,
6.4, 4.6, and 7.5 percent of GDP, respectively. Revenue from oil exports
alone amounted to 4.9,3.2, 1.3, and 5.3 percent of GDP, respectively, in the
same years.15 Export volume and production grew slowly because of
delayed and inadequate investment in the sector, but unstable world oil
prices accounted for most of the variability (see figure 2.716). (implemen-
tation of a "stabilization fund," which would even out the revenue flow
by accumulating funds when oil proceeds were relatively high and
releasing resources when oil proceeds were relatively low under rigorous
rules, would help reduce oil-export revenue volatility.17)
Although the domestic non-oil taxation system generates inadequate
revenue and is characterized by inefficiency and inequity, the difficulty of
reaching agreement among the various parties in the Congress has
impeded modernization. The reforms the Congress has approved since
the crisis began have tended to be piecemeal, stopgap, and temporary
measures. Beginning in 1999, the Congress and the Executive agreed to
set an unusual 1 percent tax on financial transactions while suspending


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS         37
Figure 2.6 Ecuador: Per-Capita Nonfinancial Public-Sector
Revenue (in 1998 U.S. Dollars at 1998 Prices), 1990-2000
US dollars per capita at
1998 prices and exchange rate
500.0  - - - - --- - -- -  ------ - -_-      __   --    _---
450.0 -                                                             7
400.0 -                                                          W
150.0 --
100.0 -
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
U Public enterprise operating surplus U Oil-export revenue 0 Oil revenue from domestic sales
EB Non-oil external-source revenue m Non-oil domestic-source revenue
Source: Central Bank of Ecuador.
the personal and corporate income taxes, which had low yields and were
difficult to administer. In April 1999, however, a realignment of political
coalitions in the Congress led to restoration of the income tax. In Novem-
ber 1999, the Congress reduced the transactions-tax rate to 0.8 percent,
allowing it to be credited against income tax, and lifted the value added
tax (VAT) rate from 10 to 12 percent (but rejected an increase to 15 per-
cent). The 12 percent VAT rate was still below the rates in comparable
Latin American economies (Peru and Chile, for example, have 17 percent
rates). The Congress essentially refused to consider integral reform pro-
posals. A proper integral reform would rebuild the tax system as a whole,
setting mutually appropriate rate structures for (a) VAT, (b) personal arnd
company income tax, (c) excises, and (d) import levies, and would also
modernize the national law covering provincial and municipal revenues,
helping relieve financial constraints at those levels. (Kopits and others,
1999, discuss the taxation issues comprehensively.)
Ecuador maintains intricate systems of revenue sharing between the
central administration, provincial and municipal governments, and sev-


38                            CRISIS AND DOLLARIZATION IN ECUADOR
Figure 2.7 Ecuador: Monthly Average Crude Oil-Export Price,
June 1995-September 2001
30.00
Dollarization announcement o
25.00
20.00
15.00
10.00
5.00
Monthly from June 1995
Source: Central Bank of Ecuador.
eral specific autonomous public entities. In February 1997, just after the
Bucaram Government was forced from office, the Congress and the
interim government rapidly approved a measure under which 15 percent
of central-government revenue would have to be transferred to subna-
tional governments (9 and 11 percent in 1997 and 1998, respectively). In
the event, this legislation proved difficult to implement, partly because of
the continuing resource scarcity as the economy slid into crisis, but also
because subnational governments themselves had inadequate absorption
capacity and limited abilities to take on new spending responsibilities.
Education, health, and most public works remain almost entirely central-
government responsibilities, and a large political and administrative
effort would be required to decentralize them. Meanwhile, Ecuador
maintains its long-standing practice of revenue earmarking, which has
limited budget planners' scope to make discretionary expenditure
choices. Tax evasion is widespread, partly because tax administration
remains inadequately developed, but also because taxpayers have been
"demoralized," perceiving that their taxes go to such "questionable" pur-
poses as debt service, bureaucracy, and corruption.
On the expenditure side, the public payroll has been difficult for poli-
cymakers to control: Most public workers are unionized and effectively
tenured. Pay levels are, as in many economies, politicized and con-


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS       39
tentious. About 90 percent of the roughly 240,000 workers on the central
government's payroll work in the national education system, health (the
central government runs public hospitals and various health programs),
the national police, and the armed services. Employment in education,
health, and the police will have to increase as Ecuador grows and devel-
ops (although this should be accompanied by a decline in the ratio of
administrative to line staff). In addition to workers on the central gov-
ernment's direct payroll, mandated central-government transfers largely
go to other public-sector workers (such as at universities). One conse-
quence of the central government's chronically tight finances has been
that its capital budget has been tightly constrained: Public expenditure on
capital formation and maintenance has lagged, affecting real growth.
Figure 2.8 shows the evolution of the central government's expendi-
ture over the 1990s. Expenditure is divided here into five functional cate-
gories: (1) education, health, and social services; (2) transport and
communications; (3) agricultural development; (4) all other noninterest
expenditure, and (5) interest on the public debt. While overall social
expenditure declined in the crisis years of 1998 and 1999, the total inter-
Figure 2.8 Ecuador: Per-Capita Central Government
Expenditure (in 1998 U.S. Dollars at 1998 Prices), 1990-2000
U.S. dollars at 1998 prices
and exchange rate
400.0
350.0
20.0-H            M           AM                          M
1990  1991  1992  1993  1994  1995  1996  1997  1998  1999  2000
M Education and health   EI Transport and communications
I Agricultural development  0Other-noninterest expenditure
S Interest due
Source: Central Bank of Ecuador.


40                           CRISIS AND DOLLARIZATION IN ECUADOR
est bill increased sharply. In 1998 the nonfinancial public sector's accrued
interest bill was 5.1 percent of GDP (of which external interest accounted
for 3.8 percentage points). In 1999, accrued interest reached 10.1 percent
of GDP, of which external interest accounted for 6.4 percentage points
(again, largely because in 1999 recession and exchange-rate depreciation
sharply reduced the GDP figure in this ratio's denominator).
It is important to note in this context that Ecuador's social safety net is
especially limited (see chapter 4). Apart from the national pension system
(discussed below), its most important component is the Bono Solidario set
up in September 1998. This program provides small monthly stipends to
mothers of poor families and to poor retirees who are registered by the
Catholic Church. Survey work implies that beneficiaries include many
people who should be ineligible'8 while excluding many who would be
eligible. The Emergency Social Investment Fund (Fondo de Inversion Social
Emergente, FISE), created in 1993 with funding from various external
sources, is used for local infrastructure projects in areas affected by emer-
gencies, the idea in part being to employ people temporarily in order to
provide them income. These programs apart, while there are various pro-
grams in education, health, and nutrition intended to benefit poorer peo-
ple, none can be said to fulfill the objectives of a social safety net.
The rising public interest bill was driven by three developments after
the mid-1990s. First, after running at relatively low levels after 1992, the
public deficit widened. Second, net domestic financing came to figure
more heavily than net external financing in overall public financing. And,
third, since public borrowing was dollar-denominated, the real-effective
exchange-rate depreciation increased the value of the interest bill.
Domestic Treasury debt in bonds and bills rose from 1.2 percent of GDP
at the end of 1993 to 7.1 percent at the end of 1998 (88 percent of which
was dollar-denominated). This figure rose to 15.4 percent at the end of
1999 (largely on account of the sharp decline in the dollar value of GDP,
resulting from recession and sharp real-effective exchange-rate deprecia-
tion). In addition, after December 1998, the Treasury added an additional
US$1.6 billion in dollar-denominated bonds to recapitalize commercial
banks and pay deposit guarantees (see Part 4). (In November 1999, as the
predollarization crisis turned acute, the authorities unilaterally termed
out the dollar-denominated domestic debt falling due through December
2000 for seven years, with two years' grace, at London interbank offered
rate (LIBOR) plus 2 percent interest.)
Although the volatile performance of public finances is basically the
consequence of the volatility of oil revenue and the large interest bill and
payroll, the problem has additional dimensions. The Public Budgets
Law and various reform attempts by the Council for the Modernization
of the State notwithstanding, administration of the various aspects of


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      41
public finance has remained weaker than the country requires. Tax
administration was lax until the mid-1990s, when the revenue service
began to focus on "large taxpayers," an approach that has had some suc-
cess in other countries. In 1998, however, the Alarc6n Government car-
ried out a thorough reform of tax administration, establishing a new
agency and replacing a large proportion of the staff. This new agency has
proved more successful than the one it replaced, largely because the
transactions tax that went into effect in January 1999 provided vital
information relevant for collection of other taxes. Customs administra-
tion gave rise to so many complaints of corruption that in the mid-1990s
the authorities turned it over to a foreign company. The Bucaram Gov-
ernment restored it to civilian control, but complaints (and evidence) of
corruption revived, and in 1997, the Alarc6n government turned it tem-
porarily over to military control.
Figure 2.9 shows a striking characteristic of Ecuador's nonfinancial
public-sector accounts. Despite the economy's unsatisfactory growth per-
formance in the 1990s, the primary balance has been strongly in surplus
since 1990, excepting only the initial predollarization crisis year of 1998.
Because the interest bill has been so large, however, the overall balance
has tended to be in deficit. Ecuador's large primary balance raises several
issues. One is the question of whether, when analyzing the effect of the
primary deficit on the domestic economy, it is more appropriate to focus
on the primary balance excluding oil-export revenue. A primary surplus
(deficit) presumably indicates the net resource flow the fisc draws from
(pumps into) an economy to pay down financial obligations or accumu-
late assets. In Ecuador's case, however, oil-export revenue flows do not
pass through the domestic private economy. Another important issue is
that the primary surplus is calculated for the consolidated nonfinancial
public sector. This misses the point that operating surpluses in, say, state
enterprises cannot be transferred directly to other public entities. (More-
over, there is a fundamental conceptual difference between a government
deficit, which is a change in the public net liability position, and a state-
enterprise's operating loss.) Analysis of Ecuador's fiscal accounts
requires separate consideration of the various public-sector compo-
nents-the central government, public enterprises, subnational govern-
ments, and social security. In recent years, the central government has
been the main source of the overall public-sector deficit, and has been the
main source of its variation. Regional and municipal governments ran a
consolidated overall deficit of about -0.3 percent of GDP from 1996
through 1999 (although they managed slight surpluses in 2000 and 2001).
Public enterprises ran a combined operating deficit of around 1 to 1.3 per-
cent of GDP in 1996-99 (they managed surpluses of about 0.3 percent in
2000 and 2001).


42                            CRISIS AND DOLLARIZATION IN ECUADOR
Figure 2.9 Ecuador: Nonfinancial Public-Sector Overall and
Primary Surplus (US$ Million at 1998 Prices and Exchange
Rate), 1990-2000.
US$ million at 1998 prices
and exchange rate
150.0
1990  1991  1992  1993  1994  1995  1996  1997  1998  1999  2000
100.0       -m1.
50.0
-50.0
-100.0
-150.0
1990-2000
g Primary surplus  g Interest due Ea Overall surplus
Source: Central Bank of Ecuador.
Public finances have remained unstable partly because Ecuador's bud-
get-management processes remain outdated. The processes by which
annual budgets are formulated, considered by the Congress, codified into
a payments calendar, adjusted over the course of budget exercise for
unforeseen events, and finally executed have various shortcomings. These
arise in part from the practical difficulty of planning properly in an unsta-
ble context; institutional complexities in the planning and implementation
phases; and long-standing problems in the processing of information. Once
dollarization brings about price stability, the need to alter the. budget in
mid-year for unanticipated events should diminish. Since the mid-1990s,
with Woild Bank support, the government has been developing and imple-
menting a modern, computerized management information system. The
system was officially inaugurated for a core group of public entities in May
2000, and implementation has been proceeding since then. When this sys-
tem is complete, policymakers will be in a far better position to plan and
oversee public resource allocation. These changes will resolve only part of
the problem of public-sector financial management, however: Apart from
the "structural" problems of overreliance on oil revenue, the use of human


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      43
resources, and the external debt burden, Ecuador still needs to modernize
its ways of determining public expenditure.
Part 4 argues that the structure of the public finances magnified the
consequences of the 1997 and 1998 shocks that set off the predollarization
crisis. Reduced oil revenue and the need to increase public expenditure on
account of El Niflo, together with the inflexibility of public expenditure,
combined to increase the public deficit. The authorities simply could not
reprogram expenditure sufficiently in response to' their changed priorities.
Three additional aspects of Ecuador's public-sector structural-reform
agenda go beyond the government budget narrowly defined. These are
(a) the need for pension reform, (b) the issue of political and administra-
tive decentralization, and (c) the lagging privatization of publicly owned
assets.
Like many of South America's older national pension systems,
Ecuador's pay-as-you-go social-security system has become financially
unviable, and a fundamental reform, like those of Chile, Bolivia,
Argentina, and Peru, is clearly necessary. Since the mid-1980s, in addition
to contributions for its own staff, the central government has been pro-
viding a subsidy to the IESS (the Instituto Ecuatoriano de Seguro Social, that
is, the Ecuadoran Social Security Institute) covering 40 percent of pension
payments due as well as certain specific pension deficits, including those
of the national police and armed forces. The subsidy has been provided
in cash, however, only to the extent the IESS actually needed it to meet its
obligations. The balance has been capitalized into an interest-bearing
loan from the IESS to the government, which amounted to about US$600
million by the end of 1999. At present, basic pension activity is restricted
to the IESS, with no role for private institutions. Various reform propos-
als have been made, under which, in general, the central government
would amortize the loan in cash over time, if and as the social-security
system were placed on a viable financial basis and a role were created for
the private sector. Many groups remain opposed to reform, however.
Peasant groups in particular fear that reform could affect the Seguro
Campesino, a program of pension and health benefits peasants receive but
for which they make no direct contributions. Modernization of the social-
security system is essential to ensure that no new pension-system bailout
becomes necessary, that workers receive the pensions for which they con-
tributed, and that appropriately regulated private-sector financial insti-
tutions can participate in the system.
In recent years, debate has revived in Ecuador on the potential for
political and administrative decentralization. Participants in these
debates refer often to positive and negative points of recent decentraliza-
tion experiences in other countries. Proponents argue that, by applying
the "subsidiarity" principle and devolving political and administrative


44                            CRISIS AND DOLLARIZATION IN ECUADOR
decisionmaking to more appropriate governmental levels, Ecuador could
ease its regional rivalry (see Part 2) and make expenditure more respon-
sive to local circumstances. Participants in these debates are well aware,
however, of decentralization's pitfalls. Moreover, there is a wide range of
views on precisely how it ought to be done. The fiscal aspects of decen-
tralization are especially thorny. Ecuador's subnational governments are
financially pressed, largely because existing legislation and outdated
property values severely constrain their revenue-generation capacity and
they have very limited financing capacities. As they elaborate their
decentralization project, Ecuadorans will need to solve several problems
simultaneously. Not only must they find a generally accepted political
formula; they must ensure that expenditure responsibilities and financial
resources of the various levels of governments are more or less balanced.
(Brazil and Colombia offer striking examples of the dangers of decentral-
izing without such matching.)
The Durdn Ball6n Government successfully privatized many small
enterprises (including several that had come under public control
through insolvency), but privatization of the national telecommunica-
tions, electricity, and hydrocarbon monopolies has been more difficult.
Political and labor-union opposition was only part of the problem. The
technical problem was that the enterprises themselves were not orga-
nized on commercial bases, and so could not readily be transferred to pri-
vate ownership. In the case of the electricity enterprise, establishment of
new generating and transmission enterprises was delayed by the diffi-
culty of allocating assets. Governments following the Durin Ball6n Gov-
ernment gradually succeeded in reorganizing the telecommunications
and electricity sectors, formulating sectoral policies, and creating new
regulatory agencies. Thus far, however, the enterprises remain unsold (an
attempt in November 1997 to auction management contracts and minor-
ity holdings in the telecommunications monopoly's two successor com-
panies failed, and they are still in government hands). Moreover, rate
setting remains subject to political pressure. The dollarization legislation
approved in March 2000 included reforms increasing the shares of the
telecommunications and electricity enterprises that private owners could
hold. Thus far, the process of reorganizing and privatizing the state oil
monopoly, PetroEcuador, has not yet been possible. To do so would
require complex reorganization and legal reforms, and political and
labor-union opposition remains powerful.
B. Ecuador's Financial System and Partial Dollarization
Ecuador's financial system proved especially vulnerable during 1998, and
this was the main reason the crisis proved so devastating (see part 4


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS       45
below). Beginning in the mid-1980s, Ecuador's financial system had
undergone liberalization, which changed the financial system from a
"repressed" structure with directed-credit programs, high reserve require-
ments, restricted foreign-exchange operations, and regulated interest rates
to one in which private entities were essentially free to manage their
affairs. The decade of liberalization culminated with the 1994 General Law
of Financial Institutions. Directed-credit programs ended, reserve require-
ments were reduced and rationalized, interest rates were freed, and banks
were permitted to accept dollar deposits and provide dollar loans. Com-
mercial banks were allowed to have offshore operations, on the reasoning
that if Ecuadoran funds could not be prevented from going off shore, it
should at least be possible to bring them home for credit operations.
As it liberalized, Ecuador modernized its Central Bank. It phased out
the Central Bank's export-subsidization programs and introduced mod-
em monetary-management techniques, including more transparent pro-
cedures for lending to commercial banks and liquidity management
through repurchase operations and open-market operations in Central
Bank liabilities. In 1992 a new Law of the Monetary Regime and State
Bank substantially modernized the institution. This law prohibited Cen-
tral Bank direct lending to the public sector and transferred various debt
stocks (including the external debt remaining from sucretizaci6n) from the
Central Bank to the Treasury. The institution's technical capacities and
staff skills were significantly upgraded. Until 1998, however, the mone-
tary authority retained an antiquated structure, under which the Central
Bank executed policy set out by a "Monetary Board" whose members
were the finance minister, the banking superintendent, representatives of
commercial banks and the nonbank private sector, and a fifth member
elected by the other four. That year, a constitutional reform abolished this
institution, created a conventional presidency and board of directors, and
made them completely independent once they were appointed by the
president and confirmed by the Congress.
Financial liberalization was not accompanied, however, by adequate
development of banking supervision, for many of the same reasons why
public administration generally had developed inadequately. Even after
the onset of the 1998 banking crisis, many Ecuadorans perceived the exer-
cise of banking supervision as political, not administrative. (There was a
widespread view that if supervisors acted against Guayaquil banks, fair-
ness required that they also act against Quito banks.) Banking supervi-
sion was inadequate at various levels. Laws and norms covering such
matters as connected lending, portfolio concentration, risk management,
capital adequacy, accounting standards, documentation, income recogni-
tion, and asset classification were uneven-in some instance outmoded,
in some instances up-to-date. Enforcement was generally deficient, how-


46                           CRISIS AND DOLLARIZATION IN ECUADOR
ever, partly because supervisors' technical capacities were uneven, but
also because bankers were often able to intimidate supervisory personnel
administratively and legally. In any case, the main supervision problem
was that the authorities had no formal means of intervening in banks
short of liquidation.
Banks maintained many long-standing risky practices. Connected
lending and portfolio concentration were commonplace-indeed, many
banks belonged to economic groups that used them to serve their own
financing needs. These practices aggravated the risks of bank lending in
a contingency-prone economy. Liberalization provided banks scope to
engage in additional risky activities, including aggressive interest-rate
competition, offshore banking, and U.S.-dollar operations. While interest-
rate competition was a presumable objective of financial liberalization,
absence of effective supervision meant banks could undertake riskier
operations than they could safely manage. Managers of more conserva-
tive banks found themselves having to engage in risky activities in
response to competition.
Offshore banking turned out to be a source of instability. Banks ran
their offshore funding operations pretty much as if they were onshore,
taking deposits and doing other business in branches within Ecuador.
Although the Banking Superintendency nominally regulated these off-
shore operations, it was unable in fact to work effectively outside
Ecuador. After the crisis began in 1998, the authorities' inadequate
knowledge of the offshore banks' situation complicated their ability to
deal with it. This is why in December 1998, for example, the authorities
had little choice but to extend the same guarantee to offshore deposits
that they provided to onshore deposits. The March 1999 deposit freeze
applied to the off-shore banks, but banking authorities in some places-
in particular, the United States-did not recognize it.19 Since the onset of
the crisis, the authorities have concluded that, however logical the argu-
ment for allowing offshore operations may once have seemed, their
inability to supervise such operations left the authorities little choice but
to conclude them (the March 2000 dollarization legislation provided for a
gradual phase-out).
Important as the financial system's operational and supervisory inad-
equacies were, the evolution of the predollarization crisis as described in
Part 4 shows that the banking system's partial dollarization (see table 2.2)
was probably the main reason the predollarization crisis evolved as it
did. Strictly speaking, partial dollarization did not cause the crisis, but it
did intensify the destabilizing effects of exchange-rate depreciation, mak-
ing the crisis far harder to manage than it would otherwise have been.
Partial dollarization meant that the economy was operating internally
with two different units of account, subject to an unstable-that is,


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS        47
volatile and uncertain-exchange rate. Exchange-rate depreciation not
only increased the sucre equivalent of the dollar component of the money
supply, it also drove*private firms and individuals with open, exposed
positions into insolvency. Although commercial banks tried hard to main-
tain matched positions on their own balance sheets,20 they apparently
took less care to ensure that their borrowers had matching positions.
The reason "spontaneous" dollarization became so pervasive was that
long experience of inflation and exchange-rate depreciation made the
value of the national monetary uncertain, encouraging people to choose
a hard currency unit to denominate their assets. In December 1996, 24
percent of all onshore bank demand, savings, and time deposits were in
dollars rather than sucres; in December 1998, this percentage had risen to
41, and in March 2000 it stood at 63 (see figure 2.10). Over this period, the
commercial banks' overall deposit base declined about 30 percent in dol-
lar terms, with sucre deposits falling by more than two-thirds while total
dollar deposits grew. Offshore deposits were entirely in dollars. In addi-
tion, a growing quantity of dollar currency circulated within Ecuador and
came into increasing use for transactions.
Banks' loan portfolios underwent a corresponding evolution. In
December 1994, 33 percent of all bank loans were in dollars; by Decem-
ber 1998, this percentage had risen to 60, and in Marth 2000 it stood at 91
(see figure 2.11). Moreover, after December 1998, the proportion of dollar-
denominated loans classified as nonperforming rose sharply, in contrast
to sucre loans. As the crisis progressed, banks collected sucre loans and
gave far fewer; at the same time, their dollar lending stocks stabilized and
turned increasingly nonperforming on account of real-effective deprecia-
Table 2.2 Ecuador: Dollarization Indicators
Year-end percentage in U.S. dollars of
Year             Quasi money       Deposits         Loan portfolio
1989                 9.7             14.7                1.9
1990                 7.4             13.3                1.5
1991                 7.5             14.5               3.0
1992                10.8             20.0                6.8
1993                12.6             16.9              13.4
1994                15.7             15.6               20.3
1995                24.3             19.2               28.3
1996                28.0             22.3              32.6
1997                36.9             23.6              45.1
1998                43.9             36.9              60.4
1999                47.4             53.7              66.5
Source: Central Bank of Ecuador.


48                           CRISIS AND DOLLARIZATION IN ECUADOR
Figure 2.10 Ecuador: Onshore Commercial-Bank Deposits (US$
Million)
US$ million
6,000
50
4,000
3,000
2,000
1,000
0                                                 ....  . . . N  N  .% .0 0  %
December 1996 -February 2000
EU S. -dollar deposits  E Sucre deposits
Source: Central Bank of Ecuador.
tion, as borrowers without dollar income found it harder to meet their
obligations.
As always, exchange-rate depreciation tended generally to increase the
price level, if only by raising tradable-goods prices. With the money sup-
ply dollarized, depreciation directly increased its local-currency value,
and so increased the pressure on the price level more than it otherwise
would. Moreover, since the inflationary aftermath of any exchange-rate
depreciation eroded at least some of its (real-effective) effect, deeper
depreciation was required in the partially dollarized system to achieve
any given external-accounts objective. On this reasoning, all other things
being equal, the farther dollarization proceeded in the bank-deposit base,
the larger the inflationary consequences of any exchange-rate deprecia-
tion were likely to be. Moreover, once the exchange rate and price level
began rising, they affected the state of expectations and uncertainty
regarding their future levels. This is true in any inflationary economy, but
in an economy with two currency units the consequences were bound to
be more complex and unstable. As the account in Part 4 indicates, once
the exchange rate began depreciating sharply, commercial banks became
acutely illiquid, first because debt service from dollar-denominated loans


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS        49
Figure 2.11 Ecuador: Onshore Commercial-Bank Loans
Performing Normally and in Arrears
US$ million
6,000
5,000
4,000
3,000
2,000
1,000
'CoNIN     N       N00            mmmC'mO
M  (7  (71  a,  N,  0N  a, 'C   000 0 1  C71 0 \ 0 \  2
December 1996 -February 2000
* U.S.- dollar credit performing normally  I U.S.-dollar credit in arrears
* Sucre credit performing normally  a Sucre credit in arrears
Source: Central Bank of Ecuador.
diminished, and second because depositors, knowing or fearing that the
banks' condition had deteriorated, began withdrawing.
In summary, the structural weaknesses of Ecuador's banking system
meant that the system would play a central role in the evolution of the
crisis. As a consequence of uneven structural reform, going into the crisis
Ecuador had a liberalized, but inadequately supervised, banking system
working in two units of account. Partial dollarization was, in hindsight,
the crucial problem. Better supervision might have enabled the authori-
ties to manage it better and faster, but, as Part 4 argues, a partially dol-
larized financial system would inevitably prove too vulnerable to sharp
exchange-rate depreciation.
C. Labor-market and Foreign-trade Reform
Going into the crisis in 1998, the most important aspects of Ecuador's
incomplete structural-reform agenda were those having to do with the
public and financial sectors. Nevertheless, important structural-adjust-
ment agendas remained in several other aspects of Ecuador's economy.


50                            CRISIS AND DOLLARIZATION IN ECUADOR
Two subjects worth mentioning in this connection are (a) formal labor
markets and (b) the trade regime.
FORMAL LABOR MARIETS. Ecuador's formal labor markets were (and are
still) highly regulated. Job-tenure and severance-payment rules were
especially so, contributing to the large size of the informal sector. In
addition, until full dollarization commenced in 2000, Ecuador main-
tained an unusual formal-sector wage regime. Wages came to be set
every six months by special sectoral commissions, with labor-union,
employer, and government representatives. A central commission sets
the minimum wage, which guides many of -the sectoral wage commis-
sions. At the outset of the crisis, formal-sector wages comprised a large
number of components, including thirteenth, fourteenth, fifteenth, and
sixteenth wage payments made in different months of the year, cost-of-
living adjustments, and a remarkably extensive array of other
allowances and benefits. The dollarization legislation (see chapter 3)
included provisions introducing gradual change. One would gradually
"unify" all these wage components in both the private and public sec-
tors; the other introduces temporary hourly employment contracts. Full
unification, further "flexibilization," and gradual extension of "formal-
ity" to the labor market as a whole are essential to making labor markets
work efficiently.
THE TRADE REGIME. During the 1950s, 1960s and 1970s, like many devel-
oping economies, Ecuador constructed a restrictive trade regime. In the
late 1980s and early 1990s, however, it liberalized and modernized it to a
considerable degree. Formally, Ecuador's external tariff is the Common
External Tariff of the Andean Group, as liberalized in the late 1980s,
although its basic tariff rate is somewhat lower than the Common Exter-
nal Tariff. During 1998 this afforded Ecuador some scope to set tariff sur-
charges ranging between 2 and 10 percent-mainly as a revenue
measure, but partly (as their differentiation reveals) as a protection mea-
sure. These surcharges remained in place until sometime after dollariza-
tion commenced. The present tariff system has an anachronistic structure
favoring raw materials over final products. Raw and intermediate goods
pay tariffs ranging between 5 and 15 percent, capital goods pay 15 per-
cent, and consumer goods pay tariffs of 20 percent (new automobiles
remain subject to a 35 percent rate). Although Ecuador eliminated most
nontariff and restrictive barriers, several remain. Some agricultural
imports are subject to levies based on reference prices, and certain
imports (including used automobiles) are banned. Although the trade
regime is not at present the most pressing structural-reform priority, com-
pletion of the reform process-in particular, movement toward a uniform


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      51
external tariff--would encourage development of industrialized exports,
and to this extent reduce the economy's reliance on commodity exports.
4. Ecuador's Predollarization Crisis
A. The Onset of the Crisis, 1998
Ecuador's predollarization crisis commenced at the end of 1997, about
halfway through the interim government (February 1997 to August 1998)
of Fabian Alarc6n, appointed by the Congress after it deposed Abdald
Bucaram's government. The shocks that produced the crisis included (a)
declining crude-oil export prices (see figure 2.7 above); (b) severe damage
from the 1997-98 El Nifo rains, affecting coastal populations, agriculture,
and infrastructure;21 and then, during 1998, (c) the effects of the financial
crises involving East Asia, the Russian Federation, and Brazil. These last
included recession in export. markets (Ecuador temporarily lost a new
Russian flower-export market, for example), intensified competition from
economies with depreciated exchange rates, and the retraction of finan-
cial flows to developing economies generally.
The public deficit surged in 1998 as a consequence of the shocks. Pub-
lic-sector oil-export revenue fell to 1.3 percent of GDP in 1998 from 4.9
and 3.2 percent in 1996 and 1997, respectively. The El Niflo damage
reduced tax revenue and forced heavy emergency and reconstruction
expenditure. The crisis stiffened political resistance to tax increases. Even
before the severity of the crisis became clear, it was generally recognized
that the tax system needed to be modernized to increase yields and
improve efficiency. In early 1998, however, Congress considered but
rejected several integral tax-reform proposals. Meanwhile, as explained
in Part 3, section A above, the interim government's policymakers had lit-
tle scope to limit public expenditure. An additional problem was that the
government removed from office in February 1997 had stopped the auto-
matic adjustment system for motor-fuel prices in effect since 1994. Elec-
tricity rates and the price of cooking gas were tending to lag behind their
production costs as well, effectively creating large subsidy flows. As a
consequence, the government found itself in a tight cash squeeze. Presi-
dential elections held in mid-1998 made it politically harder to tighten fis-
cal policy. The 1998 nonfinancial public deficit reached 5.6 percent of
GDP,2 compared with 2.9 and 2.5 percent in 1996 and 1997, respectively
(see figure 2.12).
As oil-export earnings declined and the trade accounts deteriorated,
importers concluded that the authorities would be forced to end the pre-
announced crawling-peg exchange-rate policy in effect since 1993, and
began advancing orders for inventory In late March and mid-September


52                              CRISIS AND DOLLARIZATION IN ECUADOR
Figure 2.12 Ecuador: Indicators of Macroeconomic Imbalance,
1988-2000
Percent of GDP (deficits)                      Annual percentage rate (inflation)
12.0                                                               100.0
10.0                                                               90.0
8.0                                                               80.0
6.0                                                               70.0
4.0                                                               60.0
2.0                                                               50.0
0.01                 1               LA4Li0
1990 '1991 1992 '1993 '1994 1995 W6 199/V 9  9      4.
-2.0                                                               30.0
-4.0                                                               20.0
-6.0                                                               10.0
-8.0                                                               0.0
-Current-account deficit/GDP  mNonfinancial public deficit/GDP
- Growth of consumer prices
(December/December)
Source: International Monetary Fund, World Bank.
1998 the authorities carried out devaluations beyond the pre-announced
crawling-peg band. Despite these devaluations, the 1998 current-account
deficit surged to 11 percent of GDP, compared with 3.6 percent in 1997
(see figure 2.12). A large proportion of the financing came through private
capital transfers, including withdrawals from offshore deposit holdings,
as well as some international-reserve loss.
The shocks affected commercial banks particularly seriously. They had
lent heavily in affected sectors, including coastal agriculture, oil-sector
services, and exports generally, and their nonperforming loans began ris-
ing. In addition, the emerging-markets crises and the country's worsen-
ing prospects persuaded foreign banks to retract credit lines to
Ecuadoran banks, intensifying liquidity pressure and forcing banks to
reduce credit to companies that depended on these lines for working cap-
ital. Given the developments on the external and fiscal accounts, how-
ever, the Central Bank took the view that it had to tighten credit and raise
interest rates to limit exchange-rate depreciation and inflation. During
the first half of 1998 several commercial banks underwent episodes of
illiquidity and heavy deposit withdrawals.


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      53
In August 1998, following a two-round election in May and July, a new
government headed by President Jamil Mahuad began what was to have
been a five-year term, under a constitution revised by a constitutional
assembly earlier in the year. The revisions were an ambitious attempt to
overcome Ecuador's long-standing governance problems. They included
measures to strengthen the president's authority, limit the Congress'
powers to increase taxes and public expenditure, make it harder to
impeach cabinet members and judges on purely political grounds, set
minimum electoral support requirements for political parties to be repre-
sented in the Congress, make the Central Bank fully independent, elimi-
nate mid-term congressional elections (which tended to weaken the
president), decentralize fiscal responsibilities, and make the judiciary
more independent. Unfortunately, however, the predollarization crisis
commenced even before the new constitution went into effect in August
1998. As this part shows, the crisis subjected the new constitution to
severe stress: Much of what happened over the next two years violated
the spirit and letter of the constitution-not least, of course, the Mahuad
government's forced departure and the move to dollarization (see Arteta
and Hurtado 2002). Nevertheless, the 1998 constitution remains in effect,
and, now that dollarization has brought about more normal circum-
stances, it is fair to hope that it will not be subjected to such severe stress.
A month after taking office in August 1998, the, Mahuad government
carried out an essential reform of the tong-standing cooking-gas and elec-
tricity subsidies, raising the prices and introducing a new direct cash-
transfer mechanism (called the Bono Solidario) targeted to poorer
households. These subsidies had been expensive, amounting at some
times--depending on the current exchange rate and prices-to several
percentage points of GDP. The Mahuad Government also began consid-
ering ambitious proposals to advance longer-term structural reform. Its
attention was focused, however, on negotiations with Peru to settle a
long-standing border dispute (which led to an historic peace accord in
November 1998). Over the latter part of 1998, however, the banking crisis
deepened. An important bank failed in August 1998, and virtually all
banks experienced intensified portfolio and liquidity problems. A Sep-
tember 1998 World Bank mission, noting that the authorities had no way
to intervene in problem banks short of the traumatic procedure of liqui-
dation, recommended that the authorities institute a universal deposit
guarantee and establish an agency capable of taking over and restructur-
ing banks in crisis. In December 1998, the president approved emergency
legislation extending a virtually unlimited Treasury guarantee to all
deposits, even to the trade-credit lines owed to foreign banks. This legis-
lation established Ecuador's first Deposit Insurance Agency and estab-
lished modalities through which the authorities could intervene in


54                           CRISIS AND DOLLARIZATION IN ECUADOR
troubled banks. The Congress had taken a month to debate .the.-emer-
gency legislation, partly because legislators from coastal.areas.feared that
their region's banks would be unfairly affected, and partly because it was
combined with.the unusual tax reform that,substituted a-financial-trans-
actions tax while suspending the income tax (see below) The guarantee
raised the stakes for the authorities and inevitably. created doubts. It was
credible as such only for deposits in smaller institutions: Itwas clear-that
if large banks failed, the authorities would either have to keep them open
or honor the guarantee in some sense less than-fully. While the guarantee
may have limited deposit withdrawals for a time, in retrospect its inher-
ent lack of credibility undermined its effectiveness.
On December 1, 1998, the day it began operating, the Deposit:,Insur-
ance Agency took over Ecuador's largest.bank (Guayaquil-based Filan-
banco), which had been foundering for several months. In.a pattern to be
followed during 1999 for larger failing banks, the authorities kept it open;
recapitalizing it with special 10-year dollar-denoninated Treasury bonds
paying 12 percent annual interest. The bank used,these bonds as.collat-
eral for Central Bank liquidity loans to help meet withdrawal demand. In
the first weeks of 1999 several smaller banks failed and eventually liqui.
dated. The Treasury paid their- deposits (after- several months' delay)
through the Deposit Insurance Agency.
The same legislation also replaced the poorly performing personal and
company income taxes with a 1 percent tax on all financial transactions,
including checks. The government needed to raise revenue, but the trans-
actions levy was the only tax measure for which a legislative majority
could be formed. The president's Democracia Popular Party, although the
largest in the Congress, had far less than a majority of the seats in the
Congress and relied for support on other parties. The next largest party,
the Partido Social'Cristiano, opposed tax reform generally but was will-
ing to substitute the transactions tax for the income tax. Although it
proved an effective revenue source during 1999 and 2000, the transac-
tions tax encouraged financial disintermediation and set an added incen-
tive for deposit withdrawals at a moment when the banks were already
in severe crisis.
B. The Deepening Crisis, 1999
In February.1999 the Central Bank floated the exchange rate to limit inter-
national-reserve loss.23 Because the 1999 budget incorporated an
exchange-rate assumption that the float would have made implausible,
the Central Bank delayed the float, at a substantial cost in reserve loss,
until the moment the Congress approved the budget. Over the following
four weeks the exchange rate lost 30 percent of its U.S.-dollar value. Bank


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS       55
loan portfolios deteriorated accordingly. Consumer prices were 13.5 per-
cent higher in March than in February (see figure 2.13), and there were
intensifying fears of hyperinflation. Several large banks were now in
acute danger, notably the large- Guayaquil-based bank (Banco del Pro-
greso) that had operated with a high-interest-rate policy and a heavily
dollarized loan portfolio.24 Ecuador's regional politics were deeply
involved here: The bank's principal shareholder claimed that authorities
were seeking to close the bank in order to damage coastal interests, and
for a time secured broad regional political support on this basis.
In mid-March in an attempt to limit inflation pressure and prevent
further bank failures, President Mahuad first announced a bank holiday
and then, after several days, a deposit freeze: All checking and savings
deposits were frozen for one year and time deposits were frozen for one
year from the original maturity date.2 He also announced that interna-
tional firms would be contracted to audit the banks to determine their
true capital adequacy. In response to the freeze, the Central Bank's presi-
dent and several board members tendered their resignations. The freeze
temporarily reversed the exchange-rate depreciation and slowed the
inflation-by mid-April the exchange rate had appreciated to nearly its
prefloat value. Inevitably, however, it severely damaged depositor confi-
dence. Banking-system credit operations, already shrinking, nearly
Figure 2.13 Ecuador* Consumer Prices, 1995-2000
Percent per month
16                    Dollarization announcement -
14
12
10
8                                A
D 95 Jun 96 Dec 96 Jun 97 Dec 97 Jun 98 Dec 98 Jun 99 Dec 99 Jun 00 Dec 00 Jun 01 Dec 01
-2
December 1995-December 2001
Source: International Monetary Fund.


56                           CRISIS AND DOLLARIZATION IN ECUADOR
ceased, and this largely explains why the economy slid into such a deep
recession in 1999.
This recession aggravated Ecuador's deepening poverty (see chapter
4) and worsened most social indicators. Ecuador had gone into the crisis
with some of Latin America's most unfavorable indicators of poverty
incidence and income inequality. In 1998, at the outset of the crisis, 46 per-
cent of the population was poor, compared with 34 percent in 1994. Dur-
ing the same years, extreme poverty (insufficient income for a minimum
food basket) had worsened from 15 to 17 percent. In 1998 69 percent of
the rural population was impoverished, compared with 56 percent in
1994. Worsening inequality accompanied this trend of deepening
poverty: The overall income Gini ratio worsened from 0.54 in 1994 to 0.58
in 1998. During 1999 poverty worsened even further. Health and nutri-
tion standards plunged. Another indication of the social devastation the
crisis caused is the measured urban unemployment rate, which roughly
doubled between June 1998 and June 1999 and remained at a high level
into 2000. Family structures throughout the society came under intensi-
fied pressure, and by the middle of 1999 this in itself had become a crisis
of overwhelming proportions (see chapter 5). Ecuador's public sector
lacked the institutional means, let alone the resources, to cope directly
with its population's immiserization. Apart from the reviving energy
subsidies (resulting from lagging adjustment of the relevant prices), the
Bono Solidario introduced in September 1998 constituted the nation's
social safety net, and its real value was deteriorating rapidly as prices
surged. Ecuador had essentially no emergency employment program, no
emergency nutrition programs for vulnerable children, and no means to
encourage students from impoverished families to remain in school.
On July 30, 1999, on the basis of the bank audit results, the Banking
Superintendent affirmed that 19 of the 32 banks examined (including 3
closed earlier) were sound, but closed 6 banks (including the Banco del
Progreso) and took 4 relatively large banks into enhanced monitoring,
recapitalization, and restructuring programs under the Deposit Insurance
Agency. Three of these four banks failed within two months. The author-
ities nevertheless kept these banks in operation, merging them with other
banks previously taken over. In all, by the end of September 1999, com-
mercial banks accounting for roughly 60 to 70 percent of total banking
assets were under public stewardship.
Within weeks of the freeze, the authorities began accelerating the
unfreezing schedules for checking and savings deposits, hoping in this
way to restore normal banking operations more rapidly. They also set up
a scheme under which time deposits could be converted into marketable
"Reprogrammable Certificates of Deposit," which could be negotiated,
held, or used to service bank loans at par. Unfreezing led to deposit with-


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      57
drawals, however. Between April and December, some US$465 million
(about 3.1 percent of 1999 GDP and about 16 percent of the end-June
broad money supply) in checking and savings deposits (in both on- and
offshore offices of the banks) was unfrozen. About one-third was with-
drawn from the banking system. These withdrawals contributed to capi-
tal flight and renewed pressure on the exchange rate. In November 1999,
the Constitutional Tribunal ruled that the freeze had been unconstitu-
tional and that the authorities must undo it expeditiously, increasing the
pressure on the government to accelerate the unfreezing process.
The Central Bank found it had little choice but to provide the banks
liquidity credit to help cope with withdrawals. From December 1998
through 1999,the Treasury issued some US$1.6 billion (about 11 percent
of 1999 GDP) in bonds to recapitalize banks kept open and to finance pay-
ment of guaranteed deposits in banks that had been closed. Banks receiv-
ing this support used a large proportion of the bonds for rediscount or
repurchase operations with the Central Bank. As a consequence, the Cen-
tral Bank acquired some US$1.2 billion of these bonds. The monetary
base grew 136 percent over 1999 (growing at annual rates of 101 and 522
percent, respectively, in the third and fourth quarters). The liquidity oper-
ations amounted to more than the full amount of this growth. Indeed, the
monetary expansion would have been even larger had it not been for sig-
nificant absorption operations by the Central Bank, carried out using
issues of its own interest-bearing liabilities. A handful of banks purchased
these liabilities: These banks benefited from an internal "flight to quality"
by depositors. In effect, these banks lent the deposit proceeds to the Cen-
tral Bank to help finance its liquidity lending.
Oil-export prices and earnings recovered during 1999, and, although
non-oil exports then began to decline,26 recession, exchange-rate depreci-
ation, and unavailability of bank credit combined to cut merchandise
imports by half. As a result, the current account swung from an 11 percent-
of-GDP deficit in 1998 to a surplus of about 6 percent of GDP in 1999 (see
figure 2.12), a massive adjustment-achieved, as noted above, at a mas-
sive human and social cost. The overall 1999 nonfinancial public deficit
reached 6 percent of GDP, about the same as in 1998: Higher oil-export
revenue was offset by lower non-oil tax receipts, rising interest charges,
and diminished revenue from domestic motor-fuel sales. The main reason
domestic motor-ftiel receipts had declined was that in July 1999 the presi-
dent had agreed to freeze motor-fuel prices for a period of one year to set-
tle a national transport strike. The primary surplus rose to 3.2 percent of
GDP from a 0.7 percent deficit in 1998. As noted in Part 3, section A above,
except for 1998, the nonfinancial public sector has run substantial primary
surpluses in every year since 1994. Despite the contractionary conse-
quences and the pressure on real social expenditure (which has undergone


58                            CRISIS AND DOLLARIZATION IN ECUADOR
a secular decline in real terms over the past decade),.the government had
to do so in order to pay the massive debt service.
Ecuador's crisis took on an additional dimension in late August 1999
when the. government, under intense fiscal pressure despite rising oil
prices, decided to miss an interest payment due then on Brady bonds and
called on holders to discuss relief. (The IMF supported the authorities, in
keeping with its policy of "bailing in" private external creditors.) Over
the month-long period before the bond contracts permitted legal action-to
commence, the government tried unsuccessfully to persuade bondhold-
ers to open discussions. At the end. of September, the government
announced that it would pay interest only to holders of uncollateralized
bonds, and invited holders of collateralized bonds to seek payment from
the, collateral. Holders of the collateralized bonds took the view that it
was wrong in principle to treat uncollateralized bondholders preferen-
tially, however, and elected to accelerate the principal. This activated
cross-default clauses that thrust Ecuador effectively into default on all its
public external bond issues (US$6.5 billion, about half the total public
external debt). Later in the year, the authorities succeeded in opening a
dialogue with a group of bondholder representatives, but discussions
failed to achieve significant progress (although bondholders did refrain
from litigation). Since their own reputations would be on the line if they
recommended any deal to other bondholders, it was difficult for the
bondholder representatives to agree to a deal.27
Even before the onset of the.crisis, Ecuadoran governments had sought
multilateral support, including an IMF program and coordinated World
Bank, IDB, and Andean Development Corporation (Corporaci6n Andina de
Fomen to, CAF) support. The Mahuad Government had initiated discussions
with the IMF almost immediately after taking office in August 1998. These
discussions were interrupted in the latter part of 1998 when the government
suspended the corporate and personal income tax, but then resumed in
early 1999 and became increasingly urgent as the crisis deepened. In April
1999 the four institutions promised publicly to help develop and support a
banking-sector strategy built around the audit results. Throughout the
remainder of 1999, the IMF, World Bank, IDB, and CAF worked closely with
the authorities, focusing on the banking sector. The government and the
IMf failed to conclude an agreement during 1999, however. They came
close several times, even signing a Letter of Intent for a stand-by program
in September 1999. Tax legislation the Congress approved the following
month fell short of what was called for in the Letter.28
By the end of 1999 virtually all checking and savings deposits had
been unfrozen. Time deposits were due to be unfrozen beginning in
March 2000, but by the end of 1999 the authorities concluded that they
would have to prolong the freeze in some way, because the time deposit


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      59
stock was simply too large. Although the banks .had made a determined
effort to build up liquid-asset stocks, it was clear they would have only a
fraction of what they expected to need to meet withdrawal demand. The
banks' on- and offshore branches had some US$2.2 billion in time
deposits, due to be unfrozen over the months of March to June 2000.
Large-scale withdrawals, the authorities reasoned, would either thrust
banks into failure, producing contagion effects throughout the system, or
else oblige the Central Bank to create money, intensifying exchange-rate
depreciation, inflation, and capital flight. They accordingly began con-
sidering schemes under which deposits could be"partially paid out in
Treasury bonds or in bank certificates of deposit with extended terms.
By November 1999, the monetary expansion together with intensify-
ing withdrawal demand generated heavy pressure on the exchange rate
and prices. In late November, .a new Central Bank administration
announced that it would tighten monetary policy, saying it would no
longer automatically inject liquidity to prevent bank failures, and driving
interbank interest rates to three-digit levels. Unfortunately, this policy
proved unworkable. In its efforts during the year to absorb liquidity, the
Central Bank had built up a massive stock of short-term remunerated lia-
bilities at high interest rates. This meant that the Central- Bank's policy
approach had perverse consequences: As interest rates rose, the Central
Bank itself had to pay higher interest charges and had to create money to
do so-so that monetary tightening actually led to money creation. This
was symptomatic of the reality that, by this advanced stage in the crisis,
the monetary authorities had lost the capacity to control the money sup-
ply, exchange rate, and price level. With the sucre now depreciating sig-
nificantly every day, the only alternative to dollarizing was clearly
hyperinflation, which would have ended with dollarization in any case.
In retrospect, Ecuador did not so much "choose" dollarization -as slide
into it.
5. Conclusion: Underlyinp Causes of Ecuador's
Predollarization Crisis
From the account of events in the preceding section, it is clear that the
"causes" of the crisis were far deeper than the immediate shocks that trig-
gered it. Structural problems that clearly affected the evolution of the cri-
sis included (a) the dependence of public revenue on volatile oil earnings,
(b) the banking system's exposure to volatile and risky activities, (c) bank
borrowers' exposure to exchange-rate depreciation, (d) inadequate bank-
ing supervision, (e) the massive public debt, (f) political fragmentation,
(g) weak public administration, and (h) the government's tendency to
revert to energy subsidization. The public debt and many other public-


60                           CRISIS AND DOLLARIZATION IN ECUADOR
sector structural distortions originated, in turn, with the rise of the oil
economy in the 1970s.
In retrospect, there were four broad, interrelated reasons why the 1998
shocks caused such heavy damage to the banking system and to the econ-
omy generally. First, the external accounts, the public sector, and the
banking system were exceedingly sensitive to the shocks. Second, the
public sector had accumulated a massive external debt stock, and, during
the 1980s and 1990s, policymakers' efforts to cope with it and prevent it
from growing thrust the economy into a lower growth mode, leaving the
economy debilitated. Continual exchange-rate depreciation had induced
the partial dollarization of the economy, which was the third main reason
why the shocks were so devastating. Partial dollarization meant that
exchange-rate depreciation forced money-supply growth and damaged
the balance sheets of borrowers in dollars who lacked dollar earnings-
and, perforce, the balance sheets of their creditors. Finally, Ecuador's sys-
tems of governance-its political structure and public administration-
lacked essential means of coping with the crisis. The political system is
set up more to reconcile interests-in particular, regional interests-than
to act decisively in the broad national interest. The main institutions of
public administration were too weak, both legally and technically, to deal
forcefully with the crisis as it unfolded. In this context, the shocks set off
a dynamic process that could not stop until it produced incipient hyper-
inflation.
The deeper reasons why the economy and governance systems had
taken on these characteristics must be sought in Ecuador's history and
geography. The regional rivalry helps explain why government and
administration has remained so weak and so heavily focused on and
restricted by the reconciliation of interests. Many nations have competing
regional interests, to be sure. What is different, perhaps, about Ecuador is
that it has two dominant regions, more or less evenly balanced. If
Ecuador had a larger number of regions (say, like Colombia), or if one of
its regions had achieved dominance (say, as Lima has in Peru), it might
have been able to develop a more forceful central government. The weak-
ness of the central political and administrative systems helps explain
many characteristics of governmental decisions in the crisis. The central
government did not have an adequate political base to secure essential
legislation; it did not have the executive authority to act on its own deci-
sions; administrative institutions lacked the authority and capacity to ful-
fill their roles; and the need to reconcile interests and compromise
repeatedly affected the consistency and effectiveness of political and-
crucially-administrative decisionmaking.
At the same time, Ecuador's geography has crucial consequences for
its economic vulnerability. The country is exposed, among other things,


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS      61
to earthquakes, volcanoes, El Nifio rains, and drought. In addition, it is a
textbook case of primary commodity dependence, having undergone
cycles involving cacao, bananas, and most recently oil. The oil cycle has
proved particularly disappointing, since oil earnings were widely
expected to raise living standards significantly. In the end, oil earnings
seem only to have saddled the country with a massive debt burden and
led to a prolonged period of low growth.
An important lesson of Ecuador's experience concerns the dangers of
repeated exchange-rate depreciation. All too obviously, repeated depreci-
ation makes the currency undesirable to hold. Once they could, people
understandably moved their wealth into dollars, shrinking the "sucre
base" on which monetary and exchange-rate policy could operate. Offer-
ing high interest rates on sucre holdings to offset the currency's undesir-
ability was ultimately futile, amounting only to rewarding sucre holders
by creating more sucres. Once the crisis commenced, and depreciation
intensified, monetary and exchange-rate policy finally became impotent.
Dollarization, from this perspective, was simply the formal recognition of
this reality.
The crisis experience also offers lessons about central bank indepen-
dence. The revised constitution that took effect in August 1998 made the
Central Bank independent. In March 1999, however, the government
overrode the Central Bank's views and carried out the banking holiday
and deposit freeze, leading to the resignations of the institution's presi-
dent and some directors. The Central Bank remained without a president
in mid-1999, during the crucial months following the freeze. In Novem-
ber 1999, when a new Central Bank administration tightened monetary
policy, some government officials questioned this approach, but
respected the Central Bank's independence. In January 2000, however,
with the exchange rate depreciating sharply, the government announced
dollarization despite the Central Bank's opposition. The Central Bank
president and several directors resigned. One lesson of these events is
that central bank independence is difficult to maintain under the pres-
sures of acute crisis.29 No less important, as a practical matter, central
bank independence involves more than directors being able to ignore
ministerial wishes. Because of the economy's advancing spontaneous
dollarization, and because the attempt to sterilize the monetary expan-
sion over the course of 1999 led the institution heavily into short-term
debt-indeed, decapitalized the institution-the Central Bank had sim-
ply lost the power to carry out exchange-rate and monetary policy. Once
this happened, of course, its directors' "independence" ceased to matter
in a practical sense.


Table 2A.1 Ecuador. Selected Annual Macroeconomic Indicators, 1991-2000
Historical                         Estimate
1991/4 avg.  1995       1996      1997       1998      1999     2000     2001
Growth rates (percent)
GDP at market prices            3.7        2.4        1.8       3.6        0.5      -7.3       2.3      3.4
Population                      2.3        2.1        2.1       2.1        1.9       2.0       1.9      1.9
Per-capita GDP                  1.5        0.2      -0.3        1.6      -1.4       -9.1       0.4      1.4
Consumer prices                43.9       22.9       24.4      30.6       43.4      60.7      91.0     23.0
Real-effective exch. rate (1990 = 100
+ = depreciation)              86.9       80.0       75.9      74.5     102.4      116.2      84.1      0.0
National accounts (percentage of
current GDP)
Gross fixed-caoital formation  19.5       18.6       17.8      19.0       21.0      14.8      16.2     18.5
National saving                16.9       14.6       17.7      16.6       13.7      22.6      24.0     14.3
Foreign saving (current-account
deficit)                       4.0        4.1      -0.4        3.6      11.0       -7.0     -0.7       4.2
Resource gap                    2.3        1.1        7.1       1.0      -6.7        8.6       5.1     -0.1
Real per-capita nongovt.
consumption (1998 - 100)       96.1      102.5       90.7      96.9      100.0      84.6      80.5     94.6
Nonfinancial public surplus
(percentage of GDP             -0.3       -1.5       -3.2      -2.7      -5.7       -3.3       0.4      3.5
Total revenue:                 21.7       29.3       23.3      23.1       20.3      17.2      27.8     44.2
Petroleum                      8.4        9.6       8.8       6.7        4.6        5.3       9.6      8.4
Nonpetroleum                  13.3       19.6       14.5     16.5       15.7       11.8      18.2     35.7
Public enterprises' operating surplus 2.9  4.0        2.6       1.6       0.1        0.7       1.1      0.5
Total expenditure:            -25.0      -34.7      -29.1     -27.4      -26.0     -21.1     -28.5    -41.1
Current expenditure:         -18.1      -26.1      -21.0    -20.8      -20.2      -16.0     -22.8    -30.1
Staff remuneration           -7.1      -10.3       -8.3      -8.1       -8.6      -5.0      -5.6     -9.5
Interest                     -4.7       -5.7       -4.6      -5.2       -5.0      -6.0      -7.7     -6.9
External                     -4.2       -4.8       -3.7      -3.9       -3.8      -4.2      -6.2     -4.8
Domestic                     -0.5       -0.8       -1.0      -1.3       -1.2      -1.8      -1.5     -2.2


Other current expenditure    -6.3      -10.2      -8.1      -7.5       -6.6      -5.0      -9.5    -13.7
Capital expenditure:         -6.9       -8.6       -8.1     -6.6       -5.8      -5.1      -5.7     -11.0
of which, capital formation  -6.4       -7.2       -7.1     -6.5       -5.8      -5.0      -5.7     -7.2
Primary balance (surplus plus
interest due)                 4.4        4.2        1.5       2.6      -0.7        2.7      8.1     10.4
Saving (total revenue less
current expenditure)          6.6        7.1        4.9       3.9       0.2        1.8      6.1     14.5
External accounts (US$ million)
Current-account surplus      -546.8     -735.0      84.0    -714.0   -2,166.0     959.0     90.4    -822.6
Merchandise trade           704.0      354.0    1,193.0    598.0     -990.0    1,667.0   1,525.7  1,163.6
Merchandise exports        3,215.3   4,411.0    4,873.0   5,264.0   4,208.0    4,453.0  4,926.6  4,673.1
Merchandise imports (FOB)  -2,511.3  -4,057.0  -3,680.0  -4,666.0  -5,198.0   -2,786.0  -3,401.0  -3,509.5
Net factor payments       -1,225.0   -1,191.0  -1,043.0  -1,070.0.  -1,227.0  -1,317.0  -1,725.0  -1,931.8
Other current account       -25.8      102.0      -66.0    -242.0      51.0     609.0     289.7    -54.4
Capital-account surplus     1,369.3     -82.0    -1,762.0    -55.2    2,464.6  -2,973.4    795.1  -1,347.5
Net errors and omissions       29.3    1,336.0    1,343.0    477.0     353.0    2,024.0      0.0      0.0
Change in net international
reserves (+=incr.)           851.8     519.0     -335.0    -292.2     651.6        9.6    885.5  -2,170.1
Total external debt (US$ million) 13,493.3  13,992.0  14,615.0  14,984.7  15,951.5  15,716.4  13,692.4  16,730.5
Public and publicly guaranteed
(US$ million)             10,077.3   12,067.0  12,444.0  12,376.0   13,089.0  13,555.7  11,366.3  14,116.5
(percentage of GDP)          73.9       87.3      69.4      65.0       66.2      68.7      83.0    103.7
Service on public-sector term debt
(US$ million)                 843.3    1,286.0   1,065.0   1,718.0    1,398.0   2,042.1   1,557.3  1,680.3
(percent of exports of goods,
nonfactor services)          22.1       16.0       22.5     17.5       34.3      26.6      34.5     28.0
Interest paid (US$ million):  380.8    574.0      572.0    712.0      755.0     917.4     627.5    727.4
Interest paid on external bonds  0.0  -147.0     241.0     250.0      349.0     390.8     140.0    150.2
Repayment (US$ million)     462.5      712.0      493.0   1,006.0     643.0    1,124.7    929.8    952.9
Gross domestic product
(US$ million)              13,829.6   17,939.4   19,039.8  19,768.5  19,722.6  13,689.0  13,607.0  19,764.0
Sources: Central Bank of Ecuador, International Monetary Fund, World Bank.


Table 2A.2a Ecuador: Selected Monthly Macroeconomic Indicators, 1998
97                                         98
Dec     Jan    Feb    Mar   Apr May     Jun    Jul   Aug     Sep    Oct    Nov    Dec
Exchange rate
(pd. avg.; sucres/
U.S. dollar)      4,393.1 4,498.0 4,537.2 4,661.6 4,961.9 5,152.0 5,236.5 5,300.4 5,431.4 5,899.4 6,642.2 6,442.4 6,595.9
Real-effective
exchange rate
(1990 = 100;
+ = depreciation)    75.0   73.3   70.9   70.8  72.2  73.9   72.5   72.8   73.2   76.3   82.0   77.6   79.0
Annualized growth
rate of consumer
prices (percent)     25.1   60.7   70.0   38.1  67.9  22.8   41.4    9.8   17.0   80.2  112.9   27.5    9.3
a'    Reference interest rates
(annual percentage rate):
Sucre-denominated
commercial-bank
liabilities          31.5   33.6   34.4   34.8  36.8  39.8   40.8   43.0   43.4   43.9   46.7   49.1   49.2
Sucre-denominated
commercial-bank assets 39.0  41.3  40.6   42.0  43.7  44.1   48.6   52.0   53.0   54.3   60.3    61.8  61.4
Dollar-denominated
commercial bank
liabilities           8.7    8.6    9.2    9.3   9.2   9.6   10.1    9.8   10.1    9.8   10.7    11.4  10.9
Dollar-denominated
commercial-bank assets 12.1  12.7  12.0   12.7  14.2  12.0   12.6   12.9   11.0   13.2   16.3    15.1  15.9
Avg. interbank sucre
interest rates (annual
percentage rate)     25.1   60.7   70.0   38.1  67.9  22.8   41.4    9.8   17.0   80.2  112.9    27.5   9.3


Annualized growth rate
of the monetary base
(percent)          107.3   -53.2   8.3   -2.5 179.9 -14.7  -38.2  53.0  -26.1  -22.6  325.3   13.0 1948.9
Annualized growth rate
of the broad money
supply (percent)  52,037.7  133.0  146.8  77.6  60.5 167.0  124.3 108.5  94.4  131.8  189.7  137.4 142.1
BCE Index of current
economic activity
(1990 = 100)       225.5   152.8  168.7  198.6 153.9 224.4  220.6 205.0  170.2  180.9  160.2  177.6 146.1
National stock-market
index ECUINDEX;
month-end)        3,121.6 3,111.2 3,137.7 3,102.9 3,127.2 3,083.1 3,054.4 3,087.8 3,118.0 3,082.7 3,072.0 3,046.2 3,059.6
Trade balance
(US$ million):      20.0  -20.0   53.7  -78.6 -42.4 -67.0 -109.3 -185.9  -86.8  -147.6 -123.8  -22.5 -76.7
(7      Merchandise exports
(US$ million)      416.5   386.7  381.6  391.2 384.3 373.8  338.6 311.2  321.7  332.1  338.5  318.5 324.7
Merchandise imports
FOB (US$ million)  -396.5 -406.7 -327.8 -469.8 -426.7 -440.8 -447.9 -497.1 -408.5 -479.7 -462.3 -341.0 -401.4
Average crude-oil
export price (US$)  13.6   12.0   10.6    9.5   9.4   8.8    8.3   8.6   8.2    10.2    9.8    8.2   7.0
Gross international
reserves less gold
(US$ million)     2,092.8 1,941.3 1,980.8 1,960.8 2,058.2 1,879.7 1,828.7 2,037.9 1,816.9 1,567.8 1,598.1 1,664.6 1,619.7
Brady bonds (par)    55.5    54.3  55.3   55.0  53.3  54.3   54.1  54.4   41.0   42.5   45.0   50.5  44.5
Sources: Central Bank of Ecuador, International Monetary Fund.


Table 2A.2b Ecuador: Selected Monthly Macroeconomic Indicators, 1999
98                                           99
Dec     Jan    Feb    Mar    Apr  May    Jun    Jul    Aug     Sep    Oct    Nov    Dec
Exchange rate
(pd. avg.; sucres/
U.S. dollar)       6,595.9  7,133.1 7,807.3 10,754.3 9,430.0 8,969.0 1,0923.2 11,723.0 11,197.2 12,116.5 15,656.8 17,525.5 18,205.8
Real-effective
exchange rate
(1990 = 100;
+ = depreciation)    79.0    82.5   86.4  104.4  87.5   82.3   98.0  101.9  97.9   104.7  130.4   137.1  135.2
Annualized growth
rate of consumer
prices (percent)      9.3    45.7   37.2  356.5   91.0  11.0   23.7   43.4   6.6    23.2   63.3   110.1   91.8
Reference interest rates
(annual percentage rate):
Sucre-denominated
commercial-bank
liabilities          49.2    50.0   53.4   53.9  50.2   49.2   47.8   48.4  47.6    45.5   43.8    43.6   46.5
Sucre-denominated
commercial-bank assets 61.4  61.7   67.5   66.7  63.2   67.9   68.2   60.8  64.8    62.5   61.7    61.6   68.3
Dollar-denominated
commercial bank
liabilities          10.9    10.9   11.6   11.6   11.8  10.5   10.0    9.6  10.2     9.1    8.3     8.5    9.0
Dollar-denominated
commercial-bank assets 15.9  16.4   15.9   16.3   16.4  16.1   17.2  .16.5  15.6    15.9   16.4    16.3   16.6
Avg. interbank sucre
interest-rates (annual
percentage rate)      9.3    45.7   37.2  356.5  91.0   11.0   23.7   43.4   6.6    23.2   63.3   110.1   91.8


Annualized growth rate
of the monetary
base (percent)    1,948.9  -20.3  22.1  656.7  48.1  65.2  -16.2 285.4  -68.3  562.4  259.4   34.9 4863.5
Annualized growth rate
of the broad money
supply (percent)   142.1    21.2  174.5  162.0 152.5 123.2  96.4 114.2  155.8  100.5  110.7  108.9  93.4
BCE Index of current
economic activity
(1990 = 100)       146.1   188.2  150.(  193.5 191.3 191.2  168.4 215.5  189.0  179.9  177.1  167.0 183.6
National stock-market
index ECUINDEX;
month-end)        3,059.6 3,037.5 3,048.8 3,072.9 3,010.2 2,973.6 2,975.6 2,983.5 2,985.6 2,988.9 3,091.1 3,088.0 3,132.9
Trade balance
(US$ million):     -76.7   -30.4  39.0  130.4 180.5 200.9  181.7 165.2  173.5  175.4  184.5  154.9 158.5
Merchandise exports
(US$ million)      324.7   312.4  301.7  386.7 370.8 382.1  364.1 385.0  369.8  392.1  411.2  381.6 393.5
Merchandise imports
FOB (US$ million)  -401.4  -342.8 --262.7 -256.3 -190.3 -181.2 -182.4 -219.7 -196.3 --216.7 -226.8 -226.7 -235.0
Average crude-oil
export price (US$)   7.0     7.8   7.4   10.4  13.4  13.7   14.0  15.8   17.0   19.6   19.0   21.9  22.3
Gross international
reserves less gold
(US$ million)     1,619.7 1,723.7 1,557.2 1,481.9 1,527.7 1,622.2 1,580.3 1,565.9 1,648.2 1;824.3 1,694.5 1,591.9 1,642.4
Brady bonds (par)    44.5    42.5  40.5   40.5  43.0  39.5   39.3  37.5   32.0   30.5   32.1   35.1  34.3
Sources: Central Bank of Ecuador, International Monetary Fund.


Table 2A.3 Ecuador: National-Income Accounts
Five-year averages
1966/  1971/ 1976/  1981/  1986/ 1991/ 1996/
1970   1975  1980   1985   1990  1995 2000   1996 1997   1998  1999 2000
Annual growth rates
GDP at 1975 prices               4.4   11.6   6.5    2.2    2.2   3.5   0.2   2.0   3.4   0.4   -7.3   2.3
Population                      3.0   3.0    2.9    2.7   2.4   2.3   1.9   2.0    2.0   1.9   1.9   1.9
Per-capita real GDP             1.4   8.4    3.5   -0.5  -0.2   1.2  -1.7   0.0   1.4   -1.5  -9.0   0.4
GDP deflator                    6.4  13.2   14.8   28.2  47.2  36.9  51.7   29.4  25.9  35.4  62.0 105.9
National expenditure (percentage of
GDP at current prices)
Expenditure                   100.0  100.0 100.0  100.0  100.0 100.0 100.0  100.0 100.0 100.0  100.0 100.0
Consumption                   87.2   79.9  75.9   76.7   80.3  77.5  76.8  75.6  78.8  82.0   75.8  71.6
Nongovernment                77.8  68.3   61.9   63.8   69.4  8.9  11.0   11.8  11.6  11.7  10.4   9.5
Government                    9.5   11.5  14.0   12.9   10.9  68.6  65.8  63.9  67.2  70.4  65.5  62.1
Investment                    17.3   22.4  26.0   20.3   20.6  20.4  18.4  17.3  20.2  24.7   12.9  16.8
Gross fixed capital formation  14.5  19.7  23.9  18.6  20.4  19.3  17.8   17.8  19.0  21.0  14.8  16.2
Nongovernment               9.6   14.4  17.8   13.0   15.1  15.7  14.9  14.5  15.8   17.1   8.0  19.0
Government                   4.8   5.4   6.1    5.6    5.3   3.6   2.9   3.2   3.3    3.9   6.9  -2.8
Increase in stocks            2.8   2.7    2.2    1.7   0.3   1.2   0.6   -0.5   1.1   3.7  -1.9   0.6
Resource balance              -4.5  -2.2   -1.9    3.0   -0.9  2.0   4.8    7.1   1.0  -6.7   11.2  11.6
Exports of goods and nonfactor
services                     14.7  24.2   24.6   23.8  27.5  29.1  33.1   30.5  30.0  25.3  37.1  42.4
Imports of goods and nonfactor
services                    -19.2  -26.5 -26.5  -20.8  -28.4 -27.1 -28.2  -23.4 -29.0 -32.0  -25.8 -30.8
Saving flows (percentage of GDP)
Gross national saving          13.1   23.4  27.3   30.3   26.2  27.3  29.2  29.9  26.1  22.2   28.4  39.4


Gross domestic saving              12.8   20.1   24.1    23.3    19.7   22.5   23.2   24.4   21.2   18.0    24.2   28.4
Net external factor and
transfer receipts                 -0.3    -3.2   -3.2    -7.0    -6.5   -4.8  -6.0     -5.5  -4.9   -4.3    -4.2  -11.0
Foreign saving (current-account
deficit)                             4.8     5.5    5.2     4.0     7.4   2.8    1.1    -1.5    4.0   11.0   -7.0   -0.7
Resource gap (imports less exports) 4.5    2.2     1.9   -3.0     0.9   -2.0  -4.8    -7.1   -1.0     6.7  -11.2  -11.6
Net external factor and
transfer payments                   0.3    3.2     3.2     7.0    6.5    4.8    6.0    5.5    4.9    4.3     4.2   11.0
Gross domestic product:
US$ million                       1,505.8 2,797.1 8,143.5 13,888.8 10,462.9 14,6515 17,342.5 19,039.8 19,768.6 19,722.6 14,580.9 13,600.9
Source: Central Bank of Ecuador.


Table 2A.4 Ecuador: Nonfinancial Public-Sector Accounts (Percentage-of GDP)
1990   1991   1992   1993  1994  1995  1996   1997 1998   1999  2000
Consolidated nonfinancial
public-sector accounts                  0.9   0.9    0.8    0.7   0.6   0.6    0.5   0.5   0.5    0.7   0.9
Total revenue (excl. operations of
public enterprises)                  24.6   22.4   22.7   22.3  21.2  22.4   21.9  22.2  20.2   24.1  26.5
Oil revenue:                          11.6   8.8    9.6    8.7   7.2   7.4    8.2   6.4   4.6    7.5  10.1
Export revenue                       9.7    7.1    7.9    5.7   3.9   3.8   4.9    3.2   1.3    5.3   9.3
Domestic derivatives sales           1.9    1.7    1.7    2.9   3.3   3.6   3.3    3.2   3.3   2.2    0.9
Non-oil revenue:                      13.0  13.6   13.1   13.6  14.0  15.1   13.6  15.8  15.6   16.6  16.4
Tax and other domestic-source revenue  10.6  11.5  11.4  11.9  12.2  13.2  12.3   13.5  12.4   14.1  13.7
Tariff and other external-source revenue  2.4  2.1  1.7   1.7   1.8   1.8   1.4    2.3   3.1    2.5   2.8
Operating surplus of public enterprises  2.5  3.0    3.1    2.7   3.2   3.1    2.5   1.6   0.1    0.9   0.9
Total expenditure                      26.6  26.0    26.9  25.0  23.8  26.6   27.3  26.3  25.9   30.5  31.2
Current expenditure                   19.4  18.6   19.6   18.2  17.3  20.1   19.7  20.0  20.0   23.6  23.4
Interest (accrued)                   6.4    5.8    4.8    4.5   4.0   4.4   4.3    5.0   4.9   9.5   10.0
External                            5.9   5.3     4.3   4.0   3.5   3.7    3.4   3.8    3.8   6.2    6.8
Domestic                            0.5   0.5     0.5   0.5   0.5   0.6    0.9   1.2    1.2   3.3    3.2
Noninterest current expenditure     13.1   12.8   14.8   13.7  13.3  15.7  15.4   15.0  15.1   14.1  13.4
Personnel remuneration              7.3   7.0     7.2   7.3   7.4   7.9    7.8   7.8    8.5   7.1   5.9
Current expenditure on
goods and services                 2.9   2.5    2.9    3.0   2.2   1.7    2.8   3.0   2.9    2.8   2.8
Severance payments                  0.0   0.0     0.0   0.0   0.0   0.0    0.0   0.0    0.0   0.2   0.1
Other current expenditure           2.9   3.3     4.7    3.4  3.7   6.1    4.8   4.2    3.7   3.9    4.7
Capital expenditure                    7.1   7.4    7.3    6.8   6.5   6.6    7.6   6.3   5.8    6.9   7.7
Fixed capital formation              6.7    6.9    7.0    6.3   5.9   5.5   6.6    6.3   5.7   6.8    7.5
Other capital expenditure            0.5    0.4    0.3    0.5   0.6   1.1   1.0    0.0   0.1   0.1    0.2
Overall nonfinancial-sector balance    -2.8  -3.0   -3.5   -1.7   0.3  -1.5   -3.3  -3.0  -6.0   -5.6  -3.7


Financing                              2.8   3.0    7.6    3.7   1.5   2.5    3.3   3.0   6.0    5.6   3.7
External financing (net)              0.0   0.0    0.0    0.0   3.1   0.7   3.1    4.4   0.4   2.1    0.1
Net domestic financing                2.8   3.0    7.6    3.7  -1.6   1.7   0.2   -1.4   5.7   3.5    3.6
Nonfinancial public-sector saving       7.2    6.4    5.9   6.3   6.5   4.4    3.7   3.8   0.1    1.4   3.8
Nonfinancial public-sector surplus     0.5  -0.6    -1.2   0.0   0.6  -1.1   -2.9  -2.5  -5.6   -5.4  -3.7
Primary (overall surplus plus interest due)  6.9  5.2  3.7  4.5  4.6  3.2    1.4   2.5  -0.7   4.2    6.3
Primary excluding oil-export revenue  -2.8  -1.9  -4.2  -1.3   0.7  -0.6  -3.5  -0.7   -1.9  -1.2  -3.0
Oil-export revenue                   9.7   7.1    7.9    5.7   3.9  3.8    4.9   3.2    1.3   5.3   9.3
Interest due                          6.4   5.8    4.8    4.5   4.0   4.4   4.3    5.0   4.9   9.5   10.0
Nonfinancial public-sector fixed
capital formation                     6.7   6.9    7.0    6.3   5.9   5.5   6.6    6.3   5.7   6.8    7.5
Source: Central Bank of Ecuador.


Table 2A.5 Ecuador: Balance-of-Payments Accounts (US$ Million)
1976/   1981/   1986/     1991/
1980    1985    1990      1995     1996   1997      1998     1999    2000
Current-account surplus           -465.6  -498.4  -704.8   -584.4     84.0  -714.0  -2,166.0   959.0    90.4
Goods and nonfactor
services surplus               -174.1   430.5   395.0     486.6   837.0    -35.0  -1,715.0  1,175.0  697.9
Merchandise trade                91.3   717.8   563.4     634.0  1,193.0   598.0   -990.0  1,667.0  1,525.7
Merchandise exports          1,781.5  2,545.6  2,300.8  3,454.4  4,873.0  5,264.0  4,208.0  4,453.0  4,926.6
Merchandise imports         -1,690.2 -1,827.8 -1,737.4  -2,820.4 -3,680.0 -4,666.0  -5,198.0 -2,786.0 -3,401.0
Nonfactor services             -265.4  -287.3  -168.4    -147.4  -356.0   -633.0   -725.0  -492.0   -827.8
Factor services                 -324.5  -962.7 -1,195.4  -1,218.2 -1,043.0 -1,070.0  -1,227.0 -1,317.0 -1,725.0
Income                           44.4    41.3    22.4      43.8    77.0    102.0     82.0    49.0     75.0
Payments                       -368.9 -1,003.9 -1,217.8  -1,262.0 -1,120.0 -1,172.0  -1,309.0 -1,366.0 -1,800.0
Current transfers                 33.0    33.8     95.6    147.2   290.0    391.0    776.0  1,101.0  1,117.5
Capital-account surplus            607.0 -1,774.0 -2,132.8  -867.8  1,242.0  1,288.2  1,706.4  1,055.6  -913.7
Investment accounts              607.0  -723.4   -680.0     89.8   491.0    625.0    814.0    690.0   722.0
Other net financial inflows        0.0 -1,050.6 -1,452.8  -957.6   751.0    663.2    892.4    365.6 -1,635.7
Net errors and omissions           -15.0    33.6   -70.2   -290.7 -1,343.0  -477.0   -353.0 -2,024.0     0.0
Overall balance                    126.4 -2,238.9 -2,907.8  -1,742.9  -17.0   97.2   -812.6     -9.4  -823.3
Total reserves less gold           694.2   582.1   582.4   1,328.9  1,858.5  2,092.8  1,619.7  1,642.4  946.9
Source: International Monetary Fund.


Table 2A.6 Ecuador. Year-End External Debt Outstanding and Disbursed (US$ Million)
1975   1980    1985    1990     1995    1996    1997    1998     1999     2000
External debt outstanding       N/A    5,998   9,082  12,110    13,992  14,495  14,918  15,668   15,175  12,482
Term debt                       710   4,423   7,713  10,296   12,680  12,909   12,849  13,369  13,690   11,059
Term debt excluding IMF        710  4,423    7,353  10,031   12,507  12,764  12,716   13,299  13,690   10,912
Public and publicly guaranteed  436  3,301  7,198  9,867    12,067  12,444  12,376  13,089   13,616  10,846
Official creditors          236   1,325   1,800   4,065    5,260    5,116   4,842   5,234   5,439    5,210
Multilateral               103    323     823    2,127    2,999   2,911   2,809    3,164   3,257    3,030
Concessional            N/A      114     288     451      647     654      639     634       0        0
Nonconcessional         N/A      209     535   1,676     2,352   2,257   2,170   2,530    3,257   3,030
Bilateral                  133  1,002     977    1,938    2,261   2,205   2,033   2,070    2,181    2,180
Concessional            N/A      188     172     468     1,159   1,214   1,145   1,300       0        0
Nonconcessional         N/A     814      805   1,470     1,102    991     888      770    2,181   2,180
Private creditors           200   1,976   5,398   5,802    6,807    7,328   7,534   7,855   8,177    5,636
Bonds                        0     55       0       0     5,999   6,013   5,834   6,325    6,363   3,920
Commercial banks and
other private sources     200  1,921   5,398   5,802      808    1,315   1,700   1,530    1,814   1,716
Private nonguaranteed        274   1,122     155     164      440     320     340      210      74       66
Use of IMF credit              0       0     360     265      173     145     133       70      - 0     148
Short-term debt                N/A    1,575   1,369   1,814    1,312   1,586    2,069   2,299   1,486    1,423
Interest arrears on term debt    0      0      56   1,523       12       77      84      85       0        0
Other short-term debt        N/A    1,575    1,313    291     1,300   1,509   1,985   2,214    1,486    1,423
Gross domestic product
(US$ million)                4,310 11,733   15,957  10,686   17,939  19,040  19,769  19,723   13,689  13,607
Source: World Debt Tables (World Bank).


Table 2A.7 Ecuador: Year-End Monetary and Commercial-Bank Aggregates (Percentage of GDP),
1987-1999
December 31
1987    1988  1989  1990  1991   1992   1993   1994   1995 1996   1997 1998   1999
Monetary aggregates
Broad money supply (M2) 23.5  20.7  17.6  18.2  19.2   19.1   20.6   24.3   27.3  29.8   30.9  33.0  40.7
Means of payment (Ml) 12.2   11.2   9.0   8.7   8.5    7.7    8.2    8.3    7.5   7.7   7.6   7.6   9.5
Currency in circulation  4.1  4.1  3.4   3.3   3.1   3.0     3.1    3.0    3.0   3.1   3.0   3.2  5.6
Monetary deposits in
local currency      8.1    7.1   5.6   5.4   5.4    4.7    5.1     5.3    4.5  4.6    4.6   4.3  3.9
Monetary base (MO)    7.5     7.3  6.1    6.2   6.0    6.0    5.9    5.1    5.2   5.0   5.1   5.3   8.3
Monetary issue of the
Central Bank        4.5    4.4   3.7   3.6   3.5    3.4    3.4     3.5    3.5  3.8    3.7   3.9  6.5
Monetary issue by
other entities      3.1    2.9   2.4   2.6   2.6    2.6    2.5     1.6    1.7   1.2   1.4   1.4  1.8
Quasi money          11.3     9.5   8.6   9.5  10.7   11.3   12.4   16.0   19.9  22.1  23.3  25.4  31.3
Quasi money in
local currency     10.6    8.7   7.7   8.8   9.9   10.1   10.9    13.5   15.1  15.9  14.7  14.0 12.0
Quasi money in
foreign exchange    0.7    0.8   0.8   0.7   0.8    1.2    1.6     2.5    4.8  6.2    8.6  11.4  19.3
Commercial banks (onshore
offices only)
Deposits               20.4   25.0  38.3  66.7  58.4   38.1
Domestic currency    18.0    15.1  12.9  13.8  14.5   14.1   15.0   17.9   18.4  19.7  18.3  16.6 14.1
Foreign currency      2.5     6.6  18.6  48.4  41.8   24.0
Credit                 18.0   12.3  10.1   9.2  10.5   11.1   15.5   23.4   36.0  39.0  83.4  73.4  35.1
Domestic currency    18.0    12.2  9.8    9.0   9.9    9.8   11.8   15.5   17.5  15.6  14.7  10.9   3.4
of which, in arrears  1.6   1.2   0.6    0.5   0.5   0.5     0.5    0.6    1.0   1.7   1.4   1.4  3.8


Foreign currency      0.0    0.1   0.4    0.3   0.6    1.4    3.7    7.9    18.5  23.4  68.7  62.4  31.7
of which, in arrears  0.0   0.0   0.1   0.1   0.2    0.6     1.7    3.8    9.3   1.4    3.1   4.9  17.1
Gross domestic product
In billions of.sucres  1,795  3,020 5,170  8,204 12,296 19,414 27,451  36,478 46,005 60,727 79,040 107,421 162,184
In millions of U.S.
dollars             10,527 10,012 9,823 10,686 11,752 12,656 14,304  16,606 17,939 19,040 19,770 19,723 14,656
Percentage in foreign
currency
Quasi money             6.6     8.2   9.8   7.5   7.6   10.9   12.6   - 15.7  24.3  28.1   36.9  44.9  61.7
Commercial-bank
deposits              12.3   26.4  48.7   72.6  71.5   62.9
Commercial-bank
credit                 0.2    0.4   3.7    3.2   5.5   12.2   23.7    33.6   51.5  60.0  82.4  85.1  90.2
Source: Central Bank of Ecuador.


76                              CRISIS AND DOLLARIZATION IN ECUADOR
Notes
1. The order in which these topics are discussed allows these sections to sum-
marize Ecuador's history in chronological sequence up to the mid-1990s.
2. This section draws on Dobronski and Segarra, 1999, and Library of Congress,
1989.
3. The penultimate Inca resided mainly in Quito in the decade before the
Spanish conquest, making the city a second capital of the Empire. What is now
the Sierra was the main battleground in the Inca war of succession, just before the
Spanish arrived.
4. One crucial event in the struggle for independence from Spain, the Battle of
Pichincha, took place on the mountain slopes near Quito.
5. Even after Independence, Ecuador's indigenous peoples-who have consti-
tuted, depending on the criteria applied, half or more of the country's popula-
tion-were mostly prevented from participating in national political processes. In
the Sierra, some were tied to large landholdings through more or less feudal rela-
tionships that persisted well into the 20th century. Some indigenous groups have
lived in self-governing village communities. Over the 20th century, however, after
revised constitutions afforded them political rights, Ecuador's indigenous peo-
ples gradually increased their political participation, more and more through
specifically indigenous organizations and parties.
6. The center-right parties are the Sierra-based Democracia Popular and the
Costa-based Partido Social Cristiano; the more center-left parties are the Sierra-
based Izquierda Democrdtica and the populist Costa-based Partido Roldosista
Ecuatoriana. It is only fair to note that the "right, center, and left" labels can often
be highly misleading.
7. The group came to be known as la argolla, literally, a large iron ring, but best
translated as "coterie."
8. The first of these presidents, Galo Plaza, promoted an explicitly develop-
mental approach to economic management, and although his government had to
cope with widespread flood damage from earthquakes and heavy rainfall in
1949-50, it succeeded in reducing inflation from double to single digits.
9. In taking power for an indefinite period with the stated objective of fostering
development, Ecuador's military were following a continental trend in the 1970s:
Brazil, Peru, and Bolivia already had such governments, and Chile, Uruguay, and
Argentina would soon follow.
10. To underscore their nationalist, reforming purpose, the military authorities
placed several people on trial for corruption associated with the negotiations of
the contracts with the foreign oil companies.
11. This growth had favorable consequences for social indicators. For example,
infant mortality rates declined from about 100 in 1970 to about 74 in 1980.
12. Although the sucretizaci6n policy constituted a substantial transfer of public
resources to the private sector, it was insufficient to resolve the private-sector crisis.


LONGER-TERM ORIGINS OF ECUADOR'S "PREDOLLARIZATION" CRISIS            77
By 1986 a large proportion of the private sector's sucre obligations to the Central
Bank were in arrears. The government authorized commercial banks to use exter-
nal debt valued at par to service obligations to the Central Bank arising from the
"sucretized" debt, although this debt was circulating at substantial discounts. In
1992, as part of a thoroughgoing Central Bank reform, the residual "sucretized" debt,
about 8 percent of GDP, was transferred from the Central Bank to the Treasury.
13. The sharp decline in real GDP and massive real-effective exchange-rate
depreciation during 1999 lifted the end-1 999 public debt-GDP ratio above 90 per-
cent. This reflected the unusually depreciated real-effective exchange rate, how-
ever, and has diminished as the real-effective exchange rate has appreciated to
more normal levels.
14. Banco Continental; the Guayaquil-based Filanbanco purchased the other,
Banco de los Andes.
15. An unusual feature of Ecuador's oil-revenue system is that gross export and
domestic-sales proceeds are received and shared out among the various ear-
marked public-sector entities. The central government turns over a negotiated
amount each month to the oil company, PetroEcuador, to cover production and
transport costs.
16. Revenue figures are reflated to 1998 using the GDP deflator series, and then
converted to U.S. dollars at the average exchange rate for that year.
17. In recent years, several laws have been approved creating what were called
stabilization funds, but which were in fact only rules for earmarking oil-export
revenues deriving from prices exceeding those set in the current annual budget.
The "funds" were no more than the deposit accounts in which proceeds were
accumulated and then transferred to the earmarked beneficiaries. The March 2000
dollarization legislation, for example, established a stabilization fund that trans-
ferred oil revenues exceeding those budgeted to certain priority investment pro-
grams and to "management of government liabilities."
18. Recipients have been further vetted to ensure that they have no bank loans
and possess no motor vehicles.
19. This meant, in effect, that a holder of a Miami deposit could legally withdraw
in Miami but not in Quito.
20. Larger banks had asset-liability committees that came to focus on the match-
ing problem.
21. Floods and landslides damaged houses and infrastructure and damaged pro-
duction. Some 300 people died and about 30,000 lost their homes. The incidence
of infectious disease increased on account of problems with water and sanitation
systems.
22. The recorded 1998 deficit would have been larger but for a dividend amount-
ing to 0.6 percent of GDP that the Central Bank paid the Treasury (which would
be counted as financing under standard IMF methodology).
23. Brazil's January 1999 devaluation intensified the pressure on Ecuador's
exchange rate.


78                              CRISIS AND DOLLARIZATION IN ECUADOR
24. Later in March, the Banco del Progreso's principal shareholder closed the
bank unilaterally. He attempted later to recapitalize it by various means (includ-
ing an invitation to convert deposits into shares).-In July the authorities closed the
bank definitively after finding its net capital position to be deeply negative.
25. The freeze applied within Ecuador to off-shore deposits, although banking
authorities in some other jurisdictions-notably Miami and Panama-refused to
allow it to take effect there.
26. The reasons varied by commodity. Shrimp production was affected by dis-
ease, while other commodities, notably cacao, were affected by lower prices.
27. In July 2000 Ecuador offered new 12- and 30-year bonds in exchange for the
bonds outstanding at what amounted to a 40 percent discount. The offer was
made directly to bondholders, with a Comfort Letter signed by the IMF
Managing Director. Bondholders accepted it. When executed on August 23, it
reduced Ecuador's outstanding debt in bonds from US$6.5 billion to 'about
US$3.9 billion.
28. 'In April 2000 Ecuador secured a 12-month, US$304 million stand-by arrange-
ment with the IMF. The first of six scheduled tranches was released immediately.
The IDB disbursed tranches of several sectoral adjustment loans originally
approved in 1994 but delayed since then for various reasons. In June 2000 the
World Bank approved- a US$150 million structural-adjustment loan with condi-
tionality covering comprehensive tax reform, public-sector financial manage-
ment, financial-sector reform, and social-sector expenditure protection. It also
approved a US$10 million Financial Sector Technical Assistance Loan. .
29. The decision to make the Central Bank independent in 1998 came at a bad
moment, because the crisis conditions implied that financial markets were uncer-
tain about whether the Central Bank would maintain its independence:
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Gomis Porqueras, Carlos Serrano, and Alejandro Somuano. 2000.
"Currency Substitution in Latin America: Lessons from the
1990s." World Bank Policy Research Working Paper 2340.
Washington, D.C.
Government of Ecuador. 2000. Letter of Intent for the Internatioial
Monetary Fund Standby Program. http://www.bce.fin.ec/avisos/
intent_fmi.html.


80                            CRISIS AND DOLLARIZATION IN ECUADOR
Hurtado, Osvaldo. 1998. Una Constitutuci6n para el futuro. Fundaci6n
Ecuatoriana de Estudios Sociales, Quito, Ecuador.
Jaramillo, Fidel. 1994. "Ecuador: Estabilizaci6n, ingreso de capitales externos
y -conflictos de politica macroeconomica." Multiplica Working Paper.
Quito, Ecuador.
Kopits, George, Erik Haindl, Eduardo Ley, and Juan Toro. 1999.
"Ecuador: Modernizaci6n del Sistema Tributario." International
Monetary Fund, Washington, D.C.
Library of Congress. 1989. Ecuador: A Country Study. Federal Research
Division, Washington, D.C. http://1cweb2.loc.gov/frd/cs/ectoc.html
Mancheno, Diego, J. Oleas, and P. Samaniego. 1999. "Aspectos te6ricos y
prdcticos de la adopci6n de un sistema de convertibilidad en el Ecuador."
Notas T6cnicas, Banco Central del Ecuador, Quito, Ecuador.
Marx Cairasco V., Carlos. 2000. Dolarizaci6n: Un camino de espinas y espe-
jismos. Cuenca, Ecuador. Processed.
Perry, Guillermo, ed. 1997. "Currency Boards and External Shocks: How
Much Pain, How Much Gain?" World Bank, Washington, D.C.
Rojas, M6nica. 1998. "Dolarizaci6n en Ecuador: Economia 'verde'... pero
no por lo ecol6gico." Gesti6n December, pp. 25-27. Quito, Ecuador.
Savastano, M. 1996. "Dollarization in Latin America: Recent Evidence
and Some Policy Issues." International Monetary Fund Working Paper.
El Universo. Guayaquil daily newspaper, various issues.


3
Ecuador under Dollarization:
Opportunities and Risks
Paul Beckerman* and Hemn Cort6s Douglas**
1. Introduction
Ecuador had no alternative to full dollarization in January 2000. Had it
not dollarized when it did, it would assuredly have slid into hyperinfla-
tion. Dollarization ended the "dual-currency" system,'which had become
a fundamental obstacle to macroeconomic stability and growth (see chap-
ter 2). Ecuador implemented dollarization during 2000 more smoothly
than many observers had anticipated. In 2001, with oil-export prices rel-
atively high, real GDP began recovering, and inflation abated. The fiscal
accounts remained in balance. Dollarization, however, is only one of the
economic reforms necessary to ensure sustained growth. Ecuador's exter-
nal and public accounts remain vulnerable to a wide range of exogenous
hazards, including natural catastrophes, export-price volatility, and exter-
nal financial-flow volatility. They are also sensitive to political and social
pressures. Much needs to be done to complete Ecuador's public- and
financial-sector structural-reform agendas. In addition, Ecuador's public
external debt stock and interest bill remain debilitatingly large, even after
the August 2000 "bond exchange" and the September 2000 Paris Club
agreement.
Many observers regarded Ecuador's move to dollarization as the
bellwether of a Latin American trend. Within a year, El Salvador
decided on full dollarization, and Guatemala authorized the use of dol-
lar operations in its financial system. Argentina's crisis in late 2001
The authors are, respectively, *an independent economic consultant and
**Professor of Economics, Catholic University of Chile. The writers thank Andr6s
Solimano for valuable, detailed comments on earlier drafts. The writers alone are
responsible for any errors of fact and judgment. Views expressed here do not nec-
essarily reflect views of the World Bank or any other institutions with which the
writers have been associated.
81


82                           CRISIS AND QOLLARIZATION IN ECUADOR
raised inevitable questions, however, abotit "hard" fixed-exchange
rates. Economists continue to vigorously debate the criteria that policy-
makers should apply in deciding on their economies' exchange-rate
regime. The so-called "bi-polar view"-that exchange rates should
either float freely or be "hard" fixed through, a currency board or dol-
larization-has gained many adherents (see Fischer.2001). The common
feature of the two "polar" approaches is that; at least in principle, they
fully endogenize the real-effective exchange rate. Many economists still
believe, however, that in many economies policymakers must retain a
handle on the real-effective exchange rate, at least for short-term pol-
icy-maintaining exchange-rate flexibility but not allowing a fully free
float. Hard fixed-exchange rates should ensure exchange-rate and price-
level stability, at least after domestic prices have moved to parity. This
has been a weighty argument for economies emerging from severe
instability. As Argentina's experience shows, the key policy challenge is
to make the real-effective exchange rate established by the hard fix com-
patible with a sustainable flow of financing.
Any decision to adopt hard exchange rates must look beyond the bene-
fits of price-level stability. The real-effective exchange rate likely to result,
the price-level and relative-price convergence processes, the public-sector
financing needs implied by the real-effective exchange rate, and. the struc-
tural reforms necessary to make the new system sustainable and consistent
with adequate growth are important issues for decisionmakers to consider.
Unfortunately, when they dollarized, Ecuador's policymakers were no
longer in a position to choose: Ecuador's residents had already decided, in
effect, that they no longer wished to hold the national currency.
This chapter discusses some of the arguments for and against hard
fixed-exchange rates in general and dollarization in particular. It
describes Ecuador's implementation of dollarization, and considers some
of the challenges and opportunities the economy will now face. Section 2
reviews some of the recent economics literature on the benefits of dollar-
ization. Sections 3 and 4 review the applicable lessons from Panama's and
Argentina's respective experiences. Section 5 describes the specific way
that Ecuador has implemented dollarization, focusing on the changes
made to the Central Bank and the financial system. Section 6 reviews the
main transition issues during 2000, including the unfreezing of time
deposits (frozen in March 1999), the price-level increase resulting from
the extreme exchange-rate depreciation at which dollarization com-
menced, and the problem of adjusting domestic prices. Section 7 dis-
cusses Ecuador's macroeconomic policies during 2000 and 2001. Section
8 deals with longer-term issues, including the need for structural reform
to help deal with Ecuador's exposure to contingency. Finally, Section 9
summarizes the conclusions.


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             83
2. Evidence and Theory from the Literature on Dollarization
To paraphrase Milton Friedman, "There is no such thing as a free float,"
since any government-or central-bank policy action amounts to interven-
tion. In practice, active intervention in foreign exchange markets is the
norm in. emerging-maiket countries. For this reason, the benefits and
costs of hard fixed-exchange rates must be compared with the benefits
and costs of flexible systems with continuing central-bank intervention.
Furthermore, low policy credibility obliges emerging-market countries
with variable exchange-rate systems to maintain large foreign-exchange
reserves. Doing so has a high opportunity cost, which must be offset
against the benefits of seigniorage. Furthermore, a hard fixed-exchange
rate becomes more attractive as spontaneous dollarization becomes wide-
spread and .policy credibility becomes weaker. This was the case for
Ecuador, where the relative merits of dollarization must be compared
with the previously existing dual-currency system under which currency
depreciation set off unmanageable macroeconomic and financial dynam-
ics (as discussed-in chapter 2).
The basic arguments in favor of flexible rate systems with significant
central-bank intervention center on their allowing policymakers to
realign the real-effective exchange rate more rapidly; at least for the short
term. Some recent literature casts doubt on whether this is really true in
practice. The existence of many nontradable goods with "sticky" prices
means that variable exchange-rate systems will systematically introduce
misalignments among nontradables prices (Calvo and Reinhart 2000).
The theoretical claim that variable exchange rate-systems can maintain
appropriate alignment (with adequate international reserves and no
indexation) is based on the assumption that there is just a single flexibly
priced nontradable good.
Hausmann and others (1999) examined the response of central banks
to the international crisis of 1997-98 and found that in practice most
countries with flexible exchange-rate systems allow only limited
exchange-rate variability. They found that central banks aim to prevent
depreciation by aggressively raising interest rates. So-called variable
exchange rates tend therefore to be managed as if they were fixed, but
without the benefits of precommitment. Interest rates tended to be higher
in countries with variable exchange rates and lower in countries where
exchange rates are credibly fixed. Furthermore, Hausmann and others
hypothesize that credible fixed exchange-rate systems promote deeper
financial markets. Countries exposed to severe -terms-of-trade shocks
require deeper financial markets to cope with them. People hold dollars
because they fear that depreciation following a terms-of-trade shock will,
all other things being equal, reduce the real value of their assets, com-


84                            CRISIS AND DOLLARIZATION IN ECUADOR
pounding the negative effects of the shock on incomes. In such circum-
stances, people will seek higher interest rates to persuade them to hold
depreciable domestic-currency obligations, to compensate not only for
expected depreciation but also for the risk that the depreciation will be
even deeper than expected. This is one basic reason why flexible
exchange-rate regimes in developing economies tend to have relatively
high interest-rate levels.
Countries in which terms of trade were more volatile were more likely
to adopt a fixed exchange rate (for a sample of 110 countries for the
1982-91 period, see Lane, forthcoming, and for the 1960-94 period, see
Frieden, Ghezzi, and Stein 2001). These results appear counterintuitive
from the perspective of policymakers, since one of the presumable pur-
poses of exchange-rate flexibility is to offset terms-of-trade movements.
One might expect flexible exchange-rate regimes to allow better con-
trol over dollar wages and the real-effective exchange rate than fixed
rates, but empirical evidence points to the contrary. Nominal wages tend
to react more swiftly to price shocks under flexible regimes than under
fixed regimes, leading to more de-facto devaluation. Evidence for
Argentina and Brazil suggests that de-facto indexation has functioned as
an insurance mechanism against the possibility of sudden price-level
movements, which are more likely under flexible exchange-rate regimes.
That is, employers and workers anticipate the likelihood that exchange-
rate depreciation will reduce real wages and take this into account in the
wage-negotiation process. This effect reduces the effectiveness of
exchange-rate flexibility as an instrument to improve competitiveness
(Hausmann and others 1999).
In practical terms, the disruptive effects of exchange-rate depreciation
often overwhelm the positive effects on output and exports. Depreciation
increases the local-currency value of dollar debt, damaging the credit sys-
tem and increasing the likelihood of debt default, encouraging capital
flight and discouraging capital inflows. In contrast, the deeper financial
markets associated with fixed exchange-rate regimes allow for smoother,
lengthier adjustments compared with the abrupt relative price changes
generated by devaluation.1
Eichengreen and Hausmann contend that fixed exchange-rate regimes
are more prone to banking crises than flexible regimes. If markets antici-
pate that the supply of "last-resort" lending to the private sector will
rapidly expand the monetary base, they will expect rapid currency depre-
ciation, and this expectation may itself be destabilizing. In flexible
exchange-rate regimes, ex-ante interest rates may seem reasonable
enough in view of likely exchange-rate depreciation, but ex-post interest
rates may turn out very high if the expected depreciation fails to take
place. In such circumstances debt stocks could grow more rapidly than


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS            85
anticipated, for the dubious reason that anticipated depreciation failed to
occur.
Dollarization has several important advantages over conventional
fixed exchange rates. Unless the permanence of the pegged exchange rate
is extremely credible, residual fears of depreciation could affect financial
intermediation. This is one reason why Latin American economies have
generally been unable to place longer-term domestic-currency debt: Latin
America's longer-term financial markets are all dollar-denominated or
index-linked, often leading to serious mismatches in corporations' and
individuals' balance sheets.
Dollarization reduces the scope for sharp relative price changes, of the
kind that often accompany inflationary processes. Such changes are often
a key reason for the vulnerability of emerging-market economies to exter-
nal shocks (see Calvo 2000).
Dollarization implies giving up independent monetary policy, and
many people argue that this is a disadvantage. In several emerging-mar-
ket economies, however, active monetary policy has proved ineffective or
even disruptive. For these countries, externally dictated monetary policy
would be advantageous. Ecuador is now effectively subject to the mone-
tary policy of the United States. Could flexible exchange rates do the job
of delinking Ecuador from the United States? A study covering six
decades of Chilean recessions, including all of the period during which
the economy was largely "closed" by high barriers to foreign trade, con-
cludes that all Chilean recessions in the period followed U.S. recessions,
through the link of the price of copper exports (Cort6s Douglas 1983).
This was so in spite of the fact that Chile attempted just about every
imaginable exchange-rate system (including the gold standard) during
the period. Furthermore, for a large group of emerging economies, a
study found that emerging markets are highly vulnerable to external
shocks, regardless of their exchange-rate systems. U.S. interest rates and
U.S. business cycles explain half the variance of real exchange-rate
changes and accumulation of international reserves (Calvo and Reinhart
2000). It seems reasonable enough to conclude that U.S. economic influ-
ence operates under any exchange-rate regime.
Another presumable disadvantage of dollarization is the loss of
seigniorage. Having a local currency allows the central bank to secure
seigniorage gains, whereas full dollarization leaves the seigniorage gains
in the hands of the U.S. Federal Reserve.2 The appropriate comparison,
however, would be not with an alternative theoretical system where the
central bank holds no international reserves, but with a more realistic sys-
tem in which the central bank maintains a large international-reserve
stock. As noted earlier, weak credibility and flexible exchange-rate
arrangements in developing economies oblige their central banks to


86                           CRISIS AND DOLLARIZATION IN ECUADOR
maintairi large international-reserve balances. The interest these central
banks earn on these reserves are typically low. Moreno Villalaz (1997,
1999a) has estimated that an undollarized Panama would have had to
hold international reserves amounting to some five percentage points. of
GDP Moreover, Panama saves the cosi of operating a central bank, which
would be significant for a small developing economy
3. Lessons from Panama's Dollarization
Panama adopted the dollar following its independence in 1904.3 Unlike
many other Latin American economies, where debilitating cycles of infla-
tion, exchange-rate depreciation, adjustment, and recession have hampered
growth and intensified social conflict, Panama has maintained monetary
and price stability and steady growth. Panamanian business has never
experienced or ever had to cope with the fear of exchange-rate depreciation.
In recent years, inflation rates in Panama have actually been below those of
the United States. Although Panama has coped with external-debt problems
and exogenous shocks, it has avoided traumatic balance-of-payments crises,
as well as systemic banking or financial crises. It has adeptly handled finan-
cial capital flows, surfing through the cycles of inflows and outflows char-
acterizing many other economies. Interest rates in Panama's banking
system have generally been in line with international rates, with insignifi-
cant risk premia. Both public and private sectors in Panama have been able
to issue international bonds, generally favorably rated.
Table 3.1 shows various aspects-of Panama's macroeconomic perfor-
mance during the past three decades. Apart from the debt-crisis years of
the early 1980s and the period of confrontation with the United States in
the late 1980s, real GDP growth has been relatively strong. Inflation has
been remarkably low since the mid-1980s, and even in the 1970s was gen-
erally lower than world inflation. The monetization rate is high and
growing, as indicated by the solid and steady increase in bank deposits
and quasi money (currency in circulation cannot, of course, be mea-
sured). Interest rates on deposits have been fairly close to LIBOR. Apart
from the troubled 1980s, during which Panama at one point was at war
with the United States, Panama's capital-formation and national-saving
rates have been strikingly high by comparison with other Latin American
economies. This result derives at least in part from the absence of
exchange-rate uncertainty and the low level of price-level uncertainty.
The adoption of the dollar enabled Panama to develop a valuable and
stabilizing service activity. In 1970, a new banking law established
Panama as an international financial center. More than 120 banks now
operate within the country. The liberalized legal structure, free entry, and
the absence of capital controls enabled the banking sector to operate at a


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS                 87
Table 3.1. Panama: Selected Macroeconomic Indicators, 1970-99
Period                   1970-   1975-   1980-    1985-   1990-   1995-
averages                  74      79       84      89      94      99
Growth rates (percent)
Gross domestic product
(GDP) at market prices  5.8    6.9      2.6    -1.0     6.8     3.3
Per-capita GDP          2.6    4.1     -0.3    -2.9     4.8     1.5
Consumer prices
(year-average)          6.7    5.3      5.8     0.5     0.9     1.3
Per-capita U.S.,dollars at
prices and exchange
rate of 1998
Gross domestic
product (GDP)      $2,382.9 $2,511.2 $2,922.0 $2,771.9 $2,916.4 $3,230.3
Nongovernment
consumption        $1,359.0 $1,462.2 $1,566.6 $1,546.1 $1,644.1 $1,769.0
National accounts
(percentage of GDP)
Gross fixed-capital
formation              28.1   25.9     21.7     13.4   17.8    27.2
National saving        34.9   34.8     32.4     6.3    18.3    35.0
Domestic saving        33.2   32.2     25.7     2.9    12.8    29.2
Net imports of
goods and non-
factor services
(resource gap)        -5.1    -6.3     -4.0    '10.5    5.0    -1.9
External accounts
(percentage of GDP)           (1977-79)
Current-account surplus       -9.0     -5.0     5.3    -1.1    -8.5
Merchandise trade           -20.2    -7.8     -2.8    -4.7   -10.6
Merchandise exports         17.0    51.8     47.7    72.9   69.8
Merchandise imports        -37.2   -59.7    -50.5   -77.5  -80.4
Other current account        11.2     2.8      8.1     3.6     2.1
Capital-acct., net err.
and omissions                  9.7      3.9   -15.2    -2.9     7.8
Gross foreign-exchange
reserves (mos. of imports
of goods, nonfactor
services)                      1.1      0.6     0.4     1.0     1.3
(1975-79)
Bilateral real-effective
exchange rate vis A vis
the U.S. (year average)  89.9    89.7    84.0     90.9   100.6   101.4
(based on GDP deflators;
1995 = 100,
+ = depreciation)                      (Table continues on the following page.)


88                            CRISIS AND DOLLARIZATION IN ECUADOR
Table 3.1. (continued)
Period                  1970-  1975-    1980-   1985-  1990-   1995-
averages                 74      79      84      89      94     99
Broad money supply
(deposit money plus
quasi money;
percentage of GDP)      29.0    32.5    35.9    37.3    52.9   73.7
Annual interest rates
Deposit rate                                          6.8     7.0
Lending rate                                         10.9   10.6
(Six-month
U.S.-dollar LIBOR)                                   5.4    5.7
Gross domestic
product (US$ million)  1302.3 2232.7  4577.2  5283.2  6556.7 8683.0
Population (million)     1.5     1.8     2.0     2.3     2.5    2.7
(1995-1998)
Total external debt
(World Bank World
Debt Tables; US$ million) 427.4  1775.5  3803.3  5526.3  6818.4  6192.9
Publ., publ.
Guaranteed yr.-end
stock                361.0 1428.5  2788.5   3756.8  3900.1 4885.3
Percentage of GDP   26.8    62.3    60.7    71.6    60.7   57.6
Service on public
and publicly
guaranteed term debt  69.1  257.4   519.2    248.6  294.9   776.1
Percentage of
exports of goods,
nonfactor services                 15.7     7.0     4.8    9.8
Interest payments    20.8   98.0   293.2   171.9   129.9  271.1
Repayment           48.3   159.4   226.0    76.7   165.0  505.1
Sources: International Monetary Fund, World Bank.
cost advantage compared with other countries. Financial integration has
turned out to be essential to enable Panama to absorb manageable capi-
tal inflows. Free capital movement has largely freed Panama from con-
cerns about excessive inflows, since excess funds can simply be
"exported" into foreign placements. In economies where capital outflows
are restricted, excess funds are likely to be placed within the economy in
low-yielding activities, leading in this way to excessive, inefficient
domestic investment or financing of public deficits.
The international banking system based in Panama acts as an auto-
matic stabilizer in two other ways. If the government borrows abroad,
banks can offset the resulting dollar inflows by reducing their net foreign


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS            89
liabilities. This stabilizing role of banks contrasts with the cham of events
typical in other economies, where capital inflows raise fiscal revenue and
international reserves, encouraging excessive public expenditure and
destabilizing fiscal and current-account deficits, inducing foreign capital
to depart. A second, more important way in which international banks
operating within Panama act as stabilizers is by having their overseas
headquarters serve as their lenders of last resort. Large shocks to the
Panamanian economy-such as the confrontation with the United States
in the late 1980s, which led to sanctions and invasion-have induced
banks to borrow abroad, receive support from their home offices, or
reduce their liquid assets to compensate for loss of local deposits. Banks
responded in similar ways to the disruptions caused by surging oil prices
in 1973 and 1979. In effect, Panama possesses what amounts to a private
lender of last resort. The international banking system can operate as a
lender of last resort without creating money.4
Latin America's recent experience has encouraged a view that capital
flows are dangerous, producing excess demand for goods (and assets)
and real-effective exchange-rate appreciation, but then ending in sudden
reversal. These effects of capital flows are unheard of in Panama, as the
adoption of the dollar and the internationalized banking system made
possible by the adoption of the dollar has led to capital movements being
absorbed within or exported out of the banking system without serious
cyclical disruptions. Any excess of expenditure over income at the macro-
economic level is accompanied by an increase in the banks' net foreign
liability position. To stay within their funding constraints, banks slow
their local lending, reducing domestic expenditure and eliminating the
disequilibrium. Panama has thus avoided having bank credit finance
excess domestic expenditure, which would lead to disequilibrating real
exchange-rate appreciation and asset overvaluation.
An additional beneficial consequence has been that Panama has
largely avoided capital flight. Calvo and Reinhart (2000) have shown that
Latin American banking crises in the 1980s and 1990s have generally been
associated with negative capital-flow reversals. Panama is an exception.
No capital flight has resulted from macroeconomic imbalances or policy
errors. The only time significant capital flight took place was in 1987-89,
as a consequence of political crisis.
The success of Panama's monetary system is centered in financial inte-
gration. It is doubtful that such integration would have been possible
without full dollarization. A country with a currency board or full dollar-
ization but incomplete financial integration would be at a disadvantage
in its ability to absorb external shocks compared with Panama. On this
point, Moreno Villalaz (1999a) compares Hong Kong (China) and
Panama. Although Hong Kong uses a currency board and has a high


90                           CRISIS AND DOLLARIZATION IN ECUADOR
degree of capital mobility, it still maintains high interest rate differentials.
Barriers to entry into the banking business and the requirement that
banks balance their Hong Kong dollar and U.S. dollar accounts sepa-
rately largely explain its relatively low degree of financial integration. For
countries without currency-board arrangements or dollarization, finan-
cial integration is even more distant. Banking systems based heavily on
purely local banks, capital-flow restrictions, segmented credit markets in
local and foreign currency, and central banks relying on their own inter-
est-bearing instruments to carry out policy (with quasi-fiscal implica-
tions) have often constituted formulas for catastrophe. Systems of this
kind encourage excessive risk taking, excessive spending and borrowing,
and real exchange-rate appreciation, leading in turn to financial-market
fragility and asset-price bubbles.
Panama's successful experience suggests. that dollarization could
potentially bring important benefits for Ecuador. Enhanced policy credi-
bility largely explains Ecuador's success in unfreezing time deposits after
March 2000 (see section 6 below). Eliminating the possibility of exchange-
rate depreciation appears to have enhanced credibility and confidence in
the banking system, among other things, by eliminating the exchange
risk inherent in bank balance sheets. The difficulty of reversing dollariza-
tion enhances its credibility even compared with currency boards (see
Berg and Borensztein 2000). Over time, it is likely to enhance the value of
collateral, such as real estate, held against external lending within
Ecuador. In addition, removal of the possibility of exchange-rate depreci-
ation should reduce domestic interest rates by ending the currency pre-
mium, that is, the component of the interest rate compensating for the
uncertainty associated with the exchange rate. This in itself would
encourage capital inflows. Ecuador has eliminated the possibility of spec-
ulative attack on its exchange rate by definition.
4. Lessons from Argentina's Currency-board Experience
In contrast with Panama's successful experience, the collapse of
Argentina's "convertibility" system in December 2001 would appear to be
a dramatic instance of a failure of a hard fixed-exchange rate. Argentina
requires a closer look. Argentina's convertibility system began in April
1991. Under legislation approved that month, the Central Bank would
henceforth sell pesos for dollars on demand at an immutably fixed
exchange rate-fixed by law. The Central Bank would publish financial
statements showing that it maintained full foreign-exchange backing for all
pesos it issued (the legislation allowed part of the backing to be in dollar-
denominated government bonds). The objective was to put an end to
nearly two decades of chronic, often severe exchange-rate and price-level


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             91
instability, which had culminated in several hyperinflation episodes dur-
ing 1989 and 1990. Argentina maintained its convertibility system for about
10 years, before it collapsed under public anger over a recession sustained
for 4 years by excessive public debt accumulation and by real-effective
exchange-rate appreciation.
Table 3.2 shows some of Argentina's recent macroeconomic perfor-
mance indicators. Inflation declined sharply from the hyperinflation
years 1989-90, but the 1990s were characterized by a strikingly high vari-
ability of real GDP growth. The economy grew rapidly in the years imme-
diately following the institution of convertibility in 1991. In 1995,
however, the Argentine financial system was badly affected by Mexico's
"Tequila" crisis (Baliio and others 1997 describe how the Argentine
authorities coped with heavy deposit withdrawals while maintaining
convertibility). After a recovery in 1996 and 1997, Argentina's economy
went into a protracted recession in 1998. Heavy external debt was a major
contributor and the onset of the East Asian, Russian, and Brazilian finan-
cial crises compounded Argentina's difficulties. Per-capita real GDP and
nongovernment consumption both declined sharply after 1997.
In one sense, Argentina's convertibility and Ecuador's dollarization
are actually quite similar exchange-rate regimes, because Ecuador has
maintained its Central Bank in operation (see section 5 below). In both
systems, the exchange rate is rigorously fixed by law. Both central banks'
ability to create new money is sharply restricted. The essential difference
is .that adopting the dollar amounts, to a stronger promise never to
devalue. While Argentina retained a domestic currency that could be
devalued against the dollar if the law were changed, Ecuador would have
to introduce a new currency in order to devalue. In this sense, dollariza-
tion in its inception is more credible than a currency board could be.
The reasons why Argentina slid into protracted recession and finally
had to abandon its currency-board regime in an overwhelming crisis
will be debated for years to come. In particular, the role of the currency
board and its hard fixed-exchange rate will be examined and debated
closely. The debate is likely to center on the relative importance of the
restrictions imposed by the currency-board system and Argentina's
long-standing fiscal deficits. The real-effective exchange rate appreciated
steadily during the 1990s (see table 3.2), largely as a consequence of the
appreciation of the U.S. dollar and, beginning in 1999, the depreciation
of the currency of Brazil, Argentina's MERCOSUR partner. This real-
effective appreciation undoubtedly contributed to the recession. With
the nominal exchange rate hard-fixed and external prices exogenous,
only wage and price-level reductions could bring about real-effective
depreciation. Like most modern economies, however, Argentina's was
structurally incapable of undergoing significant deflation in this way.


Table 3.2. Argentina: Selected Macroeconomic Indicators, 1989-2000
1989    1990   1991   1992   1993   1994    1995  1996   1997 1998   1999   2000
Growth rates (percent)
Real gross domestic
product (GDP) at
market prices            -7.0    -2.4   10.9   10.0    5.3    8.1   -4.6    4.5    9.7   2.8  -2.4   -0.4
Consumer prices
(December/December)    4923.3  1343.9   84.0   17.5    7.3    3.9    1.6    0.0    0.4   0.6  -1.8   -0.5
Per-capita U.S. dollars at
prices and exchange
rate of 1999
Gross domestic
product (GDP)          $5,774  $5,559  $6,081 $6,602 $6,862  $7,322  $6,892 $7,111 $7,700 $7,813 $7,527 $7,403
Nongovernment
consumption            $4,720  $4,524  $5,157 $5,659 $4,849  $5,191  $4,847 $5,291 $5,561 $5,664 $5,399 $5,123
National accounts
(percentage of GDP)
Gross fixed capital
formation                16.2    14.2   14.8   16.8   19.3   20.2   18.3   18.4   19.8  20.4  19.6   17.6
National saving          14.2     9.8   14.4   19.4   22.9   24.7   20.4   21.1   25.0  25.5  24.2   20.9
Domestic saving           9.5     8.3   13.2   18.5   21.7   23.3   18.6   19.0   22.8  23.0  21.3   18.3
Net imports of goods
nonfactor services
(resource gap)            6.7     5.9    1.7   -1.7  -2.4    -3.1   -0.4   -0.6   -3.1  -2.6  -1.7   -0.6
External accounts
(percentage of GDP)
Balance-of-payments
current-account surplus  -1.8     3.3   -0.3   -2.4   -3.4   -4.3   -2.0   -2.4   -4.2  -4.9  -4.4   -3.1
Merchandise trade        7.8     6.2    2.4   -0.6  -1.0    -1.6    0.9    0.7   -0.7  -1.1  -0.3    0.9


Merchandise exports    13.1     8.9    6.4    5.5    5.7    6.3     8.3    9.0   9.2   9.1    8.5    9.3
Merchandise imports    -5.3    -2.7   -4.0   -6.1   -6.7   -7.9    -7.4  -8.3   -9.9 -10.1   -8.8   -8.4
Other current account    -9.6   -2.9   -2.7   -1.8   -2.4   -2.7    -2.9   -3.1   -3.4  -3.8  -4.1   -4.0
Capital-account surplus,
net errors, and omissions  -11.4  -3.7   -0.1   3.3    8.2     4.0    1.1    3.7    5.3   6.3   5.1    2.7
Gross foreign-exchange
reserves (mos. of imports of
goods, nonfactor services)   2.6     7.5    6.0    6.0    7.3    6.1     6.3    7.1   7.1   7.6    9.6    9.7
Real-effective exchange rate
(year avg.,
1995 = 100, + = depreciation) 131.0  100.0  76.2  71.2  67.6    69.0   71.0   70.1   67.8  67.6  66.7   65.5
Nonfinancial public sector
(percentage of GDP)
Nonfinancial public-sector
consolidated surplus                                   1.2    -0.1   -0.5   -2.0   -1.5  -1.4  -1.7   -2.4
Current revenue                                      21.4    19.8   19.3   17.6   19.1  19.3  20.3   19.7
Capital revenue, incl.
privatization proceeds                                0.3    0.3     0.5    0.3   0.3    0.2   1.0    0.1
Total expenditure                                    20.5   20.2    20.4   19.8   20.8  20.9  23.0   22.2
Current expenditure                                 18.9   18.7    19.1   18.5  19.5  19.6   21.8   21.2
Staff remuneration                                 3.3     3.0    2.9  - 2.7    2.6   2.4    2.7   2.4
Interest due                                       1.2     1.2    1.6    1.7    2.0   2.3    3.0   3.4
External interest                                  1.1    1.1     1.5    1.7   1.9    2.2   2.9    3.3
Domestic interest                                  0.2    0.1     0.1    0.1   0.1    0.1   0.1    0.1
Capital expenditure                                  1.6    1.5     1.3   1.3    1.3   1.3    1.2    1.0
of which, capital formation                        0.7     0.5    0.3    0.3    0.3   0.3    0.2   0.1
Primary balance (surplus
plus interest due)                                    2.4    1.1     1.1   -0.2   0.5    0.9   1.3    1.0
(Table continues on the following page.)


Table 3.2. (continued)
1989    1990   1991  1992   1993   1994   1995   1996   1997 1998  1999   2000
Saving (total revenue
less current expenditure)                           2.5    1.1    0.2   -0.9   -0.4  -0.3  -1.6  -1.5
Broad money supply
(percentage of GDP)        21.0    11.6   10.7  13.8   19.5   21.1   20.5   23.1  27.0  29.5  31.9   31.7
Deposit rate (pesos; annual
percentage rate)          172.4   15.2    62.0  17.0   11.0    8.0   12.0    7.0   7.0   8.0   8.0    8.3
(Six-month U.S.-dollar
LIBOR)                   9.3     8.4    6.1    3.9   3.4    5.1     6.1   5.6    5.9   5.6   5.5   6.7
Total external debt (year end,
US$ billion)               65.3    62.2   65.4  68.3   64.7   75.1   98.8  111.4  128.4 141.5 147.9  N/A
Public and publicly
guaranteed year-end stock  51.8  46.9  47.6   47.6  46.2   50.6    55.2  62.6   67.1  77.3  84.6  N/A
Percentage of GDP      70.8    33.7   25.4   21.0  19.7   19.9   21.8   23.4   23.4  26.5  30.7  N/A
Service on public and
publicly guaranteed
term debt                2.8     4.8    3.7    3.2   4.4    3.6     5.3   7.0   11.4  11.7  12.2  N/A
Percentage of exports
of goods, nonfactor
services              23.5    32.5   26.0  20.7   27.0   18.5   21.0   24.6  37.0  37.7  43.8  N/A
Interest payments       1.3     2.1    2.2   2.3    2.3    2.6    3.5    3.7    4.5  5.4    6.3  N/A
Repayment               1.4     2.7    1.5   0.9    2.2    1.0    1.8    3.3    6.9  6.3    5.9  N/A
Short-term debt (excl.
arrears)/gross foreign-
exchange reserves (percent) 582.7  243.9  233.1  168.2  64.9  52.1  155.3  132.7  144.4 126.4 120.7  N/A
Gross domestic product
(US$ billion)              73.2   139.3  187.3  226.9  233.8  254.1  253.6  266.9  287.2 291.2 275.3  285.4
Population (million)       32.1   32.5    33.0  33.4   33.9   34.3   34.8   35.2  35.7  36.1  36.6   37.0
Sources: International Monetary Fund, World Bank, Ministry of Economy of Argentina.


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             95
Many observers ascribe at least equal importance to Argentina's
inability to control its fiscal accounts, particularly after the recession com-
menced in 1998. Under the currency board, continuing public-sector
deficits led to a growing debt stock at relatively high interest rates (see
table 3.2). Moreover, these interest rates incorporated risk premia, reflect-
ing Argentina's history of fiscal mismanagement and risk of future
default. The need to maintain the service on this debt placed the public
accounts under intensifying pressure, particularly as recession persisted
and simultaneously reduced public revenue and forced increased social
expenditure. The reality that a large proportion of Argentina's public
spending is carried out by provincial governments not subject to eco-
nomic management by the central government complicated policymak-
ers' efforts at fiscal management.
A balanced explanation of Argentina's macroeconomic collapse would
assign blame both to the failure of fiscal management and the exchange-
rate appreciation. Once the recession began, it is fair to say that fiscal
adjustment became far more difficult, since the recession itself widened
the deficit and the deficit then increased the debt stock and the interest
bill. At the same time, however, it is also fair to conjecture that, if
Argentina had carried out a stronger fiscal adjustment in the early 1990s,
before the recession, the authorities would have had more scope to cope
with the recession once it began, since they would then have been better
able to limit public-debt accumulation. For Ecuador, Argentina's clear les-
son is that disciplined management of public finances is cruicial to ensure
the continued viability of the hard fixed-exchange rate.
5. Ecuador's Dollarization System
Under "pure" dollarization, after repurchasing all its outstanding sucre
liabilities for dollars, the central bank would have liquidated itself,
returning its residual net assets to its owner (that is, the government).
Dollars would then circulate freely, as they do, for example, in Puerto
Rico. Ecuador chose, instead, to keep its Central Bank in operation. Using
allocated and borrowed foreign-exchange resources, the Central Bank of
Ecuador would be able to carry out a degree of liquidity management
and to provide limited amounts of credit to banks undergoing liquidity
stress.
Dollarization was implemented during 2000 according to the Eco-
nomic Transformation Law, which the president signed into law in early
March 2000 following approval by the Congress.5 The law provided that
the Central Bank would repurchase the outstanding sucre money stock
using its foreign-exchange holdings, and Ecuador would adopt the dollar
as an official monetary unit, and for practical purposes the official mone-


96                           CRISIS AND DOLLARIZATION IN ECUADOR
tary unit.6 The law made the U.S. dollar the legal unit of account and
medium of exchange, stipulating that all legal public and private
accounting records would henceforth be maintained in dollars. Dollars or
sucres could be used to settle contracts, but all foreign-trade transactions
and taxes deriving from them would have to be settled in dollars. Over
the course of 2000, the Central Bank repurchased almost the entire out-
standing stock of sucres. In September 2000, six months after the law was
approved, all bank accounts and other contractual relations were con-
verted.
The law reorganized the Central Bank into four "systems" with segre-
gated balance sheets. In the first, foreign-exchange holdings back an
equal amount of old sucres still outstanding and new small-value coins
to be introduced during 2000. (This first system amounts to a mini-cur-
rency board, with a size on the order of several dollars' worth of small
coins per resident.) In the second, foreign-exchange holdings stand
behind a precisely equal stock of bank deposits and Central Bank stabi-
lization bonds. In the third, the Central Bank's remaining foreign-
exchange holdings, its stock of Treasury bonds, and its holdings of
repurchase agreements back the Central Bank's external obligations
(including those to the IMF), the public sector's deposit accounts, and
interest-bearing Central Bank obligations to be used in open-market
operations. The foreign exchange held in this third account would hence-
forth be Ecuador's operating gross international-reserve position, since
the amounts held in reserve against coins and against the Central Bank's
obligations to commercial banks would be unavailable for external trans-
actions. The fourth balance sheet comprises all other Central Bank assets,
liabilities, and net worth. That is, the law provides, in effect, that the Cen-
tral Bank will apply its foreign-exchange holdings to back its various
obligations by priority-first, its small-coin issue and the commercial
banks' reserve-account deposits, and then all its other obligations, includ-
ing its own external obligations and the Treasury's deposit account.
This structure closely resembles that of a currency board (see Baliflo
and others 1997, and also Gulde 1999). The first two systems are essen-
tially the same as a currency board's "issue department," in which for-
eign-exchange holdings stand behind specific monetary obligations (that
is, currency issues and commercial-bank deposits at the central bank). In
Ecuador, such obligations can only be created as the Central Bank
receives foreign exchange and can be extinguished only as the Central
Bank pays out foreign exchange. Unlike a currency board, which retains
a monopoly on domestic currency issue, Ecuador's Central Bank cannot
know the full amount of the economy's actual monetary base, since it has
no way of knowing the stock of dollars in circulation.7 The third balance
sheet is similar to a currency board's "banking department": the Central


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS              97
Bank can lend foreign exchange to eligible borrowers-that is, commer-
cial banks-as long as it maintains sufficient foreign exchange to back its
monetary obligations for liquidity support and other operations.
Table 3.3 shows the Central Bank's account structure and its evolution
following dollarization. As explained in section 7 below, overall interna-
tional reserves increased, and freely available reserves rose from just
US$141 million on March 10 to US$919 million on December 31, 2000, as
a consequence of the relatively strong external-accounts performance.
Nonfinancial public-sector deposits at the Central Bank rose from just
over US$500 million to just over US$1 billion, reflecting improving fiscal
performance (and some external borrowing). The sucre "monetary base"
declined over the period, since the Central Bank largely completed the
repurchase of sucres by September 2000. The new coin issue was far
smaller in magnitude than the repurchased sucre issue; and commercial-
bank deposits at the Central Bank remained essentially unchanged, since
their deposit base remained essentially unchanged.
Table 3.3. Ecuador. The Central Bank's Four Balance Sheets,
March 10, 2000-December 31, 2001
10-Mar    30-Jun     31-Dec    30-Jun  31-Dec
US$ million            2000      2000       2000      2001    2001
(1) Exchange system (net)  0       0         0         0        0
Assets              425       153        35       35       27
International
reserves (A)     425       153        35        35       27
Liabilities        -425      -153       -35      -35      -27
Monetary
emissiona       -425      -153       -35       -35      -27
Sucres          -425      -153       -28       -28        0
Small-denomina-
tion coins         0         0        -8        -8      -27
(2) Financial reserve
system (net)          0         0        0         0        0
Assets              299       215       226       144     261
International
reserves (B)     299       215       144       144      261
Liabilities        -299      -215      -226     -144     -261
Reserve deposits -287     -212      -144      -144     -261
Monetary
stabilization bonds -12     -3         0         0        0
(Table continues on the following page.)


98                              CRISIS AND DOLLARIZATION IN ECUADOR
Table 3.3. (continued)
10-Mar     30-Jun     31-Dec    30-Jun    31-Dec
US$ million              2000      2000        2000      2001     2001
(3) Main operations
system (net)           0          0         0          0        0
Assets               821      1,203      1,579     1,651     1,454
Intemational
reserves (C)       141       523      1,025      1,025     785
Repurchase
operations         38          1          0         0       50
Treasury
obligations       642        679       625        625      618
Liabilities         -821     -1,203     -1,579    -1,651    -1,454
Nonfinancial
public-sector
deposits         -512       -661     -1,144    -1,144     -988
Private deposits  -26         -9       -14        -14      -16
Central Bank term
obligations      -283       -533      -492       -492     -450
(4) Other operations
system (net)           0          0         0          0        0
Assetsb             1,627     1,712      1,576     1,571     1,653
Liabilities and
capitalb           -1,627    -1,712     -1,576    -1,571    -1,653
Other liabilitiesc           497        270       180      438
Capital and
reserves                  -2,291     -1,883    -1,804    -2,091
of which,
accumulated
profit                        83          0        53        0
Memorandum
International reserves
(A+B+C)                  865        891      1,180     1,204     1,074
Monetary base            712        365       261        179      289
a. Small coins and sucres still outstanding.
b. Includes capital positions in international and Andean organizations and col-
lateral for interest on Brady bonds.
c. Includes exchange adjustment and provisions.
Source: Central Bank of Ecuador.
As in a currency board's banking department, all other things being
equal, the scope of operations allowable under the third balance sheet is
determined, among other things, by the exchange rate at conversion. The
more depreciated the domestic currency, the smaller the proportion of the


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             99
foreign-exchange stock that would have to be. dedicated to the issue
department, and consequently the.larger the scope for banking-depart-
ment operations. In Ecuador's case, the sharply depreciated exchange rate
on conversion effectively enabled Ecuador's Central Bank to have a larger
foreign-exchange stock relative to liabilities under its third system.8
The role the Central Bank will play in dollarized Ecuador will, of
course, be far more limited than that of a conventional monetary author-
ity. It will be able to carry out liquidity-management and lender-of-last-
resort functions, but since it cannot create money, its capacity to manage
the economy's liquidity will be limited, and so it cannot be a lender of last
resort in the full sense of the term.
The Economic Transformation Law incorporated several other provi-
sions relating to the dollarization process. Several controversial provi-
sions .dealt with interest rates. As in any currency. transition, the
authorities provided for conversion of contracts that had been formu-
lated under the assumption of a depreciating currency into'contracts in a
more stable currency.9 The law also provided for a one-time transitory
reduction in interest rates on all existing sucre and dollar-denominated
financial assets.10 More controversially, it introduced a usury ceiling, to
be set periodically as a "risk" spread over LIBOR by the Central Bank, up
to 1.5 times the banking system's prevailing weighted average lending
rate, as calculated by the Central Bank from its surveys of banks. Politi-
cally, this usury ceiling was a response to the perception that, after the
banking system was liberalized,in the first half of the 1990s, certain banks
had made abusive and unsafe use of high-interest-rate operations, taking
deposits at high rates and lending at high rates to risky borrowers. Many
observers argued that the mere existence of a usury ceiling would dis-
courage. future would-be entrants to Ecuador's financial system. (It is
preferable to rely on bank regulators to prevent unsafe high-interest oper-
ations through supervision activities.)
To supplement the Central Bank's capacity to aeal with short-term liq-
uidity crises, the authorities announced they would establish a separate
Liquidity Support Fund, outside the Central Bank. This Fund. was capi-
talized through an initial US$70 million loan provided by the CAF. Banks
would be required to place deposits with this Fund amounting to 1 per-
cent of their deposit base, a supplemental reserve requirement on top of
their 8 percent conventional reserve requirement.
The Economic Transformation Law incorporated a large number of
provisions going well beyond dollarization per. se. The government
argued that, since the ultimate success of dollarization would hinge on
resolution of the banking crisis and implementation of long-overdue
structural reform, it Was therefore appropriate that dollarization legisla-
tion address these issues. Thus, the law tightened bank-regulation stan-


100                           CRISIS AND DOLLARIZATION IN ECUADOR
dards. Commercial banks would henceforth be held to a 9 percent capital-
adequacy standard, to be closely monitored by the Banking Superinten-
dency. Banks falling short would be required to bring in new capital
within a short period of time or face intervention and perhaps liquidation.
The law provided that accounting systems would be brought more closely
into line with international standards.
The law and subsequent regulations also provided for reprogramming
of private debt to financial institutions. The 800,000-odd debtors who
each owed US$50,000 or less in all to the financial system would be per-
mitted to reprogram their debt, according to standardized formulas
applicable to different categories of debt (credit cards, mortgages, and so
on) for up to seven years. The several hundred debtors owing more than
US$50,000 were afforded a legal basis and institutional framework within
which to renegotiate their loans. Although the government subsequently
came under political pressure to make the debt reprogramming compul-
sory and generalized, for larger as well as for smaller debtors, it resisted
doing so. One practical reason was the need to avoid reprogramming
loans that were still viable, to ensure that banks maintained adequate
cash flows.
Structural-reform provisions incorporated in the law addressed the
public finances; the banks' regulatory agencies; privatization of the public
telecommunications, electricity, and hydrocarbon monopolies; private-
sector entry into these sectors; and labor legislation (chapter 2 discusses
the issues involved). These provisions implicitly recognized that dollar-
ization by itself was insufficient to improve growth prospects." In Sep-
tember 2000, the government approved a follow-up law to the Economic
Transformation Law.12 This law consisted almost entirely of structural-
adjustment measures, aiming mainly to increase private-sector participa-
tion in several key sectors. Notwithstanding the extraordinary
circumstances, the structural-reform measures incorporated in the dollar-
ization legislation were relatively limited (see section 8 below).
6. Transition Issues: Deposit Unfreezing and
Price Adjustment
Several specific financial and economic circumstances complicated
Ecuador's transition to dollarization. The first was the release of time
deposits frozen in March 1999 (see chapter 2). The second was the price-
level increase resulting from the sucre's severe undervaluation when the
exchange rate was fixed. Yet another was the need to adjust lagging
motor-fuel, cooking-gas, and electricity prices and wages. Finally, there
were several practical issues, including problems of counterfeiting, coin
shortages, and public information.


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS           101
TIME-DEPOSIT UNFREEZING. In January 2000, when dollarization was
announced, many observers argued that Ecuador could dollarize only
when there was no immediate need for inflationary financing.13 They
pointed in particular to the time-deposit unfreezing process set to com-
mence in mid-March 2000. Heavy deposit withdrawals, they noted, were
likely to ensue after unfreezing. Under dollarization, however, the mon-
etary authority would be unable to provide a large amount of liquidity
credit to banks if that proved necessary. Many observers reasoned that
Ecuador would have to endure further inflation to enable the banking
system to honor its obligations.
To cope with the unfreezing problem, at the same time dollarization
was announced the banking authorities announced that larger time-
deposit balances would be unfrozen only partially. One year after each
time deposit's original maturity date, no more than US$4,000 from the
balance would be made available in cash. The rest would be provided in
Treasury bonds, which the banks would purchase against their own
promissory notes to the Treasury. That is, the Treasury would take private
depositors' place, becoming the largest holder of the banks' liabilities.
Bonds received by depositors would assuredly take deep discounts-this
would be the form in which depositors would take losses. Their value
might be buttressed somewhat by allowing them to be used at par to ser-
vice debt due to banks or for tax payments. Over the weeks leading up to
the start of the unfreezing process, however, the state prosecutor raised
legal objections to this use of Treasury bonds.14 The authorities then con-
cluded they had no choice but to apply an alternative scheme, under
which depositors would receive deposit balances in excess of US$4,000 in
the form of longer-term bank obligations rather than Treasury bonds.
The time-deposit unfreezing process commenced on this basis in mid-
March. Despite widespread concern that the banks would be unable to meet
even the limited withdrawal demand, the unfreezing worked well. Banks
persuaded many depositors to open new accounts instead of withdrawing
cash, and, during the three months of the unfreezing process, banks' aggre-
gate overall deposit stock actually increased. There are several possible
explanations for this success. Dollarization is one. Many depositors con-
cluded that elimination of the possibility of exchange-rate depreciation
would enhance the banks' safety. Depositors may also have reasoned col-
lectively that the withdrawal limitation made it likely enough that banks
would have sufficient liquidity to meet withdrawal demand, and that there
was no need to panic. Also, a few days before the unfreezing process began,
the IMF, World Bank, IDB, and CAF announced plans to provide US$2 bil-
lion in financial support to Ecuador during 2000, 2001, and 2002, in a joint
statement timed to persuade depositors not to withdraw. In addition, vari-
ous rulings by the Constitutional Tribunal to the effect that the deposit


102                           CRISIS AND DOLLARIZATION IN ECUADOR
freeze had been illegal and the state prosecutor's position on the use of Trea-
sury bonds may have persuaded depositors that the authorities could never
again carry out such a freeze. Finally, the banks' own energetic marketing
efforts undoubtedly deserve some share of the credit.
THE PRICE-LEVEL INCREASE. The most serious transition problems derived
from the severely depreciated exchange rate at which dollarization com-
menced (see figure 3.1 and table 3.4). Attainment of parity with external
dollar prices would require a large increase in domestic prices, and this is
precisely what happened. Consumer prices rose 96.1 percent during 2000,
one of the highest annual rates in Ecuador's history, and continued rising
into 2001 as well. In January 2000 many observers calculated, assuming 2
to 3 percent world inflation, that Ecuador's prices would have to rise 120
to 140 percent from the December 1999 base in order to bring Ecuador's
real-effective exchange rate into line with the 1997-99 average within 12
months (see figure 3.1). It was fair to project this as the order of magni-
tude of the price-level adjustment that would take place. Strictly speak-
ing, what was taking place was not "inflation," but rather a
once-and-for-all price-level adjustment. To be sure, there was no way to
guess how long the price-level increase would take to complete, although
the fact that the economy was in recession suggested that it would take
longer than otherwise. Figure 3.2 shows the evolution of consumer prices
and trade-weighted external prices at the current exchange rate.) Once
the real-effective exchange rate reached its appropriate level, however,
domestic inflation would presumably slow to the-world inflation rate.
Although anticipated, the price-level rise had several troubling conse-
quences. First, relative-price adjustment was uneven over the price array.
In theory, only tradables prices could be expected to move rapidly to par-
ity: Nontradables prices would rise as the depreciated real-effective
exchange rate increased net exports and generated an increase in the
money supply. Except for oil derivatives, however, Ecuador's particular
exportables-agricultural commodities, some manufactures-are a lim-
ited part of consumers' consumption bundles. In the case of oil and oil-
derivative prices, the public sector maintains a monopoly on sales, and
since the authorities set the relevant domestic prices, domestic and world
prices are not directly linked. Importables prices figure more in con-
sumption bundles, directly or indirectly, but recession, exchange-rate
depreciation, and the banking crisis preceding dollarization sharply
reduced merchandise imports, turning many of the relevant goods at
least temporarily nontradable.15 In addition, formal-sector wages
remained under public-sector control. (Sectoral commissions still. set
Ecuador's formal-sector wage levels, relying heavily on a central com-
mission that sets the minimum wage.)


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS                     103
Figure 3.1. Ecuador: Monthly Trade-weighted Exchange-rate
Competitiveness, December 1994-December 2001
sucres per U.S. dollar (log)                           + = depreciation; 1990 = 100
100,000                                                                  180
160
140
*        - -120
10,000  Trade-weighted real-effective exchange rate          -           00
- - - ---  ---------                ,   '                         80
60
Nominal exchange rate
40
Dollarization announcement---              20
1,000 1  0.. . . .  . .                         1 ,
  0     11 N0 N0
Source: Central Bank of Ecuador.
Figure 3.2. Ecuador: Monthly Increases in Consumer Prices,
January 1999-December 2001
Monthly percentage rate
16.0
+- Dollarization announcement
14.0
12.0
10.0
4.0  C   t   B    o E
2.01                                       \
00
Source: Central Bank of Ecuador.


104                           CRISIS AND DOLLARIZATION IN ECUADOR
Figure 3.3. Ecuador: Consumer Prices and Weighted
Trading-partner Prices at the Current Exchange Rate,
December 1997-December 2001
1990 consumer prices = 100                                    170.OD
1100                                Weighted trading-partner prices  160.00
150.00
900                                            Cnue rcs      100
Exchange - rate floated    ,Consumer prices               14000
'0  /13000
120.00
110.00
500                                        Real-effective exchange rate
100.00
300                                           90.00
4-Dollarization announcement  80.00
Source: International Monetary Fund.
The price-level increase after dollarization in Ecuador was not a
unique experience. Many former Soviet republics had similar experiences
when they established new currencies upon leaving the ruble area. Esto-
nia, for example, set up a currency board in the early 1990s with its new
national currency pegged to the German mark. The authorities found it
difficult to determine the "right" exchange rate, especially since the ruble
had depreciated sharply in the previous months, and the new currency
turned out substantially undervalued at the rate chosen. Although Esto-
nia's currency board complied closely with textbook rules, the initial
undervaluation led to annual price-level increases on the order of 15 per-
cent for several years until parity was reached.
By mid-2001, the price-level increase had moderated significantly.
There are grounds to hope that price increases will continue to be mod-
erate and inflation will tend toward world rates. This is essential if
Ecuador is to forestall further decline in its international competitiveness.
PUBLIC-SECTOR ENERGY PRICE ADJUSTMENT. Public-sector energy prices,
including electricity, motor-fuel, and cooking-gas prices, were politically
contentious, as they had been before January 2000. The government had


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS               105
frozen motor-fuel prices for 12 months in July 1999 to meet striking trans-
port workers' demands, and had held the sucre price of household cook-
ing gas fixed    since September 1998. Continuing       exchange-rate
depreciation and inflation meant that these fixed prices generated rising
subsidies amounting to several percentage points of GDP.16 Adjustment
would inevitably require compensating adjustment of wages, which had
been declining in real terms under the pressure of recession and unem-
ployment. In adjusting energy prices and formal-sector wages, the
authorities had to take account of the implications for (a) private-sector
costs and competitiveness; (b) resource allocation-among other consid-
erations, cross-border oil derivative price differences give rise to dis-
torted border trade; (c) income distribution; (d) public finances, since
energy prices determined revenue while wages determined expenditure;
(e) the finances of the public enterprises; and (f) political constraints,
since energy prices had figured heavily in social protest. The "inflation-
feedback" consequences of price and wage increases were an additional
complicating issue.
Table 3.4. Ecuador: Exchange Rate (Sucres per U.S. Dollar),
Consumer Prices, and Real-effective Exchange Rate,
December 1998-December 2001
Average                      Percentage change
value                     over preceding month
Real-                            Real-
effective                       effective
exchange                         exchange
Exchange      rate    Consumer   Exchange     rate   Consumer
rate   (1990 = 100)17  prices    rate   (1990 = 100) prices
Dec-98   6,595.9       79.0      279.2       2.4        1.9       0.7
Jan-99   7,133.1       82.5      288.1       8.1        4.4       3.2
Feb-99   7,807.3       86.4      295.8       9.5        4.8       2.7
Mar-99  10,754.3      104.4      335.7      37.7       20.8      13.5
Apr-99   9,430.0       87.5      354.3     -12.3      -16.2       5.5
May-99   8,969.0       82.3      357.4      -4.9       -5.8       0.9
Jun-99  10,923.2       98.0      363.8      21.8       19.0       1.8
Jul-99  11,723.0      101.9      374.9       7.3        4.0       3.1
Aug-99   11,197.2      97.9      376.9      -4.5       -3.9       0.5
Sep-99   12,116.5     104.7      383.5       8.2        6.9       1.8
Oct-99  15,656.8      130.4      399.5      29.2       24.5      4.2
Nov-99  17,525.5      137.1      425.0      11.9        5.2       6.4
(Table continues on the following page.)


106                          CRISIS AND DOLLARIZATION IN ECUADOR
Table 3.4. (continued)
Average                    Percentage change
value                    over preceding month
Real-                          Real-
effective                     effective
exchange                       exchange
Exchange     rate    Consumer   Exchange   rate    Consumer
rate  (1990 = 100)17  prices   rate   (1990 = 100) prices
Dec-99  18,205.8    135.2      448.7      3.9       -1.4      5.6
Jan-00  24,761.0     161.2     513.0      36.0      19.3     14.3
Feb-00  25,000.0    147.8      564.4      1.0       -8.3     10.0
Mar-00 25,000.0     138.3      607.2      0.0       -6.4      7.6
Apr-00  25,000.0    125.2      669.2      0.0       -9.5     10.2
May-00 25,000.0     117.8      703.6      0.0       -5.9      5.1
Jun-00  25,000.0     113.4     741.0       0.0      -3.8      5.3
Jul-00  25,000.0     110.6     758.6       0.0      -2.4      2.4
Aug-00 25,000.0     108.4      768.9      0.0       -2.0      1.4
Sep-00  25,000.0    104.6      797.2      0.0       -3.5      3.7
Oct-00  25,000.0    101.7      818.7      0.0       -2.8      2.7
Nov-00 25,000.0      99.7      836.4       0.0      -1.9      2.2
Dec-00  25,000.0     97.6      857.0       0.0      -2.1      2.5
Jan-01  25,000.0      92.4     916.7       0.0      -5.3      7.0
Feb-01  25,000.0     89.3      943.4       0.0      -3.4      2.9
Mar-01 25,000.0      87.5      964.1       0.0      -2.0      2.2
Apr-01  25,000.0     86.1      980.7       0.0      -1.6      1.7
May-01 25,000.0      86.1      982.3       0.0      -0.1      0.2
Jun-01  25,000.0     85.8      987.0       0.0      -0.3      0.5
Jul-01  25,000.0     85.6      989.4       0.0      -0.1      0.2
Aug-01 25,000.0      85.4      993.7      '0.0      -0.3      0.4
Sep-01  25,000.0     84.0     1014.0       0.0      -1.6      2.0
Oct-01  25,000.0     82.8     1025.9      0.0       -1.3      1.2
Nov-01 25,000.0      81.6     1042.3       0.0      -1.5      1.6
Dec-01  25,000.0     80.6     1049.6       0.0      -1.2      0.7
Source: International Monetary Fund.
For the April 2000 IME stand-by program, the authorities indicated
that they would raise motor-fuel and cooking-gas prices and wages in
two steps, in May and October. In May 2000, however, reasoning that it
would be best to avoid two periods of social protest, authorities carried
out what they hoped would be the full increase, sharply increasing
motor-fuel and other oil-derivatives prices as well as public-sector
wages.'8 They decided not to increase the politically sensitive price of
cooking gas. Toward the end of May, they also raised electricity rates. The
continuing price-level increases over the remainder of 2000 reduced the


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             107
real value of adjusted prices, however. Accordingly, in January 2001 the
authorities carried out another round of price increases, this time increas-
ing motor-fuel prices by 20 to 30 percent and cooking-gas prices by 100
percent. Although the government also increased the cash transfer (the
Bono Solidario) to poorer people and authorized public-sector wage
increases on the order of 12 to 15 percent, widespread protests ensued.
The authorities negotiated an agreement with demonstration leaders,
under which they rolled back the cooking-gas price increase to 60 per-
cent, promised that motor-fuel prices would not rise for at least 12
months, and committed themselves to maintain dialogue with represen-
tatives of protesting groups.19
One reason this relative-price problem arose was that energy prices
and wages could be adjusted only in large steps at infrequent intervals as
of February 1997, when Ecuador abandoned a monthly adjustment sys-
tem because the adjustments were so large they set off street demonstra-
tions that forced the Bucaram Government from office. More frequent
adjustment would presumably have relieved the problem.20
The evolution of interest rates during the transition process has pre-
sented an additional set of concerns. Many observers have noted that
interest rates remained well below the rate of price-level increase pre-
vailing during 2000. In this sense, real rates have been "negative." Even
so, deposit rates remained well above rates available outside Ecuador.
With the economy still in recession, and banks circumspect about lend-
ing, it was only to be expected that banks would want to attract no more
than a limited stock of additional deposits. For this purpose, relatively
low deposit rates would be appropriate. As growth prospects improved,
interest rates would likely edge higher as commercial banks received
attractive lending propositions. Bank-deposit rates could be expected to
remain above international levels, however, as long as Ecuador and its
banks continued to be perceived as risky. The risk premium can be
expected to remain large until the banking system becomes more "inter-
nationalized" (see section 8 below).
CoIN SHORTAGES, COUNTERFEITING, AND OTHER "PRACTICAL" ISSUES. The
dollarization transition brought some practical inconveniences. Counter-
feiting has been a problem-by its nature it is impossible to know how
significant. The introduction of small coins only began in September
2000, although a large part of the sucre stock, including smaller-value
bills, had already been withdrawn from circulation. The shortage of
small-denomination coins caused inconvenience at that time for small
transactions. Fiscal and time constraints made it, impossible for the
authorities to carry out an adequate public information campaign, and
some confusion and scams involving conversion rates took place. Dollar


108                          CRISIS AND DOLLARIZATION IN ECUADOR
currency caused difficulties for illiterate people, who had relied on bill
colors to distinguish currency of different denominations. By the end of
2000, however, dollar currency was well on its way to being a normal,
accepted fact of life, much as in Panama.
7. Ecuador's Macroeconomic Performance under
Dollarization in 2000 and 2001
In 1998 and 1999 Ecuador had slid into one of the deepest economic crises
in its history, encompassing deep recession, a severe banking crisis, and
incipient hyperinflation (see chapter 2). During 2000, the economy con-
tinued to perform below potential and living standards were severely
affected, but macroeconomic developments were generally helpful for
the transition to dollarization. The immediate danger of the transition
was that the banking, fiscal, and external accounts would require more
financing than allowed by the constraints of the dollarization regime and
external credit availability. The banking sector was especially endangered
because of the deposit unfreezing, but, as explained in section 6, unman-
ageable deposit withdrawals were successfully prevented. High oil-
export prices, sharply reduced imports, the authorities' success in
securing external-debt relief, and public-sector wage compression limited
the fiscal and external financing needs. During the first two quarters of
2001 real GDP began to recover. The price-level rise moderated during
2001, as domestic prices moved toward parity levels: Consumer prices
rose 37.7 percent during 2001, compared with 96.1 percent during 2000.
The favorable conditions enabled Ecuador to successfully complete the
IMF program it began in April 2000: The final tranche of the program was
disbursed in December 2001.
Ecuador cannot rely on favorable external circumstances in the future,
of course. Indeed, several worrisome developments took place toward
the end of 2001. World recession and declining world oil prices began
reducing merchandise exports, while the appreciating exchange rate and
the economy's recovery stimulated imports. Declining world oil prices
began affecting public finances, which still depend excessively on oil
earnings.21
Figure 3.4 shows the quarterly evolution of real GDP over the course
of the crisis, notably the sharp drop in 1999 and the subsequent slow
recovery. Real GDP grew 1.9 percent in 2000, with an uneven sectoral dis-
tribution. Agriculture and fishing declined by more than 5 percent, while
oil, manufacturing, commerce, and transport all grew around 5 percent.
Activity levels were still significantly below their 1998 averages in the
fourth quarter of 2000, with the exception of the oil, electricity, and con-
struction sectors. Economic recovery began in the second quarter of 2000


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS           109
Figure 3.4. Ecuador: Quarterly Real GDP (1998 average =100),
1997.4-2001.4
1998 quarterly average = 100
105
100
95 J
90
85
80 t                                  _
4   1  2   3   4  1   2   3   4  1   2  3   4   1  2   3  4
1997 -   1998 -     -   1999 -    -   2000 -     -   2001
Quarterly, 1997-2001
Source: Central Bank of Ecuador.
and continued through the first half of 2001. By the second half of 2001
real GDP had risen above its 1998 level. The overall real growth rate for
2001 was 5.4 percent.
The fiscal accounts improved significantly in 2000. Following deficits
of about 6 percent of GDP in 1998 and 1999, the overall 2000 public sur-
plus was about 0.5 percent of GDP.22 (The IMF program as approved in
April 2000 called for an overall nonfinancial public deficit of 3.9 percent
of GDP for the year.) Figures 3.5 and 3.6 show the basic sources of the
improved fiscal performance during 2000 and the first half of 2001. Oil-
export revenue exceeded US$1.1 billion in 2000, compared with just
under US$250 million in 1998 and US$673 million in 1999. Measured in
U.S. dollars, overall staff remuneration was 56 percent lower in 2000 than
in 1998, essentially because of the sharply depreciated exchange rate at
which dollarization commenced. Oil-export earnings accounted for 29
percent of total 2000 revenue, compared with just over 6 percent in 1998.
The overall nonfinancial public-sector quarterly surplus averaged just
under US$15 million in 2000, compared with deficits of US$300 million in
1998. During the first two quarters of 2001, oil-export revenues remained
steady, while domestic tax revenues strengthened impressively, as a con-
sequence of recovering output and improved administration. Figure 3.6


Figure 3.5. Ecuador: Quarterly Nonfinancial Public-sector Revenue (US$ million), 1998.2-2001.4
US$ million
1,400
Dollarization announcement
1,200
1,000
800--
600
400
200
0
-200    2     3    4      1     2     3     4     1      2     3     4     1     2     3     4
-   1998 -                1999                     2000                    2001
Quarterly, 1998-2001
* Public enterprise operating surplus M Non-oil external-source revenue
M Oil -export revenue              E3 Non-oil domestic -source revenue
i Oil revenue from domestic sales
Source: Central Bank of Ecuador.


Figure 3.6. Ecuador: Quarterly Nonfinancial Public-sector Expenditure (US$ million), 1998.2-2001.4
US$ million
1,600
:- Dollarization announcement
1,400
1,200-
1,000 -
-   600
400
200
0
2      3    4      1     2      3     4      1     2    3      4      1     2      3     4
_1998-             -      1999                      2000 -                   2001 -
Quarterly, 1998-2001
M Capital expenditure M Other government current expendituie
E3 Domestic interest  E9 Government staff remuneration
[. External interest
Source: Central Bank of Ecuador.


112                           CRISIS AND DOLLARIZATION IN ECUADOR
shows the striking decline in public-sector staff remuneration during
1999 and 2000, and the partial recovery beginning in the second half of
2000 as the price-level increase moderated. Government staff remunera-
tion was nearly 27 percent lower in U.S.-dollar terms during 2000 than in
1999. Capital expenditure, already insufficient for Ecuador's needs, was
35 percent lower in 2000 than in 1999.
Figure 3.7 shows the quarterly performance of the main components of
the current account of the balance of payments over the three years 1998,
1999, and 2000 (foreign-exchange inflow accounts are above and outflow
accounts are below the horizontal axis). The quarterly current-account
surpluses averaged US$239 million and US$348 million in 1999 and 2000,
respectively, compared with quarterly deficits averaging US$543 million
in 1998. Oil exports were 164 percent higher in 2000 than in 1998. Despite
the competitive exchange rate, non-oil merchandise exports were 27 per-
cent lower in 2000. This was partly the consequence of sector-specific dif-
ficulties, including disease in the shrimp sector and market-access
problems for bananas. The sharply reduced availability of export credit
also played a role. Merchandise imports were 46 and 33 percent lower in
1999 and 2000, respectively, than in 1998, as a consequence of recession,
lack of bank credit, and exchange-rate depreciation (see chapter 2). In
2001, however, the current-account surplus diminished and actually slid
into deficit in the second quarter. Merchandise imports were 61 percent
higher in the first half of 2001 than in the corresponding period of 2000.
Capital imports were particularly strong as capital formation revived. One
striking positive contributor to the current-account performance was pri-
vate transfer receipts. Recession induced many Ecuadorans to seek work
abroad, and their remittances were substantial: Private transfer receipts
were 1.9 and 2.2 percent of GDP in 1996 and 1997, but rose to 4.3 percent
in 1998 and then 8.4 and 8.6 percent, respectively, in 1999 and 2000.
After the deposit unfreezing, the banking system settled into rough
stability during the latter half of 2000. Total deposits rose about 25 per-
cent over the course of the year, although bank credit remained essen-
tially dormant. The banks implemented the program to restructure
"small" (under US$50,000) nonperforming loans to households, but
made little progress on restructuring of larger loans. In February 2001 the
banks launched a new version of the loan-restructuring program for
larger borrowers, with better results. The banks continued to lose exter-
nal credit lines: In April 2001 the amounts available were only US$645
million, compared with about US$2.5 billion in mid-1998. The authorities
took several steps toward the end of 2000 to encourage commercial-bank
credit operations. Legislation approved in September 2000 amended the
calculation of the usury interest rate ceiling, setting it at, rather than "up
to," 1.5 times the Central Bank's "reference rate" (an average of rates on


Figure 3.7. Ecuador: Quarterly Performance of the Main Components of the Current Account of the
Balance of Payments (US$ million), 1998.1-2001.4
US$ million
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
-200
-400
-600
-800
-1,000
-1,200
-1,400
-1,600                  Dollarization announcement -+
-1,800
1     2     3    4     1    2     3    4     1    2     3     4     1    2     3    4
- 1998 -              -      1999 -          -      2000 -          -       2001
Quarterly, 1998-2001
Ef Oil exports               G Merchandise imports
0 Other merchandise exports  U Interest due
U Other current-account items
Source: Central Bank of Ecuador.


114                          CRISIS AND DOLLARIZATION IN ECUADOR
new commercial-bank loans). Moreover, in November 2000 the banking
authorities eliminated-a ceiling on fees that banks could change borrow-
ers in lieu of interest, and removed a requirement that banks make pro-
visions on loans carrying interest rates higher than 18 percent. In
December 2000 the government, transferred US$137 million to the
Deposit Insurance Agency,to enable it to make payments to insured
depositors. In January 2001 the Central Government on-lent funds from
the CAF to augment the resources of. the bank liquidity fund, and made
the Central Bank's liquidity recycling facility fully operational. These
changes persuaded the banks to increase lending in early 2001, con-
tributing to the recovery. The,banking authorities found it difficult, how-
ever, to progress on the processes of reorganizing the banks that had
failed and of selling the banks' assets they had acquired. In mid-2001
Ecuador's largest, bank (Guayaquil-based Filanbanco), which had been
under public stewardship since December 1998, failed, despite the
lengthy and expensive effort to keep it going.
During 2000, the government secured external loans to help build up
the Central Bank's foreign-exchange base.23 Dollarization and the pas-
sage of the Economic Transformation Law helped secure support from
multilateral institutions.24 As noted above, in March 2000 the IMF, World
Bank, IDB, and CAF issued a joint statement promising support amount-
ing to just over US$2 billion through 2002. In April 2000, Ecuador secured
a 12-month, US$304 million stand-by arrangement with the IMF, with the
first of six scheduled tranches. released immediately. The IDB disbursed
tranches of several sectoral adjustment loans originally approved in 1994
but delayed for various reasons. In June the World Bank approved a
US$150 million structural-adjustment loan covering a broad range of
structural reform, including comprehensive tax reform, public-sector
financial management, financial-sector reform, and social-sector expendi-
ture protection (although the initial disbursement was delayed by nearly
one year by delays in meeting the conditionality).
The strong external-accounts performance enabled Ecuador to accu-
mulate foreign exchange over 2000. The IMF program international-
reserve targets were set on the basis of "excess freely disposable net
international reserves," that is, foreign-exchange holdings net of amounts
backing coin issue and bank reserves-namely, foreign-exchange hold-
ings under the Central Bank's third account. At the end of December 2000
these amounted to US$919 million, an increase from US$141 million as of
March 10, 2000 (see table 3.3). Together with the positive effects of oil
earnings on public finances, this enabled Ecuador to meet its program
performance targets easily enough. Nevertheless, in the second half of
2000, the IMF held up disbursements because strained relations between
the government and the Congress delayed structural-reform efforts. In


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS          115
September the president approved an Investment Promotion and Citizen
Participation Law, follow-up legislation to the Economic Transformation
Law, incorporating provisions to advance the privatization process and
eliminating the financial transactions tax in -effect since January 1999.
Because this legislation had been submitted on an emergency basis, the
president was able to approve it even though.the Congress, closed by a
dispute among its parties, never even 'debated it. In October, the
reopened Congress approved legislation adjusting several aspects of the
legislation, but introduced so many changes that the president felt com-
pelled to veto it. Because of the frayed relations with the Congress, the
government delayed submitting tax-reform legislation to the Congress.
When it finally did so, early in 2001, the Congress rejected key aspects of
the proposed changes. The legislation approved in May 2001 did, how-
ever, approve elimination of many nuisance taxes, an increase in the
income tax thresholds, and an increase in the VAT rate from 12 to 14 per-
cent. The Constitutional Tribunal subsequently struck down the VAT tax
increase, however.
During 2000, the government took two important actions to help
relieve the external-debt burden. The first was the bond exchange con-
cluded in August 2000 with holders of Brady and Euro bonds. Just after
September 1999, when Ecuador defaulted on interest payments; govern-
ment officials held several meetings with selected bondholder represen-
tatives. These meetings made little progress, however, essentially because
bondholder representatives believed no agreement was possible that they
could endorse as credible. In July 2000, however, Ecuador made a direct
offer to its bondholders to exchange new 12- and 30-year bonds for the
Brady and Euro bonds at 60 cents on the dollar. Although concerned
about the precedent (eventual Argentine default seemed quite possible
even then), bondholders accounting for 97 percent of the bonds accepted,
and as a consequence the debt in bonds fell from US$6.5 billion to US$3.9
billion. The government's second action was a new Paris Club agreement,
reached in September 2000. Although it included no debt reduction, it did
provide for rescheduling of US$800 million in principal and interest
arrears accumulated since 1995 and capital and interest falling due
through April 2001. With overall public debt at about US$11.5 billion fol-
lowing the bond exchange, compared with a GDP of approximately
US$13.6 billion, Ecuador's public debt remains debilitatingly high. The
US$2.2 billion in new lending during 2000, 2001, and 2002 promised by
multilateral institutions in March 2000 is only slightly smaller than the
US$2.6 billion debt reduction achieved through the bond exchange.
Ecuador's macroeconomic performance improved significantly in
2001. The January 2001 energy-price adjustments contributed to inflation
of about 7 percent for that month, but thereafter monthly inflation rates


116                          CRISIS AND DOLLARIZATION IN ECUADOR
were below 2 percent. For the year as a whole the inflation rate was 37.7
percent, suggesting that convergence to parity, hence low inflation, was
imminent. Moreover, real GDP recovered fairly vigorously, especially in
the first half of the year. Reviving real growth brought about an increase
in bank deposits, and this permitted commercial banks to resume lend-
ing. Capital-goods imports rose significantly as capital formation began
to revive, and unemployment moderated. Construction commenced on
a second Trans-Andean pipeline, which will allow for a doubling of oil
exports beginning sometime in 2003. Reviving real activity helped sus-
tain public revenue, even though oil-export revenue declined somewhat.
For 2001, real growth was about 5.4 percent (one of Latin America's
highest growth rates that year), while consumer prices rose only 22.5
percent.
In May 2001, after several months' delay, the IMF approved dis-
bursement under the April 2000 stand-by arrangement, following the
progress on tax reform and banking-sector restructuring. In December
2001 the IMF approved the final disbursement. During the second half
of 2001, however, as noted above,-there were some worrisome develop-
ments. After steadying in the first half of the year, world oil prices
began falling as industrial economies slid into recession. Ecuador's
other commodity exports, including bananas and shrimp, continued to
perform sluggishly. At the same time, Ecuador's recovering real GDP
and the steady real-effective exchange-rate appreciation encouraged
imports. As a consequence, the trade surplus prevailing since the start
of 1999 narrowed, and went into deficit in the middle of 2001 (see fig-
ure 3.8). The import surge partly reflected construction of the new
Trans-Andean pipeline. Furthermore, declining world interest rates can
be expected to relieve the debt service on floating-rate debt. (Each per-
centage-point change in LIBOR amounted to about US$80 million per
year, or about 0.5 percent of GDP, in the current-account balance. Each
dollar per barrel in the price of crude oil amounted to about US$100
million per year, or about 0.6 percent of GDP.) The declining oil prices
showed nevertheless, once again, that Ecuador remained vulnerable. It
now had an appreciated exchange rate over which policymakers could
exercise very little control.
In summary, in 2000 Ecuador's real economy continued to perform
poorly and the price-level increase resulting from the severely underval-
ued exchange rate was a major problem; macroeconomic conditions, on
the other hand, were relatively favorable to the transition to dollarization.
The high oil-export price and low growth rate helped reduce the amounts
needed to close the fiscal and external accounts, enabling the Central
Bank to build up its foreign-exchange holdings. On the other hand, in
2001 domestic prices decelerated sharply, while real GDP recovered from


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS             117
Figure 3.8. Ecuador: Monthly Merchandise Trade and Real-
effective Exchange Rate (December 1996-October 2001)
US$ million                                    1990 = 100; + = depreciation
500                                                             240
450                                         Merchandise exports  220
400                7'^                       " .'               200
350                                                             180
160
250                                            / Merchandise imports 140
200
150                                                             120
100                                      Real- effective        100
50                                      exchange rate          80
0                                                              60
'C 'C 'C '  N  r"  N  N  00  c  00  00  ON  ON  aN  ON  CD  CD  C  0   - .
-.<  )-<      U-<       U-<       U-<       0   <    0
December 1996- December 2001
Source: International Monetary Fund, Central Bank of Ecuador.
its deep recession. Toward the end of the year, however, declining oil
prices, the appreciating real-effective exchange rate, and the widening
current-account deficit brought back some uncertainties about the longer
term, particularly in the context of Argentina's collapse.25
8. The Longer Term under Dollarization
Ecuadorans and foreign observers are inevitably asking whether
Ecuador's economy is likely to evolve more like Panama's or Argentina's
in the coming years. Section 3 analyzed Panama's dollarized systems,
which enabled it to maintain stable prices and to grow through commer-
cial and financial development and integration. In contrast, in section 4,
we see that convertibility-a hard fixed-exchange rate quite similar to
Ecuador's-helped bring Argentina to disaster.
At this writing (early 2002), with Argentina in acute crisis, it is not
unreasonable to be pessimistic where Ecuador is concerned, since its
economy appears to have strong parallels with Argentina's and striking
contrasts with Panama's. Ecuador's real-effective exchange rate could
well continue appreciating, even after its inflation rate converges to
world rates, just as Argentina's did. Ecuador's exchange rate is even
more firmly tethered to the U.S. dollar than Argentina's was. As in
Argentina, recession could result. Moreover, despite the substantial relief
secured in 2000, Ecuador's public-debt burden remains huge, and its


118                           CRISIS AND DOLLARIZATION IN ECUADOR
external borrowing capacity will now be restricted. As in Argentina, pol-
icymakers will be under intense pressure to maintain a tight fiscal stance,
to limit the.growth of the public debt.
Unlike Panama, whose financial system is strong and well-integrated
with world financial markets, Ecuador's financial system is still troubled,
and largely cut off from world financial markets. Ecuador remains vul-
nerable - to the world's volatile primary commodity export markets,
unlike Panama, whose service exports are far more stable. This is a cru-
cial distinction between the two economies.
Nevertheless, it is by no means certain that Ecuador will simply repeat
Argentina's history Argentina's real-effective exchange rate appreciated
sharply because it was tied to the appreciating U.S. dollar, and was espe-
cially hard hit by the depreciation of Brazil's currency in 1999. A favor-
able scenario for Ecuador would include a further international
depreciation of the dollar and a rise in world oil prices over the medium
term. In any case, investment in various export sectors should enable
Ecuador to increase exports in various sectors, and the crude-oil export
volume could roughly double in 2003 or 2004, when the new pipeline
now under construction comes on ling.26
Dollarization does not change the reality that Ecuador's economy
depends heavily on circumstances beyond its control. Even so, the
stronger the quality of government policy-both day-to-day fiscal man-
agement and structural reform-the more Ecuador will benefit from
good times and the less vulnerable it will be to bad times. Further
progress on liberalizing structural reform is crucial to reduce the econ-
omy's vulnerability, particularly its exposure to world oil uncertainties.
Structural reforms that would address this objective include (a) integral
tax reform, both to reduce the dependency of public revenue on oil and
to stabilize non-oil revenue; (b) full implementation of an oil-revenue sta-
bilization mechanism; and (c) resumption of frequent adjustment of
prices of domestic oil derivatives-with "capping," as appropriate. In
addition-since anything that improves the economy's efficiency
improves the likelihood that dollarization will succeed-policymakers
must still see to (d) improved management and organization of public-
sector staff and expenditure programs; (e) modernization of legal and
technical systems for budget planning and execution; (f) improvement of
public capital formation and maintenance; (g) completion of the privati-
zation processes in telecommunications, electric power, and hydrocar-
bons; (h) modernization of the social-security system; and (i)
development of politically, administratively, and fiscally viable decen-
tralization structures.
Outside the nonfinancial public sector per se, the financial system
remains the most urgent sector for structural reform. In broad terms,


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS           119
Ecuador must accomplish three objectives in this sector. One is to com-
plete the banking-system "workout" process, to divest the nonperform-
ing assets and restore the financial system to soundness in the wake of the
banking crisis. The second is to strengthen banking supervision, to
ensure that banks henceforth operate safely or, at least, that problems are
rapidly detected and resolved.
The third is to find ways to deal with the reality that banks working in
Ecuador are, perforce, exposed to Ecuador's high risks. Because most of
Ecuador's economic sectors present significant risks, commercial-bank
loan portfolios, hence banks themselves, are riskier than those of other
economies. Depositors can be expected therefore to seek risk premia on
deposit rates. They will also seek banks with relatively high capitaliza-
tion levels, obliging them to operate with high intermediation costs on
top of high funding costs. Borrowers will then face relatively high fund-
ing costs, which could place limits on longer-term economic growth.
Even the best kind of structural reform in the financial sector-and, in
particular, vigorous, high-quality banking supervision-can help relieve,
but not entirely solve, this problem. Banking can be expected to remain a
higher-risk, higher-cost business in Ecuador than elsewhere for some
time to come.
One approach would be to find ways to "dilute" the risk of loan
portfolios concentrated in Ecuador into larger, "world-dimension"
capital bases. There are several possible means. One would be to per-
suade Ecuadoran financial institutions to purchase explicit or implicit
"insurance" from foreign entities to cover the risks to which their port-
folios are exposed. Alternatively, by acquiring shares in Ecuadoran
banks, foreign banks would effectivIly place their large capital bases
behind Ecuadoran risk. The added safety should persuade depositors
to accept lower interest rates, and banks' Ecuadoran funding costs
should diminish. In return, the foreign banks would seek relatively
high intermediation spreads, to generate profits to compensate them
for bearing Ecuadoran risk and to help fund their capital bases in
readiness for Ecuadoran contingencies. This is consistent with the
argument discussed above , that dollarization will help financial inte-
gration over time, and that this integration should in itself provide sig-
nificant benefits.
Finally, there are at least two additional sectors in which a significant
structural-reform agenda remains. Ecuador has maintained a highly
inflexible system of labor legislation and an anachronistic, centralized
system of formal-sector wage determination. The dollarization legislation
allows for hoirly work contracts within the formal labor system, and also
provides for the "unification" of wages, relieving the long-standing prob-
lem caused by requirements that public and formal private wage pay-


120                          CRISIS AND DOLLARIZATION IN ECUADOR
ments comprise a large number of closely regulated components. Lastly,
the common Andean tariff retains an anchronistic structure favoring
inputs over final goods, reducing the favorable impact of the substantial
trade reform and domestic price liberalization implemented in the late
1980s and early 1990.
9. Conclusions
Since the early 1990s, many macroeconomists have been persuaded that
certain countries would be best advised to implement currency-board
arrangements and even dollarization. The experiences of Panama as well
as Estonia and some Eastern European economies suggest that these can
be effective reforms, not only for exchange-rate and price-level stabiliza-
tion, but also for establishing confidence in central banks and in macro-
economic policymaking institutions more generally
All the same, currency-board arrangements and dollarization should
never induce complacency. As Argentina's recent experience shows, a
real-effective exchange rate stuck at a highly appreciated value can con-
tribute to rapid debt accumulation, possibly to the point of leading to
severe fiscal or balance-of-payments crises. Precisely because the
exchange rate can no longer be adjusted and the central bank's capacity
to create money is severely curtailed, there is a heightened danger that
adverse exogenous events could push the fiscal and external accounts
into deepening deficit, and to this extent require more new debt than they
otherwise would. This is a troubling concern for any economy that is
already heavily indebted, such as Ecuador.
During 2000, high oil-export prices and external support helped
Ecuador make a fairly smooth transition to dollarization. The most wor-
risome transition concern-the unfreezing of time deposits-came off
far better than many observers feared. The undervalued exchange rate at
which dollarization was launched, however, induced a sharp rise in the
price level during the year, raising concerns about the adjustment of the
cost and price structure. Once the price-level increase has run its course
to parity, the inflation rate should stabilize at world levels. The real-
effective exchange rate may then no longer be as competitive as Ecuador
needs. As in Argentina, that would become a problem. It is important to
stress, in any case, that the fiscal and external accounts will still be as
dependent as ever on volatile world oil prices. Price stability should
encourage investment, but it can by no means be regarded as sufficient.
Ecuador's external-debt burden remains high. The economy remains
highly vulnerable to contingencies and further structural reform in the
public sector and the financial system is essential.


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS                 121
Notes
1. During the 1994-95 "Tequila" episode, interest rates were lower and credit
was more abundant in Argentina, which had been operating under a convertibil-
ity system since April 1991, than in Mexico. Unlike Mexican banks, Argentine
banks were not weakened by exchange-rate depreciation. As a consequence,
despite its relatively rigid labor laws, Argentina recovered more rapidly than
Mexico, which had devalued heavily.
2. U.S. Senator Connie Mack has argued that the United States should share
seigniorage with countries adopting the dollar.
3. This section draws on Moreno Villalaz' analyses of the Panamanian mone-
tary system (1997, 1999a, 1999b.
4. Argentina's recent banking crisis illustrates the point in a different way.
Under its convertibility rules, Argentina's Central Bank's money-creation capaci-
ty was restricted, but it could and did borrow dollars abroad and used the pro-
ceeds as a lender of last resort.
5. From the time it was drafted, the Ecuadoran media have referred to this law
as the "Trolleybus Law," that is, more all-encompassing than an "omnibus" law.
6. The sucre retains a de jure legal status under the Constitution, partly because
amending the Constitution would have been too contentious and lengthy a
process.
7. This difference may not matter much in practical terms, however. For exam-
ple, Argentina's Central Bank knows the full amount of the peso monetary base,
but a significant stock of dollar currency circulates in Argentina, and the Central
Bank can only guess the magnitude at any moment.
8. This was because the more depreciated conversion rate meant that any sucre-
denominated Central Bank liability became a smaller dollar amount.
9. The problem may be understood as follows. Suppose two parties negotiate a
contract under which one is to pay the other 200 pesos after one month, on the
assumption that the price level will double over the month. Suppose that the fol-
lowing day a currency reform takes place that makes it more appropriate to
assume that prices would remain stable over the month. It would then be appro-
priate to revise the contract, reducing the amount to be paid from 200 to 100
pesos. Under the stability assumption 100 pesos would have the same purchas-
ing power as 200 pesos under the inflation assumption. In reality, of course,
assumptions about future inflation rates are never formulated so explicitly nor
held with so high a degree of certainty. Contract revisions accompanying curren-
cy reforms tend, accordingly, to be complex, and often produce confusion and
resentment, since people affected may feel that they lost significantly.
10. For all such contracts extant on or after January 11, rates were reduced to
16.82 percent for assets and 9.35 percent for liabilities (contracts already at lower
rates retained their original rates).


122                             CRISIS AND DOLLARIZATION IN ECUADOR
11. Government officials argued, in effect, that unless Congress approved politi-
cally unpopular structural-reform measures, dollarization ran a high risk of failure.
12. This new law was called the "second Trolleybus Law."
13. In late 1996 and 1997, when the Bucaram Government announced plans to
move to full convertibility, many observers made a similar argument, that the
continuing need for inflationary finance would make it impossible. This argu-
ment carried considerable weight at that time. It carried less weight in January
2000 because by that time, regardless of the need for inflationary finance, the
demand for money was plunging.
14. This may have been for the best, because the Treasury bond issue would
have amounted to 3 to 5 percentage points of GDP, a substantial increase in
domestic Tieasury debt outstanding. Some observers noted that the authorities
would come under pressure to forgive the banks' obligations to the Treasury, in
which case the Treasury would take losses, since it would still have to service the
bonds.
15. The main categories of the consumer price index (and their respective per-
centage weights) are food, beverages, and tobacco products (32.1); apparel (11.2);
rent, water, and electricity (11.7); furniture and house maintenance (6.8); health
(3.4); transport (9.8); recreation and culture (3.7); education (4.8); hotels and cafe-
terias (11.9); and miscellany (4.6).
16. These subsidies were financed through forgone government tax revenues and
decapitalization of the state-owned hydrocarbons monopoly and electricity firms.
17. Higher values indicate real-effective depreciation. Real-effective values are
estimated by the writers from Ecuadoran and trading-partner exchange-rate and
price-index data.
18. Motor-fuel prices rose 60 to 80 percent and prices of jet fuel and oil deriva-
tives used in industrial applications rose 300 percent. Public-sector wages rose
between 48 and 70 percent and the Bono Solidario (the monthly stipend provided
to mothers of poorer families since September 1998) rose 75 percent.
19. Once domestic prices reached the parity level, another kind of relative-price
problem could be anticipated: Costs and wages could overshoot. Wages might
overshoot because it is impossible to know for sure when price-level parity has
been reached. Even when this actually happened, people might still anticipate
prices would continue rising. Labor unions might argue, for example, that their
pay must reflect a likelihood of further price-level increases at rates recently expe-
rienced. To the extent such overshooting took place in the public sector, it could
lead to increased demand for public-sector and external financing. To the extent
this took place in the private sector, exports would become less competitive, and
the current account of the balance of payments would slide into deeper deficit. In
addition, the disincentive effects of the appreciating exchange rate would damp-
en economic recovery.
20. Under any adjustment system aiming to maintain parity of world and domes-
tic oil-derivative prices, with exchange-rate variation eliminated, world oil-price


ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS                 123
volatility would be the largest cause of domestic price volatility. The best, or least
bad, solution to this problem would probably be to return to monthly adjustments,
but with "capping," to smooth the disrupting effects of very large increases (and
decreases). For example, if export prices surged, the domestic-price increase could
be spaced over several months. Symmetrically, however, if export prices plunged,
the domestic-price reduction could be spaced over several months.
21. One favorable development, however, has been declining world interest
rates, which will reduce the interest due on Ecuador's floating-rate debt.
22. Higher oil-export revenue in 2000 more than offset reductions in other rev-
enue categories, including earnings from domestic sales of oil derivatives, which
were affected by the 12-month price freeze that began in July 1999, and external-
trade revenues, which were affected by the sharp reduction in imports. The over-
all primary (noninterest) 2000 public surplus was approximately 9 percent of
GDP (compared with a programming target of 5.5 percent in the IMF program),
one of the highest levels Ecuador had ever recorded.
23. Funds borrowed by the Central Bank from the IMF increase both the Central
Bank's foreign-exchange reserves and its liabilities to the IMF. Funds borrowed
by the government from multilateral institutions are deposited by the govern-
ment in its Central Bank account, and so also increase the Central Bank's foreign-
exchange balances, but increase the government's-not the Central Bank's-for-
eign-exchange liabilities.
24. The IMF had been criticized within and outside Ecuador for its presumable
failure to provide support to the Mahuad Government when it was under intense
political pressure.
25. Ecuador's macroeconomic performance has come under some pressure since
the beginning of 2002. Although the economy has continued recovering from its
recession and inflation is still low (although still above world levels), the public
accounts have come under stress, particularly since the government decided
against raising politically sensitive public energy and communications prices.
The government has been discussing a new program with the IMF, but has not
yet secured agreement.
26. The new pipeline will have a capacity of 450,000 barrels per day, compared
with the present pipeline's 385,000 barrels per day. When complete, it is expected
to add about 1.5 percent of GDP to public-sector earnings.
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124                           CRISIS AND DOLLARIZATION IN ECUADOR
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4
Ecuador: Crisis, Poverty, and
Social Protection
Suhas Parandekar, Rob Vos, and Donald Winkler
1. Introduction
Ecuador's economic crisis of 1998-99 and its move to full dollarization in
early 2000 took place in a context of high poverty and income inequal-
ity-exposing the poor to the risk of irreversible losses. The constraints
on public expenditure have set tight limits on the ability of the Ecuado-
ran government to protect the poor and have threatened the delivery of
basic social services. This chapter updates our understanding of
Ecuador's poverty, especially as it concerns the human capital of the
poor; evaluates the government's policy framework for protecting the
poor in times of crisis; and discusses policy options for improving that
framework.
Poverty and inequality had already been intensifying before Ecuador
entered its predollarization crisis in early 1998. An armed border conflict
with Peru and the resignation of the vice president in 1995 marked the
beginning of a period of political instability and slippage in the macro-
economic stabilization efforts (Vos 2000a). While in the early 1990s stabi-
lization policies helped generate important reductions in urban income
poverty, the subsequent fiscal expansion led to mounting inflationary
pressures and purchasing power losses for many Ecuadorans. The El
Nifho weather shock in 1997-98 and falling oil prices (the country's major
export item) in 1998 brought the economy down. The ensuing currency
and full-blown banking, crisis led to an economic collapse, with GDP per
capita falling by more than 9 percent in 1999. Poverty and inequality
increased substantially during the crisis. The poverty headcount
Suhas Parandekar is an Education Economist at the World Bank. Rob Vos is
Deputy Rector and Professor of Finance and Development at the Institute of
Social Studies, The Hague, and Professor of Economics at the Free University of
Amsterdam. Donald Winkler is consultant to the World Bank and Visiting Fellow
at the Proyecto de Reforma de Educaci6n para America Latina (PREAL),
Santiago, Chile.
127


128                          CRISIS AND DOLLARIZATION IN ECUADOR
increased by 12 percentage points between 1995 and 1998 and by another
9 percentage points during 1999. The Gini coefficient of income inequal-
ity increased from 0.52 to 0.54 during the same period.' The bottom quin-
tile's share of total consumption decreased from 5.3 percent in 1995 to 5.0
percent in 1999.2 Using a consumption-based poverty measure for 1999,
the extreme poor-those who fall below the food poverty line-
accounted for 20 percent of the total population, or 2.2 million people,
and the poor accounted for 55 percent of the population, or 5.9 million
people.
The effects of the crisis on human development, especially that of
pregnant women and young children, may be permanent. One-quarter of
all preschool children in Ecuador have stunted growth, defined as the
height-for-age ratio being two or more standard deviations below the ref-
erence median defined by the World Health Organization
(WHO)/National Center for Health Studies (NCHS)/Centers for Disease
Control (CDC). Of children in the bottom consumption quintile, 44 per-
cent are stunted. Less than 10 percent of children of poor households
complete secondary schooling. Also, children of the poor are more likely
to drop out of school to work: 30 percent of children aged 10 to 14 in the
bottom quintile do so.
Interviews with the poor show how they respond to crisis and loss of
income (CEPLAES 1999). Households are often broken up, with some
adult members migrating to find employment, or rural parents sending
children to live with relatives in urban areas to enable them to attend
school. Assets, including working tools, are sold when it is no longer pos-
sible to borrow money or to obtain credit from small storeowners. The
poor substitute food high in carbohydrates and low in nutritional value
for protein sources and fresh vegetables.
Since the government has had limited fiscal and political room to
maneuver in setting its policies, its response to the most recent macro-
econormc crisis was financially constrained and not highly effective in
offsetting the consequences of the macroeconomic deterioration. The
existing social safety net was not designed to provide additional social
security in the face of natural disasters or economic crises. Rather, social
programs have been targeted with limited coverage of prefixed popula-
tion groups. Practically no flexibility exists, budget-wise or in program
design, to expand these programs in scope or degree of protection when
they are needed more. Furthermore, during the first part of 1999 the gov-
emnment incurred salary arrears, leading to serious disruptions in the
public delivery of basic social services. Work stoppages prevented
schools and health facilities from functioning one-quarter of the time in
the first six months of 1999. Amidst all this, an innovative cash-transfer
system (the Bono Solidario) targeted to poorer households, introduced at


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                129
the end of 1998, became the backbone of Ecuador's social-protection sys-
tem during the crisis. It was not designed this way. It was introduced to
provide compensation to the poor for the elimination of the expensive,
regressive, and untargeted subsidies on cooking gas and electricity.
Mothers of poor households with young children were the main benefi-
ciaries, and by early 1999 the program: reached 1.3 million households or
a bit less than half the population. Because of targeting errors and the lim-
ited size of the transfers, the program has not had a major impact on over-
all poverty rates, but evaluations suggest that beneficiary households
have kept more children in school than they would have without the
cash-transfer benefit. The purchasing power of the cash transfer eroded
during 2000 and 2001 as a consequence of inflationary shock created by
the dollarization process. Other early responses to the crisis took the form
of an expansion of in-kind transfer programs, specifically the school
meals program and the provision of integrated early childhood care and
expanded prenatal and neonatal care. The envisaged expanded coverage
of these programs has progressed slowly, however. Various new social-
program initiatives were discussed during early stages of the crisis, but
budget restrictions and, more importantly, political indecisiveness
impeded their progress. Some, such as employment programs, never
materialized at all and others, such as an education voucher program,
were only implemented as of late 2001.
By that time, the economy was showing signs of recovery, with GDP
growing at 2.3 and 4.5 percent in 2000 and 2001, respectively, and with
open unemployment down from a peak level of 14 percent in 1999 to
around 10 percent in 2000 and 2001. Economic recovery was helped by
rising oil prices (in 2000), migration abroad of large numbers of Ecuado-
rans, and several rounds of real-wage adjustments. In addition, many
deposit holders managed to recover some of their assets from banks that
went bankrupt during the crisis. None of these, however, are elements of
a sustainable recovery. Rising revenues allowed for expansion of fiscal
spending, but with volatile oil prices fiscal tightening was back on the
agenda in 2001-02. Workers' remittances have increased substantially to
become the second-highest single source of foreign-exchange earnings
and to provide private protection to some households. The global reces-
sion that set in during the second half of 2001 has reduced employment
opportunities of Ecuadorans abroad, however. Consequently, emigration
may slow and remittances may not be as great a source of permanent
income as many Ecuadorans currently enjoy. Real minimum wages
increased by 15 percent in 2000 and stabilized during 2001, recovering an
important part-but not all-of the purchasing power lost during the cri-
sis. At the end of 2001, the real wage was 12 percent below the level
reached in late 1997. Finally, the lack of confidence in the financial system


130                          CRISIS AND DOLLARIZATION IN ECUADOR
led many households to "reinvest" their recovered bank assets in durable
consumer goods and real estate, rather than in productive or financial
assets. All these factors helped spur a small consumption boom, but signs
of a more sustainable recovery are less visible. The aggregate demand
growth did help, though, to reduce income poverty during 2000 and
2001, as urban survey data suggest (Vos and de Jong 2001).
Ecuador's vulnerability to external shocks did not disappear with the
dollarization of the economy. More likely, the real economy has become
more sensitive to the effects of such shocks without the short-term cush-
ion-albeit imperfect-that used to be provided by exchange-rate and
monetary adjustment. The need for an adequate social-protection system
remains. In the aftermath of the crisis, the Ecuadoran government has
taken measures to allow for a recovery of real social spending after severe
declines during the crisis, and it has introduced new programs, including
the educational voucher program, targeted to the poor. Overall, however,
the social safety net in many ways still suffers from the deficiencies it had
at the start of the crisis. Much more is needed to provide effective protec-
tion to the vulnerable.
This chapter aims to analyze the effects of the crisis on poverty and
human development during the crisis- and the response capacity of
Ecuador's social safety net. The remainder of the chapter is organized as
follows. Section 2 reviews the recent trends in inequality and poverty.
Section 3 discusses the identifiable groups of people that are particularly
vulnerable. Section 4 discusses Ecuador's conditions of human develop-
ment. Section 5 describes Ecuador's existing government programs
intended to address poverty and vulnerability in the short and long
term. Section 6 discusses Ecuador's capacity in future years to help the
poor to manage crises and to deepen their human-capital formation. Sec-
tion 7 discusses some of the strategic policy options available to policy-
makers.
2. Inequality and Poverty
Ecuador"s recent crises have come in a context of high poverty and
income inequality. Although Latin America as a whole has extremely
high income inequality compared with other regions of the world, espe-
cially Europe and East Asia, Ecuador's record is unenviable even within
Latin America. Moreover, unlike some other Latin American countries,
which combine high inequality with relatively high per-capita income,
Ecuador's inequality is accompanied by low per-capita income. As noted
above, Ecuador's Gini coefficient has worsened in recent years.
Table 4.1 indicates that the headcount index of extreme poverty
increased from 12 percent in 1995 to 17 percent in 1998, peaking at 21 per-


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                131
cent in 1999. A household was classified as being extremely poor if the
total consumption expenditure of the household was lower than the food
poverty line. Although the headcount index is not sensitive to changes in
the distribution of expenditures below the food poverty line, measures of
the poverty gap and poverty severity, which overcome this shortcoming,
show the same trends3 Table 4.1 shows that the poverty gap increased
between 1995 and 1999, as did the severity of poverty. The increase in the
poverty gap and severity measures indicates a worsening distribution of
consumption even within the extremely poor households below the food
poverty line.
Table 4.1 also shows that extreme poverty is much worse in rural areas
than in urban areas, across the three regions of the country. The crisis of
1998-99 seems to have hit the poorest of the poor in the rural Sierra hard-
est. More than half of the population in the Andean highlands had con-
sumption levels below the food poverty line in 1999, up from 31 and 34
percent in 1995 and 1998, respectively. The 1998 survey was conducted
amidst the El NifAo phenomenon and reflects the impact on agricultural
incomes and employment in the flood-prone areas of the coastal low-
lands (see Vos, Velasco, and de Labastida 2000). The table shows that
extreme poverty in the rural areas of the Costa region rose by 11 percent-
age points between 1995 and 1998. Recovery of agricultural production in
those areas during the latter half of 1998 and 1999 allowed for a slight
reduction in the extreme poverty rate in that area between 1998 and 1999.
Table 4.2 indicates that the headcount index of poverty increased from
34 percent in 1995 to 46 percent in 1998 and further to 56 percent toward
the third quarter of 1999. The index implies that the number of poor grew
by 2 million people between 1995 and 1999. The patterns reported in table
4.2 are similar to those reported in table 4.1 for extreme poverty. The
largest increase in poverty was among the urban poor in the Costa region,
which contributed more than half (or 11 percentage points) to the overall
poverty increase of 21 percentage points between 1995 and 1999, fol-
lowed by the rural poor of the Andean highlands, which contributed one-
third of the total increase. The urban Sierra experienced relatively little
increase in poverty between 1995 and 1998, but then experienced a 9 per-
centage-point rise during 1999. The rise in poverty in the urban Sierra
contributed about 10 percent to the overall poverty increase. The rural
Costa also contributed a share of about 10 percent to the overall poverty
increase in 1995-99, while it contributed nearly one-third of the increase
between 1995 and 1998 as a result of the impact of the El Nifio weather
shock.
Most of these trends seem to have reverted from the second half of
2000 onward. As indicated in the introduction, the dollarization process
initiated in January 2000 initially created a large inflation shock. This


132                           CRISIS AND DOLLARIZATION IN ECUADOR
Table 4.1 Extreme Povertya in Ecuador
Headcount (PO)   Poverty gap (P1)   Severity (P2)
1995   1998 1999b 1995 1998  1999b  1995  1998   1999b
National      12    17   21     3     5     6      1     2      3
Urban        4      7    9     1     2     2     0      1      1
Rural       23     30   38     6     9    13     3      4     6
Costa region  7     14   16     2     4     4      1     1      2
Urban        3      8   11     1     2     3     0      1      1
Rural       15     26   24     4     7     6     1      3     2
Sierra region  17   20   26     5     6     9      2     3      4
Urban        6     5     5     2     1     1     1      0     0
Rural       31     34   51    10    12    19     4      6     9
Orientec      15    21          4     5            1     2
Urban        9      5          2     1           0      0
Rural       17     25          4     6           2      2
a. Population below extreme poverty line (cost of minimum food basket) based
on consumption data.
b. Data for 1999 refer to the (representative) sample for the second semester of
the survey (April - September). ECV 1999 is a year-round survey conducted
between October 1998 and September 1999.
c. ECV 1999 does not have a representative sample for the Amazon region
(Oriente).
Source: Calculations from the Encuesta Condiciones de Vida (ECV) 1995, 1998, and
1999.
shock was caused by the large devaluation implied by the high conver-
sion rate at which the U.S. dollar was introduced as means of exchange,
by the lack of coins for small change, and by an upward adjustment of
domestically controlled prices (see Vos 2000b). This situation initially
caused a tremendous drop in real wages. Subsequent rounds of real-wage
adjustments allowed for a recovery of real wages in the second half of the
year, despite the fact that the year 2000 closed with a record 100 percent
inflation rate. The trend in the real minimum wage has been a good pre-
dictor of the urban (income) poverty trend, as shown by figure 4.1 and
analyzed in more detail in Le6n and Vos (2000) and Vos (2000a). The
urban open unemployment rate also started to fall with the first signs of
economic recovery in the second half of 2000, dropping from 14.4 percent
in 1999 to 9 percent in November 2000, and then stabilizing at around that
level during 2001.


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  133
Table 4.2 Consumption-based Comparison of Poverty in
Ecuador
Headcount (PO)   Poverty gap (P1)    Severity (P2)
1995  1998 1999a 1995 1998   1999a  1995  1998   1999a
National     34     46   56    11    18    21      5     9     11
Urban       19     30   42     5     9    13     2      4      6
Rural       56     69   77    20    29    35    10     16     20
Costa region  29    47   56     8    16    19      3     8      9
Urban       18     35   50     4    11    16     1      5      7
Rural       49     70   69    15    27    26     7     13     13
Sierra region  39   46   56    15    19    24      7    10     14
Urban       21     22   31     6     6     8     3      3      3
Rural       63     69   83    26    32    42    13     18     26
Orienteb     46     53         15    20            7    10
Urban       31     28          9     7           4      3
Rural       49     59         17    23           8     12
a. Data for 1999 refer to the (representative) sample of the second semester of
the survey (April - September). ECV 1999 is a year-round survey conducted
between October 1998 and September 1999.
b. ECV 1999 does not have representative sample for the Amazon region
(Oriente).
Source: Calculations from the ECV 1995, 1998, and 1999.
Migration abroad has been one exhaust valve. Between 1998 and 2000
about 200,000 Ecuadorans left the country in search of better economic
prospects. This number represents about 2 percent of the labor force.
Some see the outward migratory flow as the major cause of the decline in
unemployment, but urban labor force survey data indicate it could
explain at best a decrease between 1 and 2 percentage points, that is,
around one-third of the observed reduction (Le6n 2001 a). Workers' remit-
tances have increased substantially and, according to Central Bank data,
contributed one-third of total foreign-exchange earnings in 2001. This
growing source of household income helped spur private demand
growth. Remittances have helped :reduce poverty, even though the
impact should not be overstated. Again using urban labor force survey
data, remittances may explain 0.6 percentage point of an observed drop
of 3.3 points in the urban poverty incidence (based on income data).4


134                          CRISIS AND DOLLARIZATION IN ECUADOR
Figure 4.1 Ecuador: Real Wage and Urban Poverty Trends
(index, 1990 = 100)
170.0
1 5 0 . 0                             10
130.0                                     w/p
110.0
90.0
70.0     I
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
-   Poverty incidence "- - Real minimum wage (Nov.)
Source: Vos and de Jong, 2001, based on data from the INEC urban labor force
household surveys for 1988-2000 and minimum wage data from the Central
Bank. Index for the poverty incidence is based on per-capita household incomes
and a poverty line of US$60 PPP (from Le6n and Vos 2000).
3. Vulnerable Groups
Consumption expenditures and incomes represent only one facet of liv-
ing conditions of the poor in Ecuador. Table 4.3 shows how household
characteristics vary across consumption quintiles. It shows that house-
hold size and the dependency ratio (the ratio of those below the age of 15
and above the age of 65 expressed as a ratio to the number of household
members between the ages of 15 and 65) are both larger in lower than in
higher quintiles. The percentage of households headed by women does
not vary greatly across quintiles, but-if anything-increases with the
average welfare of the household. The share of female-headed house-
holds has been increasing over time, most starkly when defining head-
ship by who is the main income earner of the household. Defined this
way, de-facto female-headed households increased from 24 to 30 percent
during the crisis (1998-99) and was most pronounced among rural house-
holds (from 20 to 28 percent), which could be a reflection in part of migra-
tory trends. Female-headed households are, on average, smaller in size
(with the spouse often absent), but have higher average consumption lev-
els (SIISE 2000).


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  135
The high incidence of poor sanitary conditions, lack of clean water, dirt
floors, and overcrowding are factors conducive to health problems, espe-
cially for young children. Table 4.3 provides evidence of significant differ-
ences in living conditions across the income distribution: 22 percent of
households from the poorest quintile lack electricity while only a negligi-
ble proportion in the richest quintile is without electricity. Three out of four
people in the lowest quintile have no access to piped water supply, com-
pared with about 12 percent without piped water in the richest quintile.
PREGNANT WOMEN AND YOUNG CHILDREN. Some demographic groups
among the poor-especially pregnant women and young children-are
especially vulnerable. Poor households in Ecuador adjust to low incomes
by reducing food consumption and delaying medical attention, espe-
cially for women and children. This household adjustment poses many
risks for women and children. Since women are usually the major care
providers in households, their health is particularly important for the
welfare of the household. The effects of maternal mortality on surviving
children are large and negative. Malnutrition and lack of medical atten-
tion cause children to suffer reduced mental and physical development,
including higher risks of childbirth complications for women who were
Table 4.3. Ecuador: Household Characteristics by Consumption
Quintile
Household characteristics      Q1     Q2      Q3       Q4      Q5
Household size (persons)       5.9     5.1     4.4     3.9     3.2
Female headed                 16.2    17.9    17.6    18.6    21.3
Average age                   23.1    24.0    25.6    25.9    29.9
Dependency rate                3.5    2.6      2.3     2.0     1.6
Years of schooling
Mothers                       3.6     5.2     6.4     8.3    10.9
25-year-olds                  6.3     7.1     8.9    10.0    12.4
Household head & spouse       3.4     4.9     6.1     8.0    11.2
Without electricity (%)       22.3    10.3     4.4     1.4     0.6
House has mud floor           34.1    14.6     7.5     3.7     1.5
Without piped water (%)       75.4,   58.6    41.0    31.3    12.1
Overcrowded                    0.4     0.5     0.6     0.7     1.1
Children enrolled in daycare
(0-2 years)                   2.0    1.6     0.6      1.3     4.6
Children enrolled in preschool
(3-5 years)                  17.4   26.1    29.2     38.4    51.2
Actives in formal sector (%)  25.9    27.2   33.9     37.9    50.5
Source: ECV (1998).


136                           CRISIS AND DOLLARIZATION IN ECUADOR
malnourished as girls. All these effects lower the chances that poor chil-
dren will ever be able to escape poverty as adults. In Ecuador, households
with pregnant women and mothers with children under two years of age
in the first consumption quintile have worse living conditions, a higher
incidence of stunting, and significantly lower health expenditures than
the average for the entire population.
SCHOOL-AGE CHILDREN. One particular response of poor households to
low income is to reduce their educational spending. The high private cost
of public schooling and the income foregone in order for children to
attend school combine to create strong incentives for poor families to take
their children out of school. Unfortunately, high rates of school nonatten-
dance contribute to high rates of grade repetition and premature school
dropout. Reduced enrollments reduce the human capital of children,
resulting in lower earned income and an increased probability that chil-
dren themselves eventually will be heads of impoverished households.
Analysis of household survey data confirms that school-age children
in the first quintile are at educational risk. The educational level of moth-
ers is an especially important determinant of whether children enroll in
school and how much they learn. Mothers of children ages 6 to 15 years
in the first consumption quintile are, on average, functionally illiterate
(defined as having less than four years' schooling), especially in rural
areas. Poor households also spend less on books and other supplies that
children are expected .to use in school. The consequences include lower
educational quality, lower school attendance, higher child labor rates,
and a lower probability that children will complete primary school.
THE ELDERLY. The elderly are vulnerable because they are almost entirely
dependent on small amounts of pension income and on the support of
other members of the household or extended family. They also are vulner-
able because they are more frequently ill and more frequently require the
attention of health professionals, not just home remedies. The elderly in the
bottom quintile are much more likely to live in an extended family than are
the elderly in other quintiles, but this is much more a rural than an urban
phenomenon. Within the first quintile, the health expenditures of the
elderly are considerably higher than those of the nonelderly, but the elderly
poor spend less than one-quarter of the national average for the elderly,
suggesting that the quality of their care is far less than that of the nonpoor.
The elderly with pension incomes also were hit directly by the finan-
cial crisis. Retiring pensioners receive a capital transfer based on past
salaries and the number of years contributing to social security. Most
would deposit this sum in a bank to complement the typically low pen-
sion with interest revenue. Because of the financial crisis deposits were


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  137
frozen for almost a year. Some pensioners were unfortunate enough to
have deposited funds, in banks that failed. After the dollarization of the
economy, the nominal dollar value of those financial assets was cut into
less than half because of the exchange rate effect, and the real dollar value
dropped further because of the high inflation during 2000 and 2001. The
Deposit Insurance Agency (AGD) started paying deposit holders affected
by bankruptcies of financial institutions in 2000 and more in 2001. Many
people, including pensioners, reinvested the recovered resources largely
in durable consumer goods (including cars) as a lack of confidence in the
financial system continued well into 2001. Capitalized pension income
thus was converted into depreciable commodities. In terms of current
income and consumption, pensioners-once belonging to a relatively
protected social class-have become part of the new poor.
The vulnerable groups identified above also are more likely to be poor.
Table 4.4 reports the proportion of poor households among those house-
holds that have (a) pregnant women; (b) children in the age groups 0-2,
3-5, and 6-15 years; and (c) the elderly. Comparison of the poverty rate
between households that do possess such members with households that
do not provides one indication of the relationship between poverty and
membership in these vulnerable groups. Table 4.4 shows that early into
the crisis (1998), membership in these groups was indeed correlated with
poverty. For instance, the poverty rate is 53 percent for households with
at least one child below the age of two years compared with a rate of 37
percent for households that did not have a child below age two years.
Differences in household composition are especially sharp between the
poorest and richest consumption quintiles. More than half (51.3 percent) of
households in the poorest quintile have pregnant women or children under
age two years, compared with only 18.8 percent in the richest quintile.
Among households in the poorest quintile, 57.7 percent have children ages
three to five years, compared with only 22 percent in the richest quintile.
Table 4.4 Ecuador: Correlates of Poverty
Poverty rate (headcount index)
Household does         Household does
not possess             possess
Characteristic                  characteristic        characteristic
Have infant below 2 years of age    37%                   53%
Have child 3 to 5 years of age      35%                   56%
Have child 6 to 15 years of age     33%                   48%
Have elderly person at home         39%                   49%
Have pregnant woman                41%                    45%
Source: ECV 1998.


138                           CRISIS AND DOLLARIZATION IN ECUADOR
4. Human Development
In any country, the fate of the children of the poor is closely tied to pro-
vision of health, nutrition, and educational services of high quality and
broad coverage. Since the poor have so little material wealth, future
incomes of children of the poor depend very much on their human capi-
tal, and that in turn is strongly influenced by their access to basic social
services of adequate quality.
In general, Ecuador's human-development indicators correspond to
its income level within Latin America. Malnutrition, infant mortality, and
maternal mortality indicators, for example, are not significantly better
than Bolivia's or Peru's and are substantially worse than Colombia's and
most of the rest of South America.
NUTRITION AND HEALTH. Ecuador has had considerable success since the
mid-1980s in reducing the incidence of malnutrition. The incidence of
stunting (height for age) declined from 49.4 percent among preschool
children in 1986 to 26.7 percent in 1998. Despite this progress, malnutri-
tion in Ecuador is still considerably higher than it is in several other coun-
tries in Latin America, including Colombia and Paraguay and is not less
that of Bolivia, which has a lower per-capita income (see figure 4.2).
Glaring differences remain in the malnutrition, infant mortality, and
maternal mortality rates across household expenditure quintiles, as indi-
cated by the incidence of stunting among small children in figure 4.3. In
1999, 44 percent of children in the bottom quintile had stunted growth,
compared with 6 percent in the upper quintile. Malnutrition measured
this way deteriorated significantly among the poorest households during
the crisis, as the share of children with stunted growth seems to have
increased (from 39 to 44 percent).5 Households with more resources man-
aged to keep the trend declining despite the crisis. Consistent with
poverty trends, the highest incidency of stunting is in the rural Sierra,
where it increased most dramatically during the crisis from 41 to 51 per-
cent between 1998 and 1999. The incidence of stunting is lowest in the
urban lowlands (Costa region), where it actually fell from 22 to 17 per-
cent. As shown in figure 4.4, nutrition status improved somewhat on
average with the recovery in 2000.
The very limited coverage of programs that provide nutritional sup-
plements to children under age two years in poor families contributes to
malnutrition. The precise coverage is unknown, but the single largest
program targeted to these children [the Maternal-Infant Nutrition Pro-
gram (Programa de-Alimentaci6n Complementaria Materno-Infantil, PACMI),
which in 2000 conerted to a new Food and Nutrition Program (Programa
Nacional de Alimentaci6n y Nutrici6n, PANN)] covers only 15,000 children,


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION       139
Figure 4.2 Malnutrition Rates in Latin America
30
25-
20*_-
O        * lil__..*                                _
10-
5-
Sources: WHO and ECV 1999.
Figure 4.3 Malnutrition in Ecuador: Stunting (%) by
Consumption Quintiles, 1998 and 1999
45
40
35
30
252-
20         -
15
10 U U
5 -
0-
Q1       Q2       Q3       Q4       Q5      Total
Per-capita consumption quintiles
N 1998     * 1999
Source: ECV 1998, 1999. Data processed'by SUSE project.


140                          CRISIS AND DOLLARIZATION IN ECUADOR
Figure 4.4 Malnutrition in Ecuador: Stunting (%) by Area and
Region, 1998-2000
Percent
40
35
30                                  -
25-
20-
Costa  Sierra  Oriente        Rural  Urban          Total
01998    M 1999  E 2000
Sources: INEC, ECV 1998, 1999; and TNEC, EMEDINHO survey of 2000.
while the number of children (a substantial portion of whom are at risk
of malnutrition) under age two years in the first quintile is 209,000. This
program did not expand during the crisis.
Access to health care is limited for many Ecuadorans. The Health Min-
istry covers about 45 percent of the population, and other public and
charitable organizations provide care to another 5 percent. In addition, in
1999 about 10 percent of the population was covered by the IESS and 7
percent by the Farmers' Health Insurance (Seguro Campesino), which is
part of the IESS. More than 80 percent of the population has no health
insurance coverage whatsoever, and about one-third of the population is
covered neither by Health Ministry facilities nor private health insurance.
When ill, the poor are less likely than the nonpoor to seek professional
care (32 percent self-medicate), face longer travel and waiting times to
receive medical attention, and are less likely to be covered by social secu-
rity insurance.6 The poor are more likely to be covered by the Farmers'
Health Insurance. Seventy percent of the people with access to the Seguro
Campesino belong to the poorest 40 percent. (Also see table 4.6 below.)
Large differences are observed in reproductive health practices and
family planning information across socioeconomic levels. In the poorest
population quintile, only one out of five women of reproductive age have
ever had a Pap smear, while half of those in the richest two population


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                141
quintiles have been given the test. The responses to the question, "Have
you ever received family planning information?" indicate that only half
the poorest females have such information. Among women age 15 to 20
years, only one-third have any information on family planning. These
differences partially reflect the reproductive health care practices in rural
areas as well as the different access to information as a function of socioe-
conomic status.
EDUCATION. Education indicators repeat the story found in nutrition and
health. Ecuador has shown considerable progress in raising the educa-
tional attainment of its population, as have other countries in the Latin
America and Caribbean region. Figure 4.5 uses data from the 1999
Ecuador LSMS household survey to show the average educational attain-
ment of the population by age cohort. While those 65 and older (born in
1934 or earlier) are on average functionally illiterate (less than 4 years of
schooling), those in age group 40-45 (born between 1954 and 1959) aver-
Figure 4.5 Ecuador, Jamaica, Honduras: Years of Educational
Attainment by Age Cohort
Years of educational
attainment
12
10
0-
AgOe cohrt
" cudo      "aia    -      Hnas
S   E
.0.
2
0
65+   60-64  55-59  50-54  45-49  40-44  35-39  30-34  25-29
Age cohorts
- -Ecuador    -      Jamaica  -Honduras
Soiirce: ECV 1999 for Ecuador, and World Bank data for Jamaica and Honduras.


142                           CRISIS AND DOLLARIZATION IN ECUADOR
age more than 7 years of schooling, and those in age group 25-30 (born
between 1974 and 1979) average more than 9 years of schooling. The
growth of educational attainment over time closely tracks that in Jamaica
and Honduras.
Educational inequities begin at birth. The single most important deter-
minant of a child's education prospects (as well as nutritional and health
status) is the educational level of the mother. Mothers of young children
in the first consumption quintile are, on average, functionally illiterate,
while mothers in the highest quintile are, on average, secondary school
graduates. Unfortunately, disparities in access to preschool increase,
rather than decrease, the educational risks facing poor children. Children
in the first quintile have one-third the preschool.enrollment rate of chil-
dren in the fifth quintile.
Figure 4.6 and figure 4.7 show such disparities in educational attain-
ment across socioeconomic groups and between rural and urban popula-
tions. For example, on average the extreme poor (consumption quintile 1)
in rural areas have completed less than 4 years of education whereas the
rich (quintile 5) in urban areas have completed almost 12 years of educa-
tion (figure 4.6). Men appear to have more access to education than do
women; and this gap is somewhat larger among the poorest households,
particularly in rural areas. Such disparities persist, and the gap has not
been closing very much over the past decade.7
Figure 4.8 shows the differences in educational attainment of recent
cohorts of the population by quintile. Most children now complete pri-
mary school, but educational attainment beyond the primary level is
highly unequal. Only 12 percent of children in the bottom quintile com-
plete lower secondary school, compared with 78 percent in the top quin-
tile. In addition, there are striking differences between children in rural
areas, where 29 percent complete lower secondary school, and urban
areas, where the figure is 62 percent. The indigenous population also has
lower educational attainment than the nonindigenous population.
There are several reasons for low enrollment rates at the secondary
level. The single most important explanation is cost. According to respon-
dents to the 1995 LSMS survey, cost was the major factor for 32 percent of
nonenrollment, equally for males and females. By 1998, cost was seen to
be the major factor limiting access to education for 29 percent of males not
attending and 36 percent of females of secondary school age. Further into
the crisis, in 1999, the education cost factor appeared to determine nonen-
rollment for 48 percent of males and 53 percent of females. That this fac-
tor appears to have grown in importance more for females suggests that
the economic crisis has been a source of a (renewed) widening of the gen-
der gap in education. Direct education cost also is seen as the major single
factor limiting access in primary education (more than 50 percent in 1999).


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                143
Figure 4.6 Ecuador: Educational Attainment by Rural and
Urban Areas (persons over 24 years old)
Years of school
attainment
14
12
10-
8-U
6                                                              -
0-
Q1          Q2           Q3          Q4           Q5
Per-capita expenditure quintiles
a Rural  a Urban
Source: ECV 1999.
The average monthly expenditure per child in primary education for
households in the bottom quintile is about US$2.50, or about 1.5 percent
of average total household income. For secondary education the average
direct cost of education (fees, uniforms, transport, and so on) for the
poorest is about US$5 per student or about 3 percent of total household
consumption. Although not discussed in the survey, the quality of school-
ing and the expected income gains from attending school also affect
school attendance decisions.
Child labor adversely affects the education of the poor, and the per-
centage of children participating in the labor force is very high in Ecuador
(see figure 4.9). Most children in Ecuador work and attend school, and
the large number of hours they work,must adversely affect learning. Chil-
dren age 12 to 14 years in the bottom quintile who work and attend
school report working 26 hours per week; children age 15 to 17 years who
work and attend school report working 36 hours per week. Of all children
age 12 to 14 years in the bottom quintile, 34 percent work and attend


144                         CRISIS AND DOLLARIZATION IN ECUADOR
Figure 4.7 Ecuador: Gender Gap in Education
Years of school
attainment
14
12
10                                                            -
8-
6-
EHM
4-
2--
0-7:.
Q1          Q2           Q3          Q4          Q5
Per-capita expenditure quintiles
a Female U Male
Note: Refers to years of school attainment of population 24 years and older.
Source: ECV 1999.
school, and another 26 percent only work, resulting in an overall labor
force participation rate of 60 percent (as shown in figure 4.9), up from 54
percent in 1998. Child labor undoubtedly contributes to the high rate of
school absenteeism for children in the bottom quintile. Even before the
most recent crisis, children age 12 to 14 years reported missing classes
more than half the time, and even children age 6 to 11 years reported
missing classes about one-third of the time. Learning is inevitably
affected by such high absenteeism rates.
Reducing child labor will have opportunity costs in the short run for
households in the form of less income earned and greater schooling costs.
The estimated average income of children working in the 10-14 age
group of the poorer households is about US$6.50 per month. This would
bring the total cost (direct and indirect) of primary and secondary educa-
tion to between US$8.50 and US$11.50 per student, per month, which in
turn would be indicative for the value of a transfer, which might help
keep children in school as discussed further below.


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                145
Figure 4.8 Ecuador: Percentage of 18-Year-Olds Completing
School
Percent
100 -
90 -
80-
60
50
40
20
Q1         Q2         Q3         Q4         Q5
Per-capita expenditure quintiles
Completed primary - rural      Completed secondary - rural
Completed primary - urban   U  Completed secondary - urban
Source: ECV 1999.
Expected income gains from education, next to the quality of the ser-
vices, may further influence educational performance. Contributing to
the problem of primary school dropouts and low secondary school
enrollments and also to income inequality are recent changes in the (pri-
vate) economic returns to educational investments by households. Since
1994, the wage premiums associated with completing primary school (vs.
not doing so) or completing secondary school (vs. completing primary
school) have both decreased. Meanwhile, however, the premium associ-
ated with completing university education (vs. completing secondary


146                           CRISIS AND DOLLARIZATION IN ECUADOR
Figure 4.9 Ecuador: Percent of Children Working, 1999
Percent
90
80
70
60
50
40-.
30                      ...
20                                     --             -
10
0
Q1          Q2          Q3          Q4          Q5
Per-capita expenditure quintiles
-       " Age 10-11  - " - Age 12-14           Age 15-17
Source: ECV 1999.
education) has increased considerably, from 48 percent in 1994 to 73 per-
cent in 1998 and further to 85 percent in 1999. It should be noted that edu-
cational returns for females in urban areas were consistently and
substantially higher than for males throughout the 1990s (see Le6n and
Vos 2000). All this should underpin measures helping to increase access
to the educational system and improve retention rates.
The inadequate availability of educational services is foremost a prob-
lem in rural areas. Important parts of the rural population have no pri-
mary schools that go beyond third grade in their vicinity. Low attendance
of teachers is another problem limiting school access of the rural popula-
tion (World Bank 2000).
5. Targeted Poverty Programs
The deficiencies of Ecuador's social-protection system became painfully
manifest during the crisis. Employment and labor incomes deteriorated
substantially during the crisis and likely will remain subject to high


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  147
volatility in years to come. Access to hocial security, basic social services,
and targeted social-protection programs therefore are critical to prevent
those with the least resources from falling (deeper) into poverty and suf-
fering irreversible losses in terms of human development.
As mentioned, only a small proportion of the population has access to
the social-security system. But those benefiting from the system did not
get much protection during the crisis. Pensioners suffered huge losses in
the purchasing power of their monthly benefits, and the value of their
financial assets was cut in half or less. The social-security health system
faced a financial crisis from which it: has not yet recovered. Health ser-
vices declined during the crisis as medicines and supplies ran short, and
medical personnel have been on strike on numerous occasions because
salary payment is frequently delayed. A reform of the pay-as-you-go pen-
sion system has been subject to debate for years, and by the end of 2001
the Congress still had not approved a proposal for reform. The heavily
underfinanced health service system of IESS has yet to be reformed into
a more proper social health insurance. A system that could provide cov-
erage to a major part of Ecuador's poor, however, is still beyond reach.
Ecuador continues to face several challenges in the provision of basic
social services (World Bank 2000): (a) ensuring that the poor, especially
pregnant women and children under age two years, have adequate nutri-
tion; (b) improving access by the poor to regular, preventive health care
and to expanded educational opportunities, especially at the lower sec-
ondary level; and (c) raising the qualify and equity of service delivery by,
among other things, ensuring adequate material inputs such as drugs,
medicines, and textbooks. In the context of overall fiscal austerity, meet-
ing these challenges will require improved efficiency in social service
delivery to leverage the greatest output from existing resource levels.
Such efficiency gains require institutional reforms, which take time and
face many political obstacles. During the crisis not much progress could
be made in this area.
What is more, social spending decreased by more than one third, as
public spending on social services and social programs fell from US$78 to
US$51 per inhabitant between 1995 and 2000.8 Budget projections suggest
that this trend could only be reversed by 2001 (see figure 4.10). Social
expenditures also fell as a percentage of GDP. Not including social-secu-
rity benefits, they fell from 5.0 to 4.6 between 1995 and 2000, but with the
2001 budget expenditures are back up at 5.8 percent. Also, after inclusion
of social-security benefits (which brings expenditures to around 8 percent
of GDP in 2001), Ecuador's level of social spending is well below the
average for Latin America and that of countries such as Bolivia, Chile,
Colombia, Argentina, Costa Rica, and Panama, which have sustained lev-
els well above 10 percent of GDP.


148                           CRISIS AND DOLLARIZATION IN ECUADOR
Figure 4.10 Ecuador: Social Spending per Capita, 1995-2001 (in
US$)
90-
85-
80-
75-
70-
65-
60-
55-
50-
45-
40
1995     1996     1997     1998     1999     2000     2001
Source: Ministry of Economy-UNICEF and Le6n 2001b. Data for 2001 refer to
approved budget. Data for 1995-2000 refer to executed budget.
It is not only the level of spending that counts, but even more its com-
position and effectiveness. During the crisis, the composition of social
spending shifted away from universal services such as education and
health to more targeted and specific social programs, including a cash-
transfer program (Bono Solidario) and various small programs run by the
Ministry of Social Affairs and associated institutions. Table 4.5 shows the
shift in the composition of social spending. Part of the shift should also
be explained by the level of wages in dollar terms (falling during most of
1998-2000 and recovering somewhat from the second half of 2000
onward), which has a stronger impact on the education and health bud-
get than on other components of social spending. As mentioned, the
wage decline for teachers and medical personnel affected the functioning
of education and health services during the crisis. At the same time, the
shift in composition was influenced by the introduction of the targeted
cash-transfer program, which turned out to be the government's princi-
pal response to the crisis. At first glance, the larger share of the related
benefits accrues to the poorer households.
Table 4.6 shows the direct public expenditure incidence of major com-
ponents of social spending using the 1999 LSMS survey information on
access to and use of related services and programs. Social spending gen-
erally tends to be more equally distributed than per-capita household


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  149
Table 4.5 Ecuador: Composition of Social Spending, 1995-2001
1995   1996    19971  1998   1999    2000    2001
Education        63%    63%     65%    67%     51%    45%     46%
Social welfare    8%    12%      7%     6%     10%    12%     19%
Labor             1%     1%      1%     1%      0%     1%      1%
Health           22%    20%     21%    21%     15%    17%     15%
Housing           7%     4%      6%     6%      1%     5%      5%
Cash transfer
(Bono Solidario)                              23%    20%     14%
Total           100%   100%    100%    100%   100%   100%    100%
Total in millions
of US$          894    974     877    940     706    646     996
Total social
spending p.c.
(US$)           78      83      73     77     57      51     77
Total social
spending
(% of GDP)    5.0%    5.1%    4.4%   4.8%   5.1%    4.6%   5.8%
Source: Ministry of Economy-UNICEF. Data for 2001 refer to approved budget.
Data for 1995-2000 refer to executed budget of central government; local gov-
ernments and social security are not included.
consumption. This more equal distribution holds most strongly for some
of the targeted social-protection programs, such as the Bono Solidario and
the school breakfast program, as well as for primary education and the
Farmers' Insurance system (Seguro Campesino). Equity effects of public
spending on health, secondary and higher education, and general social
security are much weaker.
The objectives of targeted poverty reduction (or social protection) pro-
grams include: (a) providing a temporary safety net for the transient poor
(new poor) to prevent their physical and human-capital investment from
depreciating (which would affect both future productivity growth and
the probability that transient poverty might become permanent); and (b)
providing a safety net for the chronically poor, whose living conditions
have further deteriorated as a result of the economic crisis. The idea is to
maintain the poor above a critical subsistence income level and to pro-
vide conditions conducive to poverty reduction.
Ecuador's existing social programs cannot be regarded as a unified
"system" of social protection. Even though the emphasis in social spend-
ing shifted in that direction during 1998-2000, existing programs are not
designed to respond to the social consequences of crisis and income inse-
curity. Although each program may fulfill its specific function of provid-


150                           CRISIS AND DOLLARIZATION IN ECUADOR
Table 4.6 Public Expenditure Incidence of Social Spending by
Type of Program and Per-capita Expenditure Quintiles, 1999
Cash
Household transfers  School breakfast  Social security
consump- (Bono              Pre-            General
tiona  Solidario) Primary  primary "Campesino" (IESS)
Poorest 20%        8.8%   23.3%    49.1%    41.2%   40.3%    5.0%
2nd Quintile     13.5%    26.5%    26.6%    29.0%   29.0%   10.9%
3rd Quintile      16.7%   23.0%    13.7%    16.3%   13.6%   19.0%
4th Quintile      22.4%   19.2%     7.6%     8.1%   13.8%   26.7%
Richest 20%       38.6%    7.9%     3.0%     5.4%    3.3%   38.4%
Total            100.0%  100.0%   100.0%   100.0%  100.0%  100.0%
Public education
Health                              Total
services  Primary  Secondary Higher education
Poorest 20%               19.7%    36.7%    15.0%    5.9%   27.4%
2nd Quintile              25.6%    29.6%    26.5%   12.6%   27.2%
3rd Quintile              20.8%    17.3%    27.1%   21.0%   20.6%
4th Quintile              20.8%    11.6%    22.8%   31.7%   16.7%
Richest 20%               13.1%     4.9%     8.6%   28.8%    8.1%
Total                    100.0%   100.0%   100.0%  100.0%  100.0%
a. Refers to distribution of total household consumption. Also expenditure bene-
fit distribution is per household.
Sources: INEC, ECV 1999 (taken from Vos, Le6n, and Brborich 2001).
ing social services and other benefits to vulnerable groups, there is no
coordination and integration of these programs into a unified system.
One consequence is that it is impossible to assess the actual amount of
protection each group of beneficiaries receives from various programs.
Under the tightened fiscal constraints, it is imperative that the govern-
ment evaluate the social programs implemented by various ministries
and agencies, with the objective of rationalizing them and developing a
coherent social-protection system. As we shall see below, postcrisis mea-
sures to strengthen the social-protection system have not brought
Ecuador much closer to these objectives.
The quality of any social-protection system is proven in times of crisis.
An important test is whether the programs in question can be quickly
expanded (in benefits or coverage) or redirected to alleviate the social
costs of the crisis. Social programs in some countries, such as unemploy-
ment insurance or public employment programs, have triggering mecha-
nisms that automatically increase coverage when unemployment


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                151
increases. Another automatic adjustment device is the increase in the
number of households eligible for social benefits as a result of loss of
employment and family income. Ecuador's social-protection program,
summarized below in table 4.7, does not have these characteristics.
In the following paragraphs, the major programs targeted toward the
groups identified in table 4.7 are evaluated in terms of their targeting effi-
ciency and their coverage. Except for the Bono Solidario, which benefits
almost all age and ethnic groups, this evaluation is organized by target
group. As noted in table 4.7, the elderly poor and indigenous poor receive
assistance mainly through the Bono Solidario, and there is no government
program to assist those who slip temporarily below the poverty line.
ECUADOR'S FLAGSHIP POVERTY PROGRAM, THE BONO SOLIDARIO. As the first
important action under its social agenda in September 1998, the Mahuad
Government eliminated the indiscriminately targeted cooking-gas sub-
sidy (for the moment), targeted the electricity subsidy to poorer con-
sumers (instituting a cross-subsidization structure under which wealthier
consumers subsidized poorer consumers), and instituted a cash-transfer
program for poor families and elderly people known as the Bono Solidario
(Presidential Decree, September 14, 1998). The Bono Solidario was not orig-
inally thought of as a safety net for the structurally and chronically poor
but, rather, as a mechanism to compensate the poor for reductions in the
subsidies. With the rapid deterioration of the economy, however, the Bono
Solidario has become the backbone of the government's safety-net strategy.
When it was introduced, the program provided the equivalent of US$15
per month to female household heads and about half that amount to
elderly people. The dollar equivalent and its purchasing power deterio-
Table 4.7 Vulnerable Groups Among the Poor and Ecuador's
Social-Protection Programs
Area
Social
Cash   infra-
Group                    Nutrition Health Education transfers structure
Pregnant women and mothers  X       X               X
The very young (0-2)        X       X               X
Preschoolers (3-5)          X       X      X        X
School-age children (6-15)  X              X        X      X
The elderly                                         X
Indigenous poor                                     X      X
The new poor


152                           CRISIS AND DOLLARIZATION IN ECUADOR
rated rapidly, however, on account of exchange-rate depreciation and
inflation. Following various adjustments in the nominal value of the cash-
transfer, the program provided US$11.50 per month to mothers from poor
families and about US$7.00 per month to poor elderly people by early
2002.9 The amount provided to individual households is small. Even at the
inception of the program, it cost a family double the amount they were
provided just to meet the minimum caloric needs of one person for a
month. Notwithstanding the small unit benefit amount, the Bono Solidario
program rapidly became Ecuador's flagship social-protection program.
With an annual expenditure of about US$164 million for 1999, the pro-
gram amounted to about 1.2 percent of Ecuador's GDP. The overall bud-
get for the program declined slightly in 2000 and 2001 to around US$140
million or 0.8 percent of GDP. The administrative costs of the program are
relatively low, representing about 4 percent of the total annual transfers.
In early 1999 the Bono Solidario reached coverage of approximately 1.3
million beneficiaries, adding to the income of about 45 percent of
Ecuadoran households. Of the total of beneficiaries, 80.7 percent are
mothers, 18.7 percent are elderly people, and 0.6 percent are disabled.10
These beneficiary percentages remained the same throughout 1999-2001.
The targeting efficiency of the program is not very high. Using the 1999
LSMS household survey and grouping the population according to the
eligibility criteria of the program, we find substantial errors of exclusion
(Type I) and inclusion (Type II). The Type I error rate is 17 percent, and
the Type II error rate is 33 percent of the total population of mothers and
elderly (table 4.8). Expressing these targeting errors somewhat differ-
ently, the degree of undercoverage of the eligible population is 48 percent
and the leakage of benefits to noneligibles is 63 percent. In fact, there are
more actual recipients of the Bono Solidario than there are eligible, poten-
tial beneficiaries. The degree of "overcoverage" in this sense is particu-
larly large in urban areas, where there are almost twice as many
recipients as eligible beneficiaries (see table 4.9).
Targeting errors are less severe when looking at the distribution of
benefits among the poor and nonpoor (defined in terms of consumption
shortfall). Leakage of benefits to the nonpoor is about 35 percent, while
the degree of undercoverage of the poor is 38 percent (see Vos, Le6n, and
Brborich 2001).
Despite these targeting errors, the cash transfers of the Bono Solidario
seem strongly redistributive because they constitute 10 percent of the
total income of the poorest 20 percent and barely 0.1 percent of the
income of the richest segment of the population. For the extreme poor,
receiving the Bono Solidario thus makes a difference. The Bono Solidario
amount of US$15 per household per month in mid-1999 covered 29 per-
cent of the gap for the extreme poor and represented 8.4 percent of


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                      153
Table 4.8 Ecuador: Targeting Errors of the Bono Solidario by
Eligibility Criteria, 1999
Type I and II errors
Eligible           Noneligible             Total
Recipients          19.3%                33.4%                52.7%
(Inclusion error)
Nonrecipients       17.9%                29.5%                47.3%
(Exclusion error)
Total               37.1%                62.9%               100.0%
LIndercoverage
Eligible           Noneligible             Total
Recipients          51.9%                53.1%                52.7%
Nonrecipients       48.1%
(undercoverage)     46.9%                47.3%
Total              100.0%               100.0%               100.0%
Leakage
Eligible           Noneligible             Total
Recipients          36.6%                63.4%
(leakage)          100.0%
Nonrecipients       37.7%                62.3%               100.0%
Total               37.1%                62.9%               100.0%
Sources: INEC, ECV (LSMS) 1999.
Table 4.9 Ecuador: Eligible Population and Actual Recipients
of the Bono Solidario, 1999
Eligible population            Actual recipients
Rural                   434,648                        506,809
Urban                   353,118                        610,108
Totala                  787,766                       1,116,918
Rural                    55.2%                          45.4%
Urban                     44.8%                         54.6%
Total                    100.0%                        100.0%
a. Total number of actual recipients as measured by the survey is less than the
officially registered number in the BANRED database (1.3 million), probably
because of sampling error and possibly because of the time period of the collec-
tion of survey data that were used for these estimates (January to September
1999).
Source: Vos, Le6n, and Brborich 2001 based on data from ECV 1999.


154                          CRISIS AND DOLLARIZATION IN ECUADOR
needed food expenditures. The gap is larger now, although data are not
available to estimate its magnitude with confidence.
The Bono Solidario is the only social-protection program directly tar-
geted to the elderly. Because most elderly people have such low income,
68 percent of all the elderly are eligible to receive it. Nevertheless, only 28
percent actually do. The percentage of those eligible who are not cov-
ered-71 percent-is very high, far exceeding the 25 percent of elderly
Bono Solidario beneficiaries who are in fact ineligible (that is, leakage). The
program does not provide protection for the elderly with regular pension
receipts who are ineligible. As discussed above, many of these elderly
have become part of the new poor, but with the inadequate functioning
of the social-security system and ineligibility for the Bono Solidario pro-
gram, these elderly are left without any social protection.
An impact-evaluation study using a matching comparison method of
beneficiaries and a comparable group of nonbeneficiaries of the program
showed that the estimated impact on poverty reduction is negligible (Vos,
Le6n, and Brborich 2001). The cash-transfer benefits appear to be offset
by negative labor supply responses of beneficiary households (particu-
larly those closer to the poverty line). A more positive impact has been
that school enrollment among beneficiaries is higher than in the compar-
ison group (again more strongly among the moderate poor). Hence,
without the program, educational outcomes would have deteriorated.
This finding is important in light of the ongoing policy debate in Ecuador
about the effectiveness of the Bono Solidario and whether it would be bet-
ter complemented, or even replaced by, cash transfers that are directly
conditioned on investment in human capital. In fact, as discussed below,
a new cash-transfer program conditioned to school attendance-the Beca
Escolar-was introduced in 2001.
In sum, Ecuador's cash-transfer program does not comply well with
its eligibility and targeting criteria. However, on the whole the program
reaches the poor reasonably well. The program reaches a large share of
Ecuadoran households, but is not very responsive to crisis situations. It
has a fixed budget constraint, which does not allow enhanced coverage
during worsening economic conditions, and there have been difficulties
in maintaining the purchasing power of the transfer. The program's
impact on poverty has been negligible, but it appears to give some pro-
tection to human development for the moderate poor because it keeps
children in school longer and some protection for the extreme poor in the
form of avoiding stronger declines in food consumption.
PROGRAMS TARGETED TO PREGNANT WOMEN AND CHILDREN UNDER AGE Two
YEARS. The target group of pregnant women and young children benefits
mainly from programs providing health and nutrition services. The Soli-


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  155
darity Health Service program (Atenciin Solidaria en Salud) is offered to
those receiving the Bono Solidario and includes maternal and infant health
care. This program helps cover charges for medicines and other costs;
medical services for poor mothers are;otherwise provided free. In a sim-
ilar fashion, the Free Maternity program (Maternidad Gratuita), estab-
lished by law during the crisis, provides universal coverage for pregnant
women who use Health Ministry facilities. This program covers prenatal
care, nonstandard birth procedures, treatment for sexually transmitted
diseases and family violence, and cancer-detection tests. This program
was only initiated in 1999, with funding from the public Solidarity Fund
(a public fund fed by proceeds of privatization and several other sources),
and it still lacks adequate operating procedures that are clearly under-
stood by providers (hospitals or health centers).
In addition to these programs, three others provide important benefits
to the poor. The Health Ministry's National Micronutrient Program (Pro-
grama Nacional de Micronutrientes) aims to reduce anemia by providing
iron and vitamin A supplements for children under age five years, preg-
nant women, and breast-feeding mothers. A second program is the
PACMI. The objective of the PACMI is to satisfy the caloric requirements
of the poor by providing a monthly food ration to families with under-
weight pregnant mothers or malnourished children. With support from
the World Food Program, PACMI was phased out in 2000 and substituted
with a new nutritional program, PANN, aimed at the same target group
as PACMI. A third program is the immunization program, which aims to
provide universal immunization coverage of pregnant women and chil-
dren under 12 years old. This program has been operating for 33 years
and was recently expanded to include such immunizations as Hepatitis
B, rubella, and parotiditis.
These programs can be improved' in terms of targeting (especially
Maternidad Gratuita), but the largest constraint on the effectiveness of
health-care delivery to the poor is low coverage (for example, the
PACMI/PANN covers only 5 percent of the needs of the targeted benefi-
ciaries) and inadequate funding. Programs that exist in principle-such
as the Solidarity Health Service-have not yet been implemented because
of inadequate funding. Indeed, poor people claim in interviews that the
quality of services provided them, especially provision of medicines, has
deteriorated during the crisis (CEPLAES 1999). Lack of access to health-
care centers, especially in rural areas, and the lack of technical health per-
sonnel further constrain effectiveness.
The Micronutrient Program is directed to the population that is ser-
viced by the Health Ministry, and so covers a large target population
(about 500,000 individuals), but it fails' to reach the 40 percent of the poor
who report that they do not use public-health facilities. When this pro-


156                          CRISIS AND DOLLARIZATION IN ECUADOR
gram began to receive funding via a World Bank-financed project, target-
ing criteria were added on the basis of morbidity, mortality, and poverty
rates using canton-level information. On the other hand, the PACMI is
directed to population groups with nutritional deficiencies, which
reduces the target population (to 300,000 individuals), but has very mod-
est results in coverage (about 5 percent, or 15,000 individuals). Targeting
is geographic, with criteria for inclusion of a canton being the incidence
of poverty and availability of transportation. This program is well-tar-
geted, providing 73 percent of all benefits to the bottom two quintiles and
61 percent to the bottom quintile alone. In its new reincarnation as
PANN, the program will reach the same target group and will use a sim-
ilar targeting mechanism.
PROGRAMS FOR CHILDREN UNDER AGE Six YEARS. Ecuador targets nutritional
supplements and a variety of other early childhood development (ECD)
services to children under age six years. In addition, several public-health
programs-immunizations, malaria control, and tuberculosis treat-
ment-benefit this age group, although only the immunization program
is particularly targeted to young children.
In addition to nutrition, these ECD services include day care,
preschool education, parental childcare training, and health services.
These services are typically delivered jointly (for example, nutrition sup-
plements with parental childcare education) by several agencies-the
Ministry of Health, the Ministry of Social Welfare, and the Instituto
Nacional del Nifio y la Familia (National Institute of the Child and Family,
INNFA), in addition to municipalities, nongovernmental organizations
(NGOs), and the private sector. The largest programs are listed in table
4.10. The multiplicity of agencies providing overlapping services, com-
bined with the relatively small scale of the programs, translates into
excessive administrative costs, inadequate planning, and weak manage-
ment controls. Unit costs of the two largest programs are high, yet the
delivery centers themselves are underfunded and often depend in part
on community financing. No evaluations have been carried out to com-
pare the impacts of the various programs.
A new program (as of 1999), Nuestro Nifos, financed by the IDB, offers
the potential both to increase ECD coverage rapidly and to improve coor-
dination and management. Rather than provide services directly, Nue-
stros Nifhos provides financing on a competitive basis to fund proposed
improvements and expansions from all providers-governments, NGOs,
and private entities. The cost-effectiveness and targeting selection criteria
used to evaluate proposals, combined with improved monitoring of
those programs financed through this mechanism, provide strong incen-
tives for increased efficiency and better coordination of the sector.


Table 4.10 Ecuador: Coverage and Targeting: Programs for Children under Six Years
Coveragea     Coveragea                                                         Unit
Program                    1999         2000         Targeting mechanism         Targeting                cost
Child Development         38,002       43,586      Geographic-high inci-    65% of beneficiaries in  US$211 per
Program (PDI)              (4%)          (4%)      dence of poverty and     1st and 2nd quintiles    year
children under six years
Child Rescue              50,296       53,469      Proportional by province;  41% of beneficiaries in  US$140 per
Operation (ORI)            (5%)          (4%)      poverty map by cantons   1st and 2nd quintiles    year
Alternative Preschool     18,027       18,027      None                     NA                       US$39 per
(PRONEPE)                  (5%)          (5%)                                                        year
Matemal-Infant            14,930       14,930      Family Poverty Index     74% of beneficiaries in  US$25 per
Program (PACMI);           (5%)          (5%)      (SISVAN) and self-       1st and 2nd quintiles    year
Food and Nutrition                                 selection (those who
program (PANN)                                     use Public Health
from 2000b                                         Centers)
Immunizations              NAc           NAc       None (universal)         78-100% of universe      US$2.30 per
depending on province    beneficiary
a. Coverage in absolute number of beneficiaries. Coverage as percentage of target population is in parentheses.
b. Coverage for 2000 still refers to the PACMI program. Data for PANN not available. Targeting mechanism for PANN is similar to
that of PACMI.
c. Health Ministry estimates suggest that coverage is around 90 percent on average. Data from the LSMS surveys suggest much
lower coverage. For children in age group 6-12 months, 95 percent received complete vaccination dose of BCG, 65 percent of DPT,
55 percent of polio, and 53 percent of measles. Overall coverage would be only 65 percent. At this level of detail, however, the LSMS
data are subject to possibly substantial sampling error.
Source: World Bank 2000, Vos and others 2000, and SIISE estimates.


158                          CRISIS AND DOLLARIZATION IN ECUADOR
Through Nuestros Nihos, ECD coverage should increase rapidly, but as of
the end of 2000, such a result was not yet visible.
Table 4.10 shows that the major programs for children under age six
years are reasonably well targeted, with most beneficiaries being in the
bottom two consumption quintiles. Coverage is a more important con-
cern than targeting. With statistics showing that 39 percent of children in
the bottom consumption quintile are malnourished, this group has con-
siderably greater need for programs that meet their basic developmental
needs than do children in the top quintile, but the coverage rate of thse
programs is only one-third that of the top quintile.
PROGRAMS FOR SCHOOL-AGE CHILDREN. The Ecuadoran government pro-
vides nutritional supplements, educational improvements, scholarships
to reduce child labor, and health services targeted to the school-age pop-
ulation. Since the school is the most effective means of reaching school-
age children, at least for children of primary school age, the Ministry of
Education is the most important program provider. The coverage and tar-
geting of these programs is reported in table 4.11. The only program with
high coverage and good targeting is the school-snack program. This pro-
gram was successfully expanded during the crisis to cover 83 percent of
school-age children in 2000, up from only 45 percent in 1998/99. More
than three-quarters of beneficiaries come from the poorest 40 percent of
the quintile distribution. The program initially consisted of a breakfast
snack, but beneficiaries now either receive nutritional complements at
breakfast or at lunchtime, or both in some cases. The program expansion
has been made possible with support of the World Food Program. There
has been no formal impact evaluation of the program. The breakfast
snack provides 272 Kcal per day and the lunch snack 600 Kcal per day,
respectively, about 15 and 33 percent of daily nutritional requirements.
The program is rated to positively influence school attendance and nutri-
tional intake, but its precise impact is unclear. It is also not known
whether school meals have acted as actual nutritional supplements for
most beneficiaries or replaced meals at home.
Both the large projects intended to improve education quality-
PROMECEB in rural areas and EB/PRODEC in urban areas-have also
been well targeted, but their coverage has been limited and their benefits
have chiefly been in the improvement of infrastructure and quality of
education, rather than nutrition. The educational reform program for
urban areas is financed in part with World Bank loans, but was being
phased out in 2000/2001. A second phase, under the new name MOD-
ERISE, was to start with Japanese aid resources in 2002. The rural pro-
gram is funded with loans from the IDB, and has operated from 2000
onwards under the name Redes Amigas. Both programs are of utmost


Table 4.11 Ecuador: Coverage and Targeting: Programs for School-Age Children
Coverage&     Coveragea                                                       Unit
Program                    1999         2000         Targeting mechanism         Targeting             cost
School Meals             648,600       128,469     School map and poverty   76% of              US$0.13 per snack
(45% of school- (16% of rural    map (SISVAN) to iden-    beneficiaries in     day; US$0.25
age children)    students)     tify parroquias with     1st and             per lunch/day
high malnutrition        2nd quintile
Rural education       -  128,469          NA       School map               58% of              US$145/student
PROMECEB/           (16% of rural                  (PROMECEB); self-        beneficiaries in    per year
Redes Amigas)          students)                   selection (Redes Amigas)  poorest cantons
Urban Education          198,065          NA       School map               Low inclusion       US$108 per
(EB/PRODEC and, (17% of urban                                               error -             student per
from 2002,             marginal                                                                 year
MODERISE)              students)
Child Labor               12,335          NA       Geographic - largest     NA                  US$45/child per
(Nifios Trabajadores)  (8% of target               urban centers; census                        year; US$200
group)                    of working children                          per child per
year for children
in dangerous
occupations
Cash transfer                -             -       SELBEN poverty map       In principle        US$5 per child
(Beca Escolar)                                     (geographic) and means   to poorest          per month with
testing in selected     (pilot               max. of two
parroqufas with highest  started second      beneficiaries
basic needs shortfall.   half of 2001)       per household
a. Coverage in absolute number of beneficiaries. Coverage as percentage of target population is in parentheses.
Sources: World Bank 2000, Vos and others 2000, and SIISE estimates.


160                          CRISIS AND DOLLARIZATION IN ECUADOR
importance to reduce dropout rates and improve educational quality.
Qualitative, internal evaluations suggest that the impact of these pro-
grams has been moderately positive. Yet, their limited coverage, principal
focus on improving the quality of school inputs, and large turnover of
program staff, imply that the impact overall probably has been rather
limited. Also, for the same reasons, the programs are not designed as a
response to crisis situations and also do not address the problem of access
to and demand for education services that were exacerbated as a conse-
quence of the economic crisis. Finally, the child-labor program run by
INNFA appears to be well targeted and relatively inexpensive, but its
impact has not yet been evaluated.
In 2001, the government introduced a new cash-transfer program con-
ditioned to school attendance, the Beca Escolar. The program is modeled
after experiences elsewhere, such as similar programs in Brazil, Hon-
duras, and Mexico. The program was the subject of policy discussions in
early 1999, but disagreement within the Ecuadoran government and
with multilateral agencies (World Bank, IDB) about the pertinence and
appropriate design of the program led to its delayed introduction.
Hence, the program did not constitute an immediate safety net during
the crisis. The program started in 2001 with a pilot of around 22,000 ben-
eficiaries (children between 6 and 14 years old) and should reach about
250,000 beneficiaries in primary school by the end of 2002. This target
population is about 50 percent of the extremely poor and 20 percent of
the poor children in the 6-14 age group. The targeting mechanism is a
combination of geographical targeting based on composite poverty char-
acteristics and individual means testing in (extreme) poor areas selected
through the geographical targeting mechanism. The targeting therefore
differs from that used for the other cash-transfer program, the Bono Sol-
idario. A new information system called SELBEN is being set up to opti-
mize targeting efficiency and allow for impact assessment and
monitoring of beneficiaries over time. Beneficiaries are selected with
preidentified poor parroquias (communities, the lowest administrative
unit of Ecuador's political system) based on an extreme poverty (desti-
tution) index (SELBEN index). Each beneficiary household receives a
cash transfer of US$5 per month, per child, subject to a proof of school
attendance (at least 90 percent of regular class time). The school director
provides the transfers, and households may receive transfers for up to
two children per family.
The impact evaluation of the Bono Solidario suggests that the size of
transfer could be sufficient to ensure permanence in the educational sys-
tem of children of poor families, despite the fact that the size of the trans-
fer is below the direct and indirect costs of schooling in the first two
quintiles (see above). That evaluation also suggested, however, that the


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION              161
positive impact on school attendance of the Bono Solidario is more signif-
icant for the moderately poor than for the extremely poor. If this conclu-
sion is correct, the Beca Escolar could become a useful complement to the
Bono Solidario program, because the extreme poor form the main target
group of the scholarship program. Nonetheless, it is likely to be difficult
to probe this in practice, since the' targeting mechanisms between the
two programs differ, and matching of relevant information for both
groups of beneficiaries may turn out to be difficult. Hence, it may be dif-
ficult in practice to fully assess the joint impact of both programs. The
same problem applies to combining information on these programs with
that of the school meals program., The Beca Escolar thus adds a new
instrument, which can help increase school attendance and reduce
human-development losses during crisis periods. At the same time, one
cannot but observe that the introduction of the new program is typical
of Ecuador's overall design of its social safety net: a large set of large and
small programs that are not well coordinated, with both gaps and dupli-
cations, and whose joint impact is difficult to assess and monitor.
SOCIAL INFRASTRUCTURE. The Ecuadoran government runs several pro-
grams that simultaneously generate temporary employment and pro-
vide social benefits to the poor, including the indigenous poor. The FISE
finances community social-infrastructure projects. Special entities,
COPEFEN and CORPECUADOR, have been created for the reconstruc-
tion and rehabilitation of infrastructure affected by the 1998 El Niflo.
There are also infrastructure components within the programs of the
Ministries of Education, Health, and Social Welfare that could contribute
to employment generation. Another obvious source of public infrastruc-
ture investment is the Ministry of Public Works, although its work tends
to be large-scale and more physical rather than human-capital-intensive.
The Ministry of Urban Development and Housing also invests signifi-
cant amounts in public-housing construction. Finally, municipal govern-
ments carry out infrastructure projects that improve water, sanitation,
local roads, and other facilities that may benefit (but are rarely targeted
to) the poor.
Although these programs have potential for generating employment
for the poor, by 2001 the government only had the beginning of a more
comprehensive strategy to organize these programs to explicitly
address the objective of public employment generation. The Employ-
ment Plan 2001-2006 envisages a broad range of actions, partly build-
ing on the institutional infrastructure of existing programs to be used
for expanding public employment in the short run (CIE 2001). A special
interministerial conunittee was set up in early 2001 to coordinate
actions to enhance employment creation through existing public invest-


162                           CRISIS AND DOLLARIZATION IN ECUADOR
ment plans in infrastructure (roads, housing, FISE), as well as through
several new schemes of microcredits and vocational training.
6. Future Prospects
A government strategy to offset the effects of the crisis would need three
basic components: (a) protection of basic and targeted public services, (b)
income or consumption support for vulnerable groups, and (c) new or
expanded programs to prevent the crisis from doing permanent and
irreparable harm to the poor. Elements of a social-protection strategy
already exist in Ecuador. Ecuador's record to date on expenditure pro-
tection is mixed, however. Some targeted programs have been protected,
while basic health and education services have not.
The Bono Solidario should be converted into an efficient income-assis-
tance program with higher benefit levels targeted on the very poor, with
mechanisms to increase coverage rapidly in times of crisis. However, the
large number of beneficiaries in the program, the depth and length of the
crisis, and the high costs of raising benefit levels have made it-fiscally and
politically difficult to make the required adjustments in the short term. In
practice, the budget of the program has declined since the first year of its
introduction (from 1.3 to 0.8 percent of GDP between 1999 and 2001) and
further cuts were announced for the 2002 budget. An alternative would
be to improve the targeting of the program and to introduce tightly tar-
geted programs that complement and build on the Bono Solidario. These
complementary programs would provide cash transfers tied to changes
in household behaviors to enhance protection of poor children. The pro-
grams could be implemented during the current crisis and downsized or
eliminated afterwards, depending on evaluations of their effects on the
welfare of the poor.
The Beca Escolar has been introduced as a cash transfer tied to
enhanced protection of school-age children. As analyzed earlier, its tar-
geting is not closely tied to the Bono Solidario, although its intended
effects could in part duplicate the observed positive impact of the Bono
Solidario in terms of raising school attendance. Another complement to
the Bono Solidario is a microcredit program to be introduced in 2002.
This program is targeted at beneficiaries of the Bono Solidario and other
extremely poor beneficiaries to be selected through the SELBEN infor-
mation system. These credits should support the development of
household firms and thus the income-earning capacity of the poor.
Credits are to be supplied through a new network of financial interme-
diaries. It is hoped the microcredit scheme will induce increases in pro-
ductive investment and, over time, reduce dependence of beneficiary
families on the Bono Solidario. The projected program size (84,000 bene-


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                 163
ficiary households by 2004), is relatively small, however, and will pro-
vide access to credits to less than 10 percent of Bono Solidario beneficia-
ries. Another complement to the Bono Solidario could be an additional
cash transfer conditional on routine health clinic visits to protect the
health of the most vulnerable of the poor-pregnant and lactating
women and children under two years of age. This option, however, has
not been pursued.
Another option for providing income support would be to introduce a
temporary public-employment program. This type of program would be
difficult to design and implement quickly, especially given the fragile
financial conditions of the municipal governments and NGOs that would
be expected to provide counterpart financing. For the medium term,
however, a temporary public-employment program could be designed
"to be taken from the shelf" in the event of a new crisis. For the short
term, a practical strategy for generating employment would be to
enhance activities of the existing FISE and several existing social infra-
structure projects to prioritize labor-intensive projects, increase the share
of costs financed by the central government, and modify procurement
and other regulations to facilitate implementation.
Several policy options could be considered to provide income support,
prevent irreversible physical and mental losses among children under
two years of age, and to limit losses in human capital. These policy
options would be targeted to especially vulnerable groups. In addition,
short- and medium-term strategies could be developed to improve social
protection.
In developing strategies to respond to crises, governments have several
options. One option is simply to protect public spending on basic services
and on services targeted to the poor, to ensure that the coverage and qual-
ity of these services does not deteriorate and thereby exacerbate the adverse
effects of the crisis on the poor. Another option is to provide a safety net for
those most affected by the crisis to ensure that their consumption does not
fall below some minimum level. Safety nets should be easily and quickly
implementable, able to provide benefits quickly, and be temporary and
counter-cyclical, phasing out as the crisis recedes. Argentina's temporary
public-employment program, Trabajar, is an example of a safety-net pro-
gram that meets these standards. A third option is to respond to the crisis by
expanding existing programs or introducing new ones to prevent irrepara-
ble harm to the poor. These programs may also address structural causes of
poverty and thus be part of a longer-term overall poverty-alleviation strat-
egy as well. Increasing efforts at poverty alleviation also serve to ameliorate
the effects of the crisis on the poor. An example of this third option would
be introduction of a new or expanded school-lunch program, which would
be expected to continue past the crisis.


164                           CRISIS AND DOLLARIZATION IN ECUADOR
Few programs are pure safety-net or pure poverty-alleviation in prac-
tice. Temporary employment programs may include training to improve
employability of unskilled laborers. Poverty-alleviation efforts, such as
new nutrition programs, also provide crisis relief in the form of increased
consumption. In recent years, many countries have implemented new
hybrid programs combining crisis relief and poverty alleviation, includ-
ing Mexico's Progresa, Honduras's PRAF, and Brazil's Bolsa Escolar. These
programs provide cash transfers or vouchers conditional on families
enrolling children in school or regularly taking children to health-care
clinics.
Options for Ecuador's crisis-response strategy include initiatives that
(a) ensure that basic and targeted services continue to function, (b)
improve income support for vulnerable groups, (c) prevent irreversible
losses in physical and mental development, and (d) prevent irreversible
losses in human capital. The strategy should also comprise macroeco-
nomic policy considerations (including wage policies) and reforms to the
social-security system.
PROTECT SPENDING AND REDUCE POORLY TARGETED PROGRAMS. Ensuring
that basic and targeted services continue to function typically means pro-
tecting precrisis expenditure levels. For a country such as Ecuador, which
has a fiscal crisis, high debt service, and-with dollarization-dimin-
ished availability of discretionary resources, it is difficult to protect all
programs that benefit the poor. Top priority should be given to programs
that provide benefits targeted to the poor, especially the most vulnerable
groups, and to those programs that provide important public goods to
society at large (for example, malaria control). Secondary priority should
go to programs providing untargeted basic services, and lowest priority
should go to nonbasic services that disproportionately benefit the non-
poor. In the case of Ecuador, such a strategy would imply prioritizing
protection of expenditure on ECD programs (Operaci6n Rescate Infantil,
ORI, of the Ministry of Social Affairs, Programa de Desarrollo Infantil, PDI,
of INNFA, and Nuestros Niflos) targeted to pregnant mothers and young
children and programs targeted to poor families with school-age children
(Bono Solidario, Beca Escolar, school meals, child labor), as well as on pro-
grams with large externalities (immunizations, malaria control). To a
large extent, since 1998 Ecuador has set its priorities in just this way. The
speed of response, however, has been rather slow for political and insti-
tutional reasons, and the coherence among the programs does not seem
to have been strengthened.
Ecuador has adequately protected those programs providing basic,
untargeted services, such as basic education and basic health. Although
the government is no longer deferring the pay of civil servants, rising


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                 165
salary arrears in much of 1999 resulted, in major disruptions in the deliv-
ery of basic services to the poor and nonpoor alike. Furthermore, at the
same time that delivery of basic social services was being cut, untargeted
subsidies (reemergence of energy price' subsidies) were rising to a signif-
icant percentage of GDP. Ecuador's experience has provided convincing
evidence of the need to protect the earnings of civil servants who provide
basic social services.
IMPROVE INCOME SUPPORT FOR VULNERABLE GROUPS. Although the Bono Sol-
idario was not originally designed as an income-maintenance program,
the crisis has led beneficiaries to view it as such. The analysis above
revealed several deficiencies in the Bono Solidario as an income-mainte-
nance program: (a) a high percentage of the eligible poor do not receive
it, especially the elderly and rural poor; (b) a somewhat smaller percent-
age of the ineligible population do in fact receive it; and (c) its value is
small relative to the extreme poverty line and relative to the needs of the
extreme poor. Table 4.12 below shows estimates for the costs of three
options to improve the Bono Solidario's targeting and impact. Option 1
would extend coverage to all the eligible poor without making any
changes in targeting. Option 2 would not change the overall expenditure
but would target it to the subindigent poor (that is, households with no
more than half the maximum eligible income level of US$100). The result
of Option 2 would be an increase in the monthly payment to $36 per
household. Option 3 would increase the amount of the Bono Solidario
stipend to $36 for the subindigent poor: and, also, retain all current bene-
ficiaries at the monthly benefit levels that existed as of April 1999.
The size of the Bono Solidario program in terms of number of benefi-
ciaries means that any significant changes in coverage, targeting, or ben-
Table 4.12 Ecuador: The Annual Cost of Alternative Coverage,
Level, and Targeting Changes in the Bono Solidario (in US$)
Option                Description                          Total
1     Extend coverage to all eligible poor              $333m
2     Target Bono Solidario only to the' subindigent poora  $212m
3     More than double benefit levels to eligible subindigent
poor and retain existing benefit levels for the
nonsubindigent                                    $377m
a. Increase Bono Solidario level to $36/month for mothers and to US$18/month
for the elderly.
Source: World Bank 2000.


166                          CRISIS AND DOLLARIZATION IN ECUADOR
efit leVels yield large changes in the annual expenditure of the program.
Improving targeting and dropping large numbers of ineligible beneficia-
ries from the program in a time of economic crisis is politically difficult.
On the other hand, simply increasing coverage and benefit levels is very
costly. The described options are all well above the actual budget for the
Bono Solidario in 2001 and 2002.
Given the time and political capital required to adjust the targeting of
the Bono Solidario, the best short-term option may be simply to maintain
its real value, while designing the changes that should occur in the
medium term. Although the preferred medium-term option depends on
what other changes are made in government programs benefiting and
protecting the poor, serious consideration should be given to restricting
coverage to the subindigent poor, raising their benefit levels, and improv-
ing targeting to reduce leakage of benefits to the ineligible. Given the con-
clusions regarding the impact of the Bono Solidario on school enrollment
among the moderate poor, however, such re-targeting should only be
considered in conjunction with the envisaged target population of the
Beca Escolar.
IMPLEMENT WORKFARE. An alternative to cash transfers would be a public-
employment program that pays below market wages and targets through
self-selection. One model of such a program is Argentina's aforemen-
tioned Trabajar program, introduced in 1997 after the national rate of
unemployment reached 17 percent and the unemployment rate of the bot-
tom decile reached 40 percent, a situation not dissimilar from that in
-Ecuador. The Trabajar program invites local community groups (munici-
palities and/or NGOs) to submit project proposals, which are evaluated
by the program in terms of location (priority is given to poorer geographic
areas), public benefits resulting from the project, and the capacity of the
sponsoring agency to implement the proposed project.11 Argentina's fed-
eral government finances all labor costs, while sponsoring agencies
finance all other project costs. To use self-targeting, the program set the
wage rate at two-thirds of the average wage rate for the poorest decile in
the Buenos Aires metropolitan region. The project was under implemen-
tatioh six months after the beginning of planning. Eighty percent of the
participating workers in Trabajar came from the bottom quintile.
A workfare program for Ecuador could have a design similar to Traba-
jar, with the central government financing all labor costs, municipalities
and NGOs financing nonlabor costs, and targeting done via self-selection
with a wage rate set at half the minimum wage rate (US$120 as of 2002)
for the lowest quintile. Assuming -the program would pay a wage of
US$60 per month and would cover enough workers (100,000) to reduce
the urban unemployment rate by 1 percentage point, its annual cost


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                167
would be approximately US$ 362 million (2.0 percent of 2001. GDP), with
US$72 million paid in salaries to workers.
Although the cost of workfare is an important deterrent, to its adop-
tion, two other factors may be even more important constraints. First,
unlike Argentina, Ecuador has no prior experience implementing a
national program of this scope and' has a proportionally much larger
informal sector. It will take time to build up capacity to run such pro-
grams, and the typical self-targeting nature of the program could be less
effective in the presence of a large number of people in. underemploy-
ment and insecure self-employment activities. Second, partly because of
accumulated arrears in central-government transfers owed them, munic-
ipalities lack the capacity to finance nonlabor costs. Therefore, in the
short term at least, the central government would need to pay a very high
percentage of the total costs of the program. Third, aside from the large,
urban centers of Cuenca, Guayaquil, and Quito, municipal governments
have limited experience in managing;social projects.
IMPROVE SOCIAL INFRASTRUCTURE PROGRAMS. A short-term option available
to the government to generate employment is to provide financing and
regulatory changes to permit more rapid execution of existing social
infrastructure programs managed by the FISE, CORPECUADOR, and
various ministries. The government also could reduce arrears in transfers
to the municipalities, which are required to spend a significant. share
(about one-third) of their revenues on capital formation. If implemented,
these various programs could generate as many as 28,000 temporary new
jobs annually. Ecuador's experience to date with the FISE, however, indi-
cates that reaching this target might be difficult (Vos and others 2000)
The government opted in 2001 for a more comprehensive approach to
employment generation through public investment programs, social
housing projects, the FISE, as well as through microcredits to small enter-
prises and the enhancement of vocational training programs., Much of
this Employment Plan (see section 5) will be embedded in existing or
planned actions, but will be coordinated by an Interministerial Commis-
sion for Employment with the involvement of local governments and
NGOs. The plan envisages generating a total of 2 million new and
improved jobs between 2001 and 2006 at a total budget of US$524 million.
This employment target seems rather optimistic and ambitious given
experiences elsewhere and the institutional constraints indicated above.
Yet the broader framework could be a meaningful start. The Employment
Plan's responsiveness to short-term employment problems caused by
shocks and crises is less clear. Greater incentives for employment gener-
ation through the FISE, road construction and maintenance, and so on,
could constitute elements for short-term employment creation.


168                           CRISIS AND DOLLARIZATION IN ECUADOR
PREVENT IRREVERSIBLE LOSSES IN PHYSICAL AND MENTAL DEVELOPMENT.
Ecuador's current programs to address the nutritional and health needs
of poor pregnant women and mothers-mainly PACMI (now PANN)-
are woefully inadequate, addressing only about 5 percent of the mal-
nourished target group and only 4 percent of women and mothers in the
bottom quintile. Although the guarantee of free maternity care may
improve this situation for some, in and of itself it does not ensure that the
poor will use public health-care facilities, which are sometimes costly to
access; nor does it provide additional income that could be used to pur-
chase nutritional supplements.
One proposal, early on in the crisis, was to address this unmet critical
need by providing a financial incentive in the form of a nutritional
voucher or cash transfer for pregnant women and women with children
aged 0 to 24 months to enable them to regularly visit public or private
health-care facilities (Vos and others 2000, World Bank 2000). Patterned
loosely after Honduras's PRAF program, the financial incentive would
take the form of a cash transfer to eligible mothers who visit public health
posts for regular checkups and well-baby care. Evidence from surveys of
how mothers use the Bono Solidario suggests that a high percentage of the
transfer would go to food (Le6n 1999). This evidence could suggest as
well, however, that the existing cash-transfer program, if targeted better to
the extreme poor, might achieve an impact similar to that of a nutritional
voucher and avoid the proliferation of a large number of cash-transfer
programs. In any case, the idea of a nutritional voucher never received
much political support and is no longer on the social policy agenda.
ENSURE SCHOOL ATTENDANCE AND ENROLLMENT. Like Brazil, Honduras,
and Mexico, Ecuador introduced a cash-transfer program to poor families
to keep their children enrolled in schools. The Beca Escolar was introduced
in late 2001 when the economy was back in recovery and some of the cri-
sis-induced poverty increase had been reversed. In the meantime, the
unconditional cash-transfer program (the Bono Solidario) apparently
served, unintentionally, to protect school attendance among the poor. The
Beca Escolar could take over this role, possibly with greater effectiveness
and targeting efficiency. However, as the evaluation of the impact of the
Bono Solidario suggested, it may well be that in the short run, the role of
the Beca Escolar should be complementary to the Bono Solidario in order to
protect the extreme poor. If, however, the targeting of the Bono Solidario
were improved and focused more on reaching the poorest people, it
could result in reduced protection of school attendance among the mod-
erate poor. Consequently, there is a need for much closer coordination of
the targeting mechanisms of both programs. The Beca Escolar is targeted
at the poor population in primary schooling age (6-14 years). If it proves


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  169
successful, expansion of the coverage of the program to also protect sec-
ondary school attendance could be considered. As with the Bono Solidario,
however, fiscal constraints could impede sufficient expansion of the Beca
Escolar, particularly in times of crisis when coverage and benefit levels
may need to be increased. Financial mechanisms, such as a fiscal revenue
stabilization fund (including oil revenues), should be put in place that
could protect (and expand) targeted social spending during economic
downswings.
ENSURE QUALITY OF IINSTRUCTION. One hypothesis as to why parents fail to
send their children to school is that they do not perceive that schooling
has a high payoff. One contributing factor to this perception is the low
quality of schooling itself. Teachers who have to travel to rural schools
from urban areas are frequently absent on Mondays and Fridays. Teach-
ers have inadequate teaching materials, and children often lack the basic
required textbooks. In short, both the effective quantity of instructional
time and the quality of that instructional time are often lacking, resulting
in children not learning adequately. A school scholarship program that
ensures that children attend school will do them little service if issues of
instructional time and the quality of instruction are not also addressed.
The Beca Escolar should help to increase school attendance (presuming
any design would require students, to attend as well as to enroll in
schools). According to the 1998 ECV, children age 6 to 11 years and 12 to
14 years in the bottom two consumption quintiles fail to attend schools
a total of 4.6 and 5.8 days, respectively, per month. However, only 1.3
and 1.6 days, respectively, are missed for reasons under household con-
trol. The two most important reasons for nonattendance that lie outside
the control of the household are weather and nonattendance by the
teacher. While little can be done about the weather, reduced teacher
absenteeism could significantly increase school attendance and, thus,
learning by children.
Financial incentives, to ensure teacher attendance in difficult areas
(either rural areas where commuting is difficult or marginal urban areas
where teaching conditions are difficult) could reduce the number of
school days missed by students and, as a result, raise learning and school
productivity. Evidence from other couitries (for example, Mexico, El Sal-
vador) suggests that communities can effectively monitor teacher atten-
dance, and teachers respond strongly to a financial incentive. The design
of the Beca Escolar does not explicitly consider such supply-side consid-
erations. Also, no explicit link has been made with the programs of edu-
cational reform (Redes Amigas and MODERISE).
In short, school scholarships can inprove attendance, but they cannot
ensure the quality of schooling. Coordination with educational reform


170                           CRISIS AND DOLLARIZATION IN ECUADOR
programs needs to be pursued to ensure that the demand subsidy does
not lose effectiveness because of a supply-side failure.
7. Strategic Options
Like many other developing countries, Ecuador faces an uncertain future.
Crises of different origins-external economic shocks, natural disasters,
policy mistakes-will continue to occur. With fewer degrees of freedom
for cushioning shocks through stabilization policies in a dollarized econ-
omy, shocks will have a stronger impact on production, employment, and
welfare of the population than before. Thus, it is imperative that the gov-
ernment have a coherent strategy to protect the most vulnerable groups
in society and to prevent permanent harm to those likely to be most
affected. This strategy should establish clear priorities for expenditure
protection and also should include programs that could be quickly intro-
duced or expanded. Important elements of that strategy already exist in
Ecuador; however, it still lacks adequate coverage, coordination between
the components, and adequate flexibility to respond to crisis conditions.
Table 4.13 below summarizes (a) the elements of the government's cur-
rent strategy, (b) changes that might be introduced in the short term to
improve protection, and (c) changes that might be introduced in the
medium term to improve protection against future crises and to sustain
current efforts.
Short-term improvements to social protection could include implement-
ing a geographically targeted Bono Materno-Infantil, introducing a Beca
Escolar and a minimum package of school supplies, and providing financ-
ing to implement and enhance existing civil-works programs. In the
medium term, coverage of the Bono Materno-Infantil would be increased
using proxy means tests for targeting, the Beca Escolar program would be
expanded to include lower-secondary students, and the coverage of the
elderly by the Bono Solidario would be significantly improved. In addition,
the Bono Solidario itself would be adjusted to allow higher benefit levels to
be paid to a smaller number of beneficiaries, at no net increase in total
spending. The Employment Plan provides useful starting points for greater
stimulus for remunerative employment generation in the short and
medium run. The plan is unlikely to reach its ambitious employment tar-
gets given existing institutional weaknesses. Moreover, overall economic
growth is not yet strong enough to lead to the booming small-scale enter-
prise activity anticipated to result from the credit scheme. Nonetheless, if
properly funded, the envisaged enhancement of public investment in
physical and social infrastructure and the new criteria for employment
generation through such programs could provide a basis for greater
responsiveness to cushion the social effects of job losses during crises.


Table 4.13 Strategies for Social Protection
Target group    Current strategy as implemented  Short-term additions to the current strategy  Medium-term improvements
Pregnant women, Basic package of health services  Improve access to and quality of health  Improve public health organi-
mothers,         including key public health     of basic clinical services in poorest   zation and financing to sus-
Children < 2     interventions (immunizations,   parroquias; introduce Bono Materno-     tai improved services to
years            micronutrients) and basic       Infantil (BMI), targeted to poorest     poor; increase coverage of
clinical services in poorest    parroquias.                              BMI using proxy means test.
parroquias.
Children 3-5     Increase coverage of ECD        Increase rate of growth of coverage of  Ensure ECD coverage reaches
years            programs, basic package of      ECD; improve access to basic clinical   rural poor.
health services.                health services.
School-age       Maintain very small child labor  Ensure improvements in supply and      Expand Beca Escolar to sec-
children         scholarship program and high    quality of educational services, giving  ondary level: provide school
coverage of school meals;       initial priority to areas with concen-   materials-to primary and-sec-
implement quality improvements tration of beneficiaries of Beca Escolar.  ondary schools in areas with a
in primary schools in poor areas.  Seek coordination with existing       high incidence of extreme
Introduction of broader primary  programs for educational reform.        poverty; improve education
school fellowships program (Beca                                         organization and financing to
Escolar) targeted at the extreme                                        broaden and sustain quality
poor in 2001.                                                           improvements.
Elderly          Maintain eligibility for        Increase real value of Bono Solidario   Reduce targeting errors of
Bono Solidario.                 to elderly. Consider expansion of        Bono Solidario to elderly.
eligibility to elderly with regular     Reform social-security system.
pension incomes, but below poverty
line (new poor).
(Table continues on thefollowing page.)


Table 4.13 (continued)
Target group    Current strategy as implemented  Short-term additions to the current strategy  Medium-term improvements
New poor         None.                           Create public employment by             Improve criteria and ensure
implementing existing civil-works       funding mechanisms for
programs. Reduce vulnerability through  (enhanced) civil works invest-
vocational training and targeted credit  ment for short-term employ-
supplies to labor-intensive production  ment generation during crisis
activities. Employment Plan 2001-2006   periods. Reform social-
provides framework.                     security system.
All poor         Bono Solidario.                 Maintain real value of the Bono Solidario.  Re-target Bono Solidario using
proxy means test; reduce
coverage and increase benefit
level.
Expenditure      None; permits serious           Ensure timely pay of essential civil     Protect key nonpersonnel
protection for   erosion in service quality.     servants and ensure minimum level of     expenditures. Develop macro-
broad-based                                      nonteacher inputs.                       strategy of fiscal stabilization
social services.                                                                          fund to smooth and protect
social expenditures over time.


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                173
Improvements in social-protection programs, several of which could
receive external financing, would almost assuredly prove unsustainable
in the medium to long term in the absence of reforms in the organization,
financing, and delivery of social services. In general, these reforms would
entail changing the way public expenditures are managed, delegating
decisionmaking and granting more managerial discretion over personnel
and budgets at the point of service delivery; developing alternative ser-
vice delivery arrangements, such as contracts with NGOs and the private
sector; and developing the capacity to monitor and evaluate programs
and policies.
Institutional stability is another prerequisite of more effective social
policies and social protection. Since 1988, successive governments in
Ecuador have tried to establish a coordination platform within the cabi-
net and with associated entities, the Secretaria Tgcnica del Frente Social
(STFS). This entity has been created and recreated in many incarnations
since then. During the crisis in 1999 it was first abolished, then recreated
as a new body, and subsequently made part of a super-ministry of
Human Development, integrating all major social-sector ministries. This
new institutional structure was abandoned again within a year, and the
STFS was reinstated in August of 2000. While some technical capacity to
support policy design has been built up, the institutional setting is still
too weakly defined to play an effective role in strengthening the greatly
needed coordination of social policies and monitoring of their impact. In
July 2000, the government created the Social Protection Program as a new
semiautonomous institution linked to the Ministry of Social Affairs. This
program is to administer all types of social-protection programs and cur-
rently manages the Bqno Solidario, the Beca Escolar, and the microcredit
program. It is unclear how this new institution will coordinate with other
areas of social protection and broader social policies, nor does it seem to
strengthen the role of the STFS. More pervasive, but sustainable institu-
tional reforms seem to be required.
Finally, the effectiveness of a social safety net as described cannot be
separated from other areas of economic and social policy. Poor macro-
economic policies leading to collapses in domestic demand or inflation-
ary pressures may cause more damage to living standards through job
losses and real income declines than*any safety net could "repair." With
the dollarization of the economy, Ecuador has fewer degrees of freedom
for anticyclical macro policies and will have to rely on foreign borrow-
ing and assistance to be able to pursue such policies in the face of
adverse external shocks. Those resources are obviously limited. Domes-
tically, mechanisms need to be designed to facilitate consumption
smoothing over time for the economy as a whole. A stabilization fund
for oil and other government revenue could help achieve greater stabil-


174                            CRISIS AND DOLLARIZATION IN ECUADOR
ity in public spending and provide a basis for sustaining adequate
expenditure levels for basic social-service systems and targeted social-
protection programs, and even allow for their expansion in times when
needed- most. Social-security reform still has a long way to go in
Ecuador, but a properly funded expansion of the system should eventu-
ally enable it to become the backbone of the social-safety net. In the short
run, however, further reliance on essentially tax-based cash and in-kind
transfer programs targeted to the vulnerable population will be needed.
The major challenge is to bring greater coherence to that system and
greater flexibility to respond to the inevitable economic volatility
Ecuador will face in the future.
Notes
The authors are grateful to the Sistema Integrado de Indicadores Sociales del Ecuador
(Integrated System of Social Indicators of Ecuador, SHSE) project team, in partic-
ular Mauricio Le6n, Wladymir Brborich, and Juan Ponce, as well as to the staff of
the Instituto Nacional de Estadistica y Censo (National Institute 6f Statistics and
Census [INEC]), particularly Csar Amores, Julio Eduardo Encalada, Alba Perez,
and Stalin Ramos, for support in providing the basic data used and analyzed in
this chapter.
1. Based on Living Standards Measurement Study (LSMS) survey data for pop-
ulation as a whole. The name of the Ecuadoran LSMS survey as referred to in the
text is Encuesta de.Condiciones de Vida (ECV). When using data from labor force
surveys (for urbarf areas only), income inequality increased even more steeply
between 1995 and 1999 (from 0.50 to 0.54)
2. - The.Gini for per-capita consumption increased from 0.43 to 0.47 between
1995 and.1999
3. These are the Foster-Greer-Thorbecke (FGT) measures with a = 1 and a = 2,
respectively.
4. The estimates are based on a simple estimation of per-capita household
incomes with and without remittances, ignoring possible household responses to
receipt of these private transfers (such as reduced labor supply or reduced
reliance on other transfers or.safety nets). See Vos and de Jong (2001).
5. The changes in malnutrition should be regarded with some caution given the
sampling error margin for this iariable in the LSMS surveys.
6. Only 5 percent of the population with access to general social health insur-
ance belong to the poorest 20 percent. Two-thirds belong to the upper 40 percent
of welfare.distribution.
7. Data from the labor force surveys show. that in urban areas the difference in
terms of years of schooling attainment in urban areas has stabilized around 0.7
years more education on average for men. (See SIISE 2000 and Le6n and Vos 2000).


ECUADOR: CRISIS, POVERTY, AND SOCIAL PROTECTION                  175
8. Social public spending includes central government spending on education,
health, social welfare, housing and urban development, labor and employment
programs and, from 1999, the cash-transfer program (Bono Solidario). It does not
include social security benefits, or special social funds such as FISE and solidari-
ty fund. It also does not cover social spending by local governments. Except for
social security, none of the excluded spending items are very important in size rel-
ative to the central government budget.
9. The program also supports handicapped individuals, but the main focus is
on poor mothers and the elderly The benefit for disabled people is the same as
that for the elderly. As analyzed in Vos, Le6n, and Brborich (2001), the purchas-
ing power of the cash transfer dropped by almost 50 percent between early 1999
(when the program coverage reached completion) and June 2000. Adjustment
thereafter allowed for a recovery, and by February 2001 it was back at the pur-
chasing power of March 1999, but some 15,percent below the initial value at the
introduction of the program. By the end of 2001, the purchasing power was
almost one-quarter below its initial value.
10. The analysis of the paragraphs below draws on Vos, Le6n, and Brborich (2001).
11. World Bank reviews of workfare programs show they typically spend about
US$4 to transfer US$1 to the poor through employment; hence, the projects have
to create assets with large public benefits to be economically feasible.
References
The word processed describes informally reproduced works that may not
be commonly available through libraries.,
CEPLAES. 1999. "Estudio cualitativo del impacto social de la crisis."
Quito: Secretaria de Estado de Desarrollo Social (SEDES). Processed.
CIE. 2001. Plan Nacional de Empleo 2001-2006. Comisi6n Interministerial
de Empleo, Quito. http://www.frentesocial.ec-gov.net.
Le6n, Mauricio. 1999. "Anilisis de la encuesta de beneficiarios del bono
solidario." Sistema Integrado de Indicadores Sociales del Ecuador
(SIISE). Quito: Secretaria de Estado de Desarrollo Social. Processed.
2001a. "La migraci6n internacional reciente: algunos interro-
gantes." Revista Gesti6n 90 (December):46-8.
2001b. "La inversi6n social." Quito: SIISE. Processed.
Le6n, Mauricio, and Rob Vos. 2000. La pobreza urbana en el Ecuador,
1988-98: Mitos y realidades. Quito: Abya-Yala Publishers.


176                          CRISIS AND DOLLARIZATION IN ECUADOR
SIISE. 2000. Sistema Integrado de Indicadores Sociales del Ecuador. Versi6n 2.0.
Quito: SISE (database on CD-Rom; website: http://www.siise.gov.ec).
Vos, Rob. 2000a. "Economic Liberalisation, Adjustment, Distribution and
Poverty in Ecuador, 1988-99. ISS Working Paper No. 311. The Hague:
Institute of Social Studies. Forthcoming in Vos, Taylor, and Paes de
Barros, 2002.
_. 2000b. Development and the Colour of Money. Should Developing
Countries Have Their Own Currency? The Hague: Institute of Social
Studies.
Vos, Rob, and others. 2000. Ecuador 1999: Crisis Econ6mica y Protecci6n
Social. Quito: Abya-Yala Publishers.
Vos, Rob, and Niek de Jong. 2001. "The Quality of Growth, Urban
Poverty and Inequality during Crisis: Ecuador 1997-2000." Paper pre-
sented at Special Development Economics Seminar in Honor of
Graham Pyatt. The Hague: Institute of Social Studies.
Vos, Rob, Mauricio Le6n, and W1adymir Brborich. 2001. "Are Cash
Transfers Effective in Reducing Poverty? Ecuador's Bono Solidario
Program." Quito, The Hague: SIISE and Institute of Social Studies.
Processed.
Vos, Rob, Lance Taylor, and Ricardo Paes de Barros, eds. 2002. Economic
Liberalisation, Distribution and Poverty: Latin America in the 1990s.
Cheltenham: Edward Elgar (forthcoming).
Vos, Rob, Margarita Velasco, and Edgar de Labastida. 2000. "Los efectos
econ6micos y sociales de El Niflo, 1997-98," In Enrico Gasparri, Carlo
Tassara, and Margarita Velasco, eds., El Fen6meno de El Nifio en el
Ecuador, 1997-99. Quito: Ediciones Abya-Yala, pp. 27-121.
World Bank. 2000. Crisis, Poverty and Social Services in Ecuador. Human
and Social Development Group, LAC Region, Report 19920-EC.
Washington, D.C.: World Bank.


5
Gender Dimensions of
Vulnerability to Exogenous
Shocks:
The Case of Ecuador
Maria Correia
1. Introduction
While Ecuador has experienced economic deterioration for most of the
past two decades, the country's macroeconomic and financial situation
has been further aggravated by the extensive damage caused by El Niflo
rains in the first months of 1998; external shocks in East Asia, the Russian
Federation, and neighboring Brazil; sharply declining petroleum export
prices; and the collapse of Ecuador's banks (see chapter 2). Ecuador's real
GDP declined sharply in 1999 and recovered only marginally in 2000.
Ecuador's crisis has had a prolonged and massive human cost. Dam-
age caused by El Nifho, for example, had devastating consequences for
the poor living in affected coastal areas, destroying homes and agricul-
tural property and causing large-scale unemployment. Large segments
of the population suffered significant income losses, and unemployment
and underemployment increased. Unemployment has fallen heavily on
the poorest groups: Among the poorest 20 percent of the population, the
unemployment rate in November 1998 was 21 percent, which was
almost double the then national average. In real terms, the income of a
typical worker earning the minimum wage in the formal sector declined
10 percent from March 1998 to March 1999. Inequality also increased in
a country that already had one of the highest levels of inequality in Latin
America. The Gini coefficient increased more than 4 percentage points
from 0.42 in 1994-95 to 0.47 in 1998 (Coraggio, Larrea, and SAnchez
Maria Correia is a Lead Specialist on gender issues at the World Bank. The author
gratefully acknowledges Wendy Cunningham and Maria Elena Ruiz Abril, both
of the World Bank, for providing valuable inputs and feedback.
177


178                          CRISIS AND DOLLARIZATION IN ECUADOR
2000). And poverty-based on the headcount of people unable to buy a
basket of basic goods-increased from 34 percent in 1995 to 46 percent in
1998, 55 percent in 1999, and 66 percent in 2000.1 Poverty in Ecuador is
highest among the indigenous and among those living in rural areas: the
rates were 76 and 73 percent, respectively, in 1995.
Macroeconomic and financial crises of the type Ecuador has experi-
enced can affect men and women in different ways, primarily as a result
of their distinct biological and societal-based gender roles. The litera-
ture on this topic, however, is weak empirically. It also focuses almost
solely on women to the exclusion of men. Much of the literature points
to the unequal burden of crises on women that result from the intensi-
fication of their work in the household and labor market (Moser 1992;
Beneria 1992, 1996; Elson 1992. For its part, the World Bank's 2000
World Development Report on poverty refers to the retrenchment of
female public-sector workers and the increased incidence of domestic
violence during economic downturns (World Bank 2000d). But more
recent studies on gender and the household effects of crises in Latin
America point to the household as the only refuge during periods of
adjustment and cuts in social services, with men and women playing
distinct household roles during these periods (Cunningham 2001;
World Bank 2001).
This chapter examines men and women's socioeconomic conditions in
Ecuador with a view to understanding vulnerability and declines in well-
being by gender during exogenous shocks and structural adjustment. The
chapter is based largely on a 1999 World Bank report on gender issues by
sector in Ecuador-issues that to a large degree have been aggravated or
worsened by Ecuador's economic stagnation during 1980-2000.2 The dis-
cussion here is framed around the concept of gender and household vul-
nerability to shocks, given data limitations on actual impacts by gender.
Section 2 defines the concept of vulnerability and establishes a framework
for examining gender and household vulnerabilities. Section 3 uses the
framework to explore the differentiated effects of Ecuador's crises on
women and men, and section 4 provides some examples of how
Ecuador's institutional framework affects vulnerability by gender. Finally,
section 5 summarizes findings and discusses broad policy implications.
This analysis suggests important gender and household effects of
crises. Women's and men's human capital has eroded in different ways
during the crisis. For example, boys have been forced to enter the labor
market to compensate for declining household incomes: In addition,
increased unemployment among men and their inability to meet the
societal expectations of being the family provider have, among other
things, been linked to increased crime and insecurity and have had neg-
ative consequences on men's health. At the household level, as families


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         179
have restructured or disintegrated and domestic,violence has worsened,
household capital has eroded during Ecuador's crisis. On the other
hand, households have also acted as insurance mechanisms during
shocks, for example, by taking on other family members and by mobi-
lizing the labor of wives and children. In terms of the effects of
Ecuador's institutional framework, such government programs as the
Bono Solidario, the Rural Development Program, and public childcare
programs have had important gender dimensions and have affected vul-
nerabilities and well-being. This chapter offers three broad sets of policy
recommendations to reduce gender vulnerabilities to exogenous shocks:
(a) strengthen family and household capital; (b) address the distinct
labor-market needs of household members; and (c) strengthen social
capital.
2. Assessing Vulnerability to Exogenous Shocks:
A Framework
Vulnerability to exogenous shocks is not synonymous with poverty.
Glewwe and Hall (1998) make the distinction between poverty and vul-
nerability by giving the example of market-induced shocks, which, while
affecting many segments of the population, tend to have limited impact
on remote rural communities because these are subsistence-based and
not in the market economy. But while poverty and vulnerability may not
be the same, it would be accurate to say that Ecuador's poor tend to be
more vulnerable for a number of reasons. First, they tend to live in areas
that are more prone to natural calamities. Second, they tend to have less
access to assets with which to manage risks. Third, they tend to have less
time to invest in social capital. And, fourth, they have less political capi-
tal and thus receive fewer social services after a disaster or during peri-
ods of crisis (Alwang and Siegel 2000).
Vulnerability depends on three factors: risk, exposure, and the ability
to respond to a crisis (Alwang and Stiegel 2000). Risk, which is exogenous
to the decisionmaker, is characterized by a probability distribution of
events, which can vary on the basis of their magnitude (including size
and spread), their frequency and duration, and their history. Exposure, in
contrast to risk, is endogenous and is dependent, at least in part, on ex-
ante risk management at the individual, household, and higher levels.
Lastly, vulnerability is dependent on the capacity to adapt or respond to
the realization of a risky event that has a negative outcome.3
In recent years, an important body of literature about rural develop-
ment has explored the processes by 'which people enter into and over-
come poverty, as well- as those factors determining people's
vulnerability (Scoones 1998; Moser 1998). The framework sustaining


180                           CRISIS AND DOLLARIZATION IN ECUADOR
this chapter is inspired in the theoretical constructions of Sen's (1993)
capabilities approach and the Sustainable Rural Livelihoods Frame-
work (Scoones 1998), but is modified to take better account of gender
and urban (as well as rural) dynamics. According to this approach, an
individual or household's level of risk, exposure, and ability to respond
to a negative shock are influenced by the production inputs they pos-
sess or have use of and control over; the constraints and opportunities
they face in acquiring production inputs; and the constraints and
opportunities they confront in transforming these inputs into well-
being (see figure 5.1). Production inputs include: (a) the labor provided
by individuals and households; (b) land, natural resources, and raw
materials; and (c) capital, defined as the inputs or investments made for
future productivity and well-being. Capital can be further disaggre-
gated into:
* human capital, which refers to the endowed abilities of an individual,
for example, formal education, job experience, and health care;
* household capital, which comprises the human capital of its members,
the physical capital of the household, and the household's social capi-
tal (intrahousehold trust, norms, and relations);
* social capital, which refers to "features of social organization such as
trust, norms and networks, that can improve the efficiency of society
by facilitating coordinated actions" (Putnam 1993);
* political capital, which refers to the accumulated influence of an indi-
vidual or group that can be used to affect a political process; and
* physical capital, which refers to physical goods that have been pro-
duced and are used in a further production process.
Lastly, the labor market, credit institutions, government services, the
political system, legal and regulatory systems, social systems (including
socially ascribed gender roles), and so on provide the institutional frame-
work that facilitates or constrains individuals and households as they
transform production inputs into well-being.
Thus, by examining both gender differences in the ownership, use,
and control over production inputs and the institutional framework
required to transform inputs into outputs, vulnerability to shocks by
gender and by the gender composition of the household can be
assessed. Based on information availability, the rest of the chapter does
just that but with a focus on the following production inputs: human,
household, and political capital, labor, and land. To the extent that
information permits, actual impacts of the crisis by gender are also cited
and discussed.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         181
Figure 5.1 Factors Affecting Vulnerability to Exogenous Shocks
transformation        2M
INSTITUTIONAL CONTEXT
that facilitates/constramnts
transformation process
3. Gender and Household Vulnerability in Ecuador
3.1 Human Capital
Education
Education not only increases labor market returns, but it also allows indi-
viduals to adapt more efficiently and, effectively to crisis and uncertainty
(Glewwe and Hall 1998). The better educated tend to use assets more effi-
ciently; have greater capacity to obtain information, credit, and other
productive resources; and are better able to exploit new income opportu-
nities (Glewwe and Hall 1998). Thus, differences in educational attain-
ment and literacy are important in determining men's and women's
vulnerability and that of the households to which they belong.
Both men and women in Ecuador have low educational attainment
rates, although on average men still have higher education levels than
women: 7.4 years for men versus 7.0 years for women according to the
latest LSMS 98 data (CONAMU/INEC 1999). Differences are more sig-
nificant in rural areas (4.1 years for women compared with 4.7 years for
men) according to LSMS 95.4 Regioral differences in education are also
significant. In the Sierra region, 58 percent of men and 48 percent of
women do not complete primary education, and less than 10 percent of


182                          CRISIS AND DOLLARIZATION IN ECUADOR
both men and women have access to secondary education. The gender
education gap is particularly high in the Oriente, where on average
women complete 3.5 years of schooling compared with 5.9 years for men.
Among the indigenous, women in the Sierra have an educational attain-
ment rate of 1.4 years compared with 2.4 years for men.5
Illiteracy, which increases vulnerability, also tends to be more common
among women, the indigenous, and rural dwellers. National illiteracy rates
are 12 and 8 percent for women and men, respectively, according to LSMS
98 data, and substantially higher in rural areas (21 percent for women and
15 percent for men). Indigenous populations overall are more likely to be
uneducated, with the gender gap being greater among the indigenous: 53
percent of indigenous women are illiterate compared with 35 percent of
men.6 Illiteracy also varies by region. The largest gaps are in the Sierra
region, where more than a quarter of women--compared with 14 percent
of men-cannot read or write. But the gender gap is not only to women's
disadvantage. In the Costa region, men-who have one of the highest illit-
eracy rates in the country among identifiable region/gender groups-are
at a disadvantage compared with women in both urban and rural areas.
But although male educational attainment is greater overall, boys have
higher school repetition and dropout rates. At the national level, boys
make up about 54 percent of students who have repeated a grade and 62
percent of school dropouts (CONAMU/INEC 1999). And in urban areas
more than 75 percent of school dropouts at the primary level are male
(CONAMU/INEC 1999). Variations exist, however, with female dropouts
exceeding those of males in urban areas in the 25-and-over age category,
presumably because of marriage. Also, girls outnumber boys who repeat
at the primary level in urban areas (CONAMU/INEC 1999).
Gender roles, as well as poverty, affect girls' and boys' educational
attainment in Ecuador. For girls, domestic work, a traditional female role,
is the most important reason for not attending school. The need to perform
(paid) work, a conventional male role, is the primary reason boys fail to
enroll in school, followed by age and cost of education, according to LSMS
98 data. And anecdotal information indicates that in the Costa region, boys
are being forced to abandon studies to enter the paid work force at a rapid
rate because of the current economic crisis. Six case studies carried out in
rural and urban areas of Ecuador confirm that, particularly in urban areas,
women are improving their educational attainment vis-A-vis men because
men need to start working at an early age (CEPLAES/EB-PRODEC 1999).
Health
Health status affects human capital, productivity, income-earning capac-
ity, and thus vulnerability. Men and women are exposed to different


GENDER DIMENSIONS OF VULNERABILITY-TO EXOGENOUS SHOCKS           183
health-related problems over their lifetimes. Distinctions emerge during
adolescence, with women's health status affected mainly by childbirth
and reproductive health-re;ated illnesses. Men are more likely to be
injured and to die from accidents and violence. For both men and
women, crises affect the quality and coverage of health-care services,
with rural areas being more disadvantaged.
FEMALE HEALTH VULNERABILITIES. Maternal mortality has delcined steadily
over the past few decades in Ecuador, but it remains relatively high.
According to 1994 data, the maternal mortality rate fell from 302 per
100,000 live births during 1981-87 to 159 during 1988-94.7 But there are
regional variations. From 1981 to 1994, for example, the maternal mortal-
ity rate was 250 per 100,000 for the Sierra compared with 197 per 100,000
for the Costa region. More recently, maternal mortality reportedly
reached 310 per 100,000 in rural areas of Cuenca.8
The primary cause of maternal mortality and morbidity is inadequate
quality and coverage of prenatal and natal care, which tends to deteriorate
during periods of crises and macroeconomic adjustment. Social-sector
expenditure for health was predicted to decline 5 percent in real terms from
1998 to 1999 (World Bank 2000a). Less-educated and rural women have the
least access to maternal health care and thus are most susceptible to health-
related problems. For example, 50 percent of rural women have fewer than
five prenatal care visits during pregnancy, and 60 percent have not received
an antitetanus vaccination, which can prevent serious infection and so
reduce maternal mortality. Similarly, more than 60 percent of women with
less than primary education make fewer than five visits to a medical facil-
ity per pregnancy, and half of these women have not been vaccinated.9
Maternal mortality and morbidity are also related to adolescent preg-
nancy, high fertility levels, and birth spacing, with women who have
more than four children or who have spaced their pregnancies less than
24 months apart considered at-risk. For example, in 1998, out of 480 cases
of maternal death, 230 were adolescent women.10 Given that teenage
pregnancy and high fertility are more prevalent in rural areas and among
women with little or no education, poorer, less-educated women would
be at greater risk of maternal illness and death. Only 8 percent of mater-
nal deaths occur because of complications resulting from abortion, and
the majority of these are spontaneous.1 And available information sug-
gests that increased poverty and vulnerability is not associated with
maternal mortality caused by induced abortion.12
Adolescent fertility, which is associated with maternal mortality and is
higher among lower socioeconomic groups, continues to be widespread
in Ecuador. About 32 percent of all Ecuadoran women age 18-19 have
already been pregnant, according to the Demographic and Maternal and


184                         CRISIS AND DOLLARIZATION IN ECUADOR
Child Health Survey (ENDEMAIN) for 1999. Level of education is a key
determinant of early pregnancy. At the national level, 38 percent of
women age 24 have been pregnant, but the proportion jumps to 59 per-
cent for women with no education (compared with 19 percent with post-
secondary education). According to data from the early 1990s, adolescent
pregnancy in Ecuador is higher than the average for Latin America and
the Caribbean (FLACSO 1992). During that period, Ecuador recorded 79
births per 1,000 adolescent women compared with an average of 68 births
for the region.
Although it has increased, access to and use of contraceptives remains
low in Ecuador among lower socioeconomic groups. In 1994, 57 percent
of all women of reproductive age used some form of contraceptive
(ENDEMAIN 94) compared with 66 percent in 1999 (CEPAR 2000 based
on ENDEMAIN 99).13 Contraceptive use, however, varies by level of edu-
cation and rural versus urban residence. In 1999, only 46 percent of
women with no education used some form of contraception compared
with 79 percent of women with a postgraduate education; in rural areas
the proportion was 58 percent compared with 71 percent in urban zones.
Overall in 1999, only 6 percent of women had problems accessing family
planning, but the proportion was as high as 26 percent among women
with no education and 18 percent among women from Amazonia.14 By
level of activity, women who work in farming and natural resources have
the highest need for family planning: the proportion is 20 percent com-
pared with 4 percent for those women classified as "professionals, direc-
tors and administrators."
MALE HEALTH VULNERABILITIES. As previously noted, men are more sus-
ceptible to mortality and morbidity from precarious behavior, accidents,
violence, substance abuse, and depression. In 1989, mortality rates from
external factors-including traffic accidents, homicides, and suicides-
were 92 per 100,000 for men and 22 per 100,000 for women (in the 15-24
year age group) and 145 and 17 (in the 25-44 year age group) for men and
women, respectively. In 1996, men made up 73 percent of accident fatali-
ties. Also noteworthy is the number of homicides among men, which rose
from the fourth cause of death among men in 1994 to the second in 1996.
According to Pan American Health Organization (PAHO) statistics,
Ecuador's homicide rate was 10.3 per 100,000 people in the late 1980s and
early 1990s, having increased over the previous decade from a rate of
6.4.15 Statistics confirm that 92 percent of all victims of 1992 homicides in
Ecuador were men and that accidents and homicides were by far the
most serious health risks for young men age 15-24 years (FLACSO 1992).
Depression, according to PAHO (1998b), is on the rise in Ecuador and in
1996 was one of the primary reasons men sought medical care. In 1995,


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         185
9.2 per 100,000 male inhabitants were hospitalized for depression (PAHO
1998b). Studies on disasters and coping have found that while both men
and women feel the psychological effects of crisis, women display their
stress more openly, whereas men's anxiety is exhibited more indirectly
through destructive behavior (for example, violence and alcoholism).
This difference is probably the result of socialization processes, which
inhibit men from expressing their feelings (Correia 2001).
The incidence of substance abuse and alcoholism-which predomi-
nantly affects men, particularly those in lower socioeconomic groups-
has likely intensified during Ecuador's prolonged economic crisis. In
addition to being important health issues, alcoholism and substance
abuse are associated with low productivity, violence and homicides, fam-
ily breakup, precarious behavior, traffic-related fatalities, and suicides.
But despite concerns over their prevalence and consequences, alcoholism
and substance abuse remain relatively unresearched problems. A Min-
istry of Public Health national survey conducted in 1985 indicated that
just under 8 percent of the population over age 15 years were alcoholics-
92 percent of whom were men-making it one of the primary causes of
male morbidity (Aguilar 1986).16 And alcoholism is a poverty issue.
According to the same study, risk factors associated with alcoholism
included (a) being a small-scale worker (agriculture and nonagriculture),
salaried, semisalaried, or underemployed; (b) belonging to a large family;
(c) being from a lower-income group; (d) having no education, primary
education, or partially completed education; (e) having a history of men-
tal health problems; and (f) being from a family with high levels of con-
flict (Aguilar 1986). A similar survey carried out in urban Cuenca in 1979
indicated that 9 percent of the population over age 15 years was alcohol-
dependent, and of those, 90 percent were men. Twenty percent of respon-
dents of a PAHO survey stated that they had been drinking in excess the
month prior to being surveyed (PAHO 1998b). In terms of alcoholism
among youth, a more recent 1998 study of 220 poor urban-based adoles-
cents indicated that males were twice as likely to consume alcohol as
females (61 percent versus 29 percent) (Programa del Muchacho Traba-
jador 1998).
According to the WHO, men often view alcohol consumption as a
form of relaxation or stress management as well as a reaction to such
negative external factors as job loss or hopelessness (Pyne, Claeson, and
Correia 2002). A Costa Rica Demographic Association study on alco-
holism indicates that a relationship exists between machismo, alcohol use,
and dangerous behavior, including unsafe sex (Madrigal and Schiffer
1992, cited in Pyne, Claeson, and Correia 2002). As a sign of adulthood,
young men are under great pressure to demonstrate courage and capac-
ity for physical combat and pain. Drinking excessively, as well as getting


186                          CRISIS AND DOLLARIZATION IN ECUADOR
drunk quickly, celebrates courage and solidarity among young men.
Homicide, brutal fights, and suicide are not considered acceptable
behavior among young men, but as outcomes of drinking they became
more tolerable.
Dangerous behavior, violence, and substance abuse among men are
likely to have increased during Ecuador's most recent crisis given the
frustrations that unemployed and underemployed men face when unable
to meet the societal expectations of being providers and protectors. In
1998, following flooding caused by El NifRo and the influx of migrants
from affected areas, the municipal government of Guayaquil was forced
to impose an extended state of emergency because of increased delin-
quency and crime. Data collected between 1988 and 1992 in Cisne Dos,
Guayaquil, indicated that women perceived that male drinking had
increased because of deteriorating economic conditions (Moser 1997).
Whereas drinking was identified as a problem among husbands, women
identified drugs as a problem among sons. Moreover, data indicated that
the community perceived a direct relationship between the growth in
drug use and the increase in street gangs and robberies (Moser 1997).
Thus, people's human-capital endowments-and, as a corollary, well-
being-are differentiated on the grounds of gender. In Ecuador, women's
and men's access to schooling, and educational-attainment levels,
dropout rates, and repetition rates are influenced, among other things, by
societal-based gender roles and expectations. As for health status, biolog-
ical and social factors affect women's exposure to health risks in the form
of maternal mortality and teenage pregnancy and men's exposure to sub-
stance abuse, violence, and their consequences. Moreover, there is some
evidence that men and women's human-capital accumulation has been
negatively affected in different ways because of the crisis in Ecuador.
3.2 Household Capital
Household characteristics affect vulnerability and the capacity to cope
with external shocks and uncertainty. For example, the ability to mobilize
and transform labor into income and well-being often depends on house-
hold structure, composition, and decisionmaking (Moser 1997; Cunning-
ham 2001). By taking on additional family members and by assigning
members to the workforce, households act as insurance mechanisms and
reduce vulnerability (Glewwe and Hall 1997). But if household members
are not employable for any reason-for example, because of age or gen-
der-they can increase dependency and, in turn, intensify vulnerability
(Glewwe and Hall 1997). And the relationship between household capi-
tal and exogenous shocks is not unidirectional. Crises also have the effect
of eroding household capital and coping capacity.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         187
Household Headship and Structure
Households that declare female headship-while increasing in number-
are not necessarily poorer than male-headed households. Overall, house-
holds with female heads now constitute about 19 percent of all households
(LSMS 98).17 At 21 percent, the proportion is greater in urban areas than
rural areas, where the proportion is about 15 percent (LSMS 98). Contrary
to conventional wisdom, however, female-headed households are not
poorer than male-headed families. This finding is consistent with poverty
findings in other countries (for example, in Nicaragua, El Salvador, and
Panama). According to LSMS 95 data, households headed by middle-aged
males in common-law marriages and households headed by widows are
significantly more likely to be poorer than other types of household in
both urban and rural areas (World Bank 1996). One explanation for this
finding is that female-headed households have a lower dependency ratio
than those headed by men.18 This is true in the case of Ecuador where,
according to LSMS 98 data, only 45 percent of female-headed households
have more than three children, compared with 70 percent of households
declaring male headship. Also, poverty analysis demonstrates that the
likelihood of being poor in Ecuador increases if the spouse or partner of a
household head is not active in the labor force, which would be the case
in many male-headed households (World Bank 1996).
But while female-headed households are not necessarily poorer than
other types of households, they may be more vulnerable in a number of
ways, for example:
* Female-headed families tend to be single-parented compared with
male-headed households, which typically have two spouses. In the
case of Ecuador, 89 percent of households that declare themselves
male-headed have a spouse present, whereas the proportion is only 6
percent in the case of female-headed households (LSMS 98). As single
parents, female-headed households thus often rely on only one adult
salary.
* In households with single mothers, domestic responsibilities cannot be
shared with other adult family members. Thus, households typically
spend a greater proportion of resources to purchase goods and ser-
vices (Geldstein 1997).
* Because of the double workload of productive and domestic responsi-
bilities, single mothers dedicate fewer hours to remunerated work,
and seek jobs offering greater flexibility but not necessarily the best
salaries, benefits, and opportunities for promotion.
* The intergenerational transfer of poverty is more typical in families
headed by women (Geldstein 1997).


188                           CRISIS AND DOLLARIZATION IN ECUADOR
* In the case of Ecuador, females heading households tend to be less
educated than their male counterparts. According to LSMS 98, 16 per-
cent of female heads and 7 percent of male heads have no education.
During periods of crisis, families are more apt to restructure as a cop-
ing strategy or as a direct consequence of the crisis. Factors giving rise to
household restructuring include marital conflict; childcare and depen-
dent parents; access to housing, employment, or job loss; changes in
income; and access to education and health (Moser 1997). Types of house-
holds that can result include (a) households led by older divorced or sep-
arated women who take on other relatives because they are unable to
survive alone; (b) extended households as a consequence of young, sin-
gle mothers having failed in a union and returning to the home of their
parents; (c) families who come together to share a house on a temporary
basis because of economic hardship; and (d) split households resulting
from urban-rural male migration, giving rise to female de-facto house-
hold heads (Moser 1997).
Household Size
Children and other dependents can reduce household financial security
(Schiller 1995) and thus increase vulnerability. The effects of more chil-
dren include an increased need for household income, constraints to
women entering the labor force, and increases in childcare and other
domestic work. In terms of the gender-differentiated effects for women,
more children means fewer opportunities to participate in economic
activities and generate income, with corollary implications for their nego-
tiating power in the household. The presence of young children also
affects the type of work that mothers can take on, for example, flexible or
contract work in the informal sector (Cunningham 2001). Moreover,
higher fertility, including reduced spacing, makes women more suscepti-
ble to illness related to maternity (see the section below on human capi-
tal). For men-who, as in other countries, are considered the main
breadwinners-more children means greater pressure to increase pro-
ductivity and income, which, in turn, can have negative consequences if
men are unable to fulfill this role (for example, because of alcoholism,
violence, delinquency, or depression).
Poorer households in Ecuador tend to have more children (World
Bank 1996), which is consistent with findings for other countries in Latin
America and the Caribbean.19 National statistics suggest progress in
decreasing fertility. Overall rates dropped from 5.3 in 1982, to 4.0 in 1990
(PAHO 1998a) and to 3.4 between 1994 and 1999 (CEPAR 2000).20 Global
rates, however, mask a high variance that is strongly correlated with


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         189
years of education, rural/urban residence, and ethnicity. According to
ENDEMAIN 99, women with university and postgraduate education had
a fertility rate of only 1.9 compared with those with no education at all,
who had a fertility rate of 5.5.21 And the urban fertility rate was only 2.8
compared with 4.4 for rural areas. As for regional differences, at an aver-
age fertility level of 5.5 children, Amazonia continues to have the highest
rates, followed by the Sierra with 3.6. High fertility levels are associated,
among other things, with problems in accessing family planning meth-
ods and information, in particular among lower socioeconomic groups
and rural inhabitants.
Household Relations and Domestic Violence
Domestic violence can be a consequence of economic crisis and, by eroding
household capital, can lead to increased vulnerability. The incidence of
domestic violence is high in Ecuador compared with other countries in
Latin America and the Caribbean. Vega and Gomez (1994, cited in World
Bank 1996) estimated the rate of domestic violence to be 58 percent in Quito
and an alarming 80 percent in Guayaquil. In contrast, sample surveys on
domestic violence in the region found that the proportion of women who
had experienced physical violence was 11 percent for Chile, 20 percent for
Colombia, 10 percent for Costa Rica, and 9 percent for Paraguay (Heise,
Pitanguy, and Germain 1994, as cited in Morrison and Biehl 1999).2 The
most recent statistics on domestic violence in Ecuador are those compiled
by ENDEMAIN 99, which indicate that at the national level, physical abuse
is the most common form of domestic violence (24 percent), followed by
threats (18 percent), and hurling of objects (16 percent) (CEPAR 2000). Irre-
spective of the type of violence, violence was found to be associated with
lower levels of education (Morrison and Biehle 1999).
At the individual level, in addition to having experienced or witnessed
violence as a child, determinants of violence include being a young male,
belonging to a low socioeconomic group, being unemployed or underem-
ployed, having low levels of education, and having abused alcohol or
drugs (Buvinic, Morrison, and Shifter 1999). In terms of the gender dimen-
sions of violence, aggression among men has been associated with male
gender roles and expectations, and in particular the inability of men earn-
ing low incomes to live up to societal and familial expectations of being
full income earners (Barker 1998). When these goals become difficult to
achieve, men regularly assert their masculinity through violence (Barker
1998). Thus, as male unemployment and underemployment increase dur-
ing periods of macroeconomic crisis and uncertainty, domestic and other
forms of male violence are expected to increase. Moser (1997) observed
these patterns in her community-based research in the barrio of Cisne Dos,


190                          CRISIS AND DOLLARIZATION IN ECUADOR
Guayaquil. She noted that escalating crime and violence is a result of
increasing unemployment, particularly among young men. Women inter-
viewed in Cisne Dos identified a direct relationship between declining
male earnings, increasing domestic violence and, in many cases, alcohol
abuse.
Household factors found to contribute to domestic violence include
the degree of crowding, household per-capita income, and dynamics and
norms (egalitarian or authoritarian) at the household level (Buvinic, Mor-
rison, and Shifter 1999). For example, a cross-cultural study of 90 societies
showed that societies with high levels of domestic violence were also
societies with authoritarian household norms, where men are dominant,
and where there is social acceptance of the use of physical violence
(Levinson 1989, cited in Buvinic, Morrison, and Shifter 1999). Feminist
writers and activists have long pointed to unequal gender relations as a
key determinant of violence against women. In the United States, for
example, a national family violence survey conducted in 1975 found that
violence against wives was most likely to occur when wives were both
economically and psychologically dependent on dominant spouses
(Levinson, 1989, cited in Buvinic, Morrison, and Shifter 1999). Indeed, all
other factors being held constant, domestic violence against women is
more likely to occur in poorer households, which suggests (a) that
poverty is a cause of violence or (b) that greater stress, uncertainty, and
declining economic conditions lead to aggressive behavior among those
predisposed to violence.
The practice of physical punishment of children by parents and rela-
tives-both male and female-is widespread throughout Latin America
and the Caribbean, and Ecuador is no exception. Physical punishment
affects both boys and girls and, as previously noted, its long-term effects
include acceptance of the use of violence (both in terms of inflicting and
enduring violence) and the production of intergenerational cycles of vio-
lence. Child sexual abuse, on the other hand, mostly affects girls. Of sexual
abuse reported in Quito and Guayaquil, 69 percent involved girls between
the ages of 10 to 19 years and 80 percent of these girls were abused by a
father, relative, friend, or someone known by the victim (Camacho 1996).
Although sexual abuse is mostly directed at girls, boys are also victims.
Less help is available for sexually violated boys or young men, however,
because cultural norms surrounding manhood make it difficult for boys
and young men to come forward and report sexual violence.
In terms of reducing household capital, domestic violence increases
women's susceptibility to illness and reduces their productivity and
income-generating capacity. Violence also has important multiplier
effects. For example, women who are less productive earn less income,
which, in turn, leads to lower consumption spending and lower levels of


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         191
aggregate demand (Buvinic, Morrison, and Shifter 1999. Also, as previ-
ously noted, domestic violence has important intergenerational effects
because children who are abused and observe chronic abuse have a
greater propensity to behave violently or be involved in some form of
interpersonal violence than children who do not experience violence
(Buvinic, Morrison, and Shifter 1999).
On the whole, household size and composition influence people's abil-
ity to adapt to crisis. Moreover, intrahousehold gender dynamics, and its
extreme manifestation in the form of domestic violence, deteriorate
women's and children's assets with which to respond to exogenous
shocks, thus making them more vulnerable to crisis. In parallel, some of
the processes derived from the Ecuadoran crisis, such as unemployment,
seem to pose stress on men's behavior and foster violence inside and out-
side the household-with negative consequences for women's and men's
well-being.
3.3 Political Capital
Female political capital in Ecuador has increased. Four factors have con-
tributed to women's greater influence over political processes. First, insti-
tutional and legal reforms have been significant. For example, the
National Office for Women was established in the Ministry of Welfare in
1980; the National Office for Women became the National Directory for
Women (DINAMU) in the Ministry of Social Welfare in 1986; women's
police stations were created in 1994; the Law on Violence Against Women
and the Family was passed in 1995; the Equal Opportunities Plan was
approved in 1996; DINAMU became the autonomous National Council
for Women (CONAMU) under the presidency of the Republic in 1997; the
Free Maternity Law was approved in 1998; and also in 1998, a new con-
stitution was approved that guarantees equal rights to women and men
in areas such as education, health, work, and political participation. The
latter also provides a legal framework that facilitates institutionalization
of public policies on gender equity.
Second, female political representation in Ecuador, albeit still low, con-
tinues to grow.23 In particular, the quota of at least 25 percent of women
on electoral lists-which was the initiative of the Parliamentary Com-
mission on Women, Children and the Family-has promoted and facili-
tated a greater gender balance in political participation. Despite this
measure, the gender balance in positions of political leadership remains
heavily skewed toward men, as the following statistics demonstrate:
* Executive Branch: The first woman minister in Ecuador was appointed
in 1979 to head the Ministry of Social Welfare. In 1990, none of the 12


192                           CRISIS AND DOLLARIZATION IN ECUADOR
existing ministries was headed by a woman, but women filled five
subsecretarial posts. In August 1998 women held 3 of the 15 cabinet
posts; in February 1999, 4 out of 15 were women, including the minis-
ter of finance (Fundaci6n Mujer y Sociedad - Woman and Society Foun-
dation 1999, cited in CONAMU/INEC 1999).
* Legislative Branch: In 1998, 20 percent of national congressional repre-
sentatives and 12 percent of provincial representatives were women.
This represents an increase from 1996 when all national representa-
tives were men and only 6 percent of provincial representatives were
female (Fundaci6n Mujer Sociedad - Woman and Society Foundation
1999, cited in CONAMU/INEC 1999).
* Local Government: Figures from 1996 indicate that the following per-
centages of women were elected as representatives at the local level: 1
out of 21 mayors (Prefecto/a), 6 percent of provincial council members
(Consejeros/as Provinciales), 3 percent of council presidents (Alcalde/sa
Presidenta Consejo), and 8 percent of local council members (Concejal/a
Municipal) (Fundaci6n Mujer Sociedad - Woman and Society Foundation
1999, cited in CONAMU/INEC 1999).
* Judiciary: Very few women are represented in the hierarchy of the
courts. In 1999, 1 of 31 supreme court judges (Ministros/as de la Corte
Suprema de Justicia) was a woman (CONAMU, personal communica-
tion). Women's representation at other levels varies. All fiscal judges,
for example, are men and 14 percent of civil judges are women (Con-
sejo Nacional de la Judicatura, Direcci6n Nacional de Personal, cited in
CONAMU/INEC 1999). The largest proportion of female judges is
Juezas/es de Inquilinato, of which 56 percent are female
(CONAMU/INEC 1999).
Third, civil society women's organizations are strong in Ecuador.
These organizations have played a central role in placing women's issues
firmly on Ecuador's social and political agenda. For example, in 1995
these organizations were instrumental in lobbying Congress to approve a
law on violence against women and the family. The creation of DINAMU
(which later became CONAMU) under the auspices of the Ministry of
Social Welfare is another example of the success of the women's move-
ment in influencing public-sector policies for women's development and
gender equity. And CONAMU's board of directors has strong civil soci-
ety participation. In March 1996, the Movimiento de las Mujeres (Women's
movement) presented El Plan de Igualdad de Oportunidades 1996-2000
(Equal Opportunities Plan 1996-2000), which focused on citizenship,
political participation, and representation; the feminization of poverty;
the gender division of labor; labor-market issues; and gender issues in
health and education.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         193
And fourth, the Ecuadoran Government has made advances in main-
streaming gender into its programs. Land and agriculture programs, for
example, have a long history of promoting women's participation. In the
area of justice, gender initiatives have included contracting civil society
organizations to manage the recently established women's police sta-
tions.24 For its part, the Ministry of Education and Culture's program to
eliminate gender stereotypes from books and teaching methods is one of
the first in Latin America and the Caribbean. Water and sanitation is
another sector that has made efforts, to identify and address gender
issues. Yet much remains to be done, which is a challenge in Ecuador's
current economic crisis. Many rural development policies and programs,
for example, have encountered difficulties in dealing with the constraints
and backlash of women's participation efforts, which in some cases has
led to domestic violence and resistance among community members.
Moreover, despite progress, both government extension workers and
rural development NGOs tend to treat men as the principal beneficiaries
of technical assistance in the agriculture sector and tend to offer women
training in health, nutrition, craft production, household gardens, and
small animal production. This continues despite a growing recognition of
women's increasingly important roles in subsistence and commercial
agricultural production as well as the daily management of natural
resources such as soil, water, and fuel wood.
By better defending women's rights and interests, the evolution of
Ecuadoran women's roles in politics, in principle, suggests lower relative
vulnerability of women as a group. The existence of CONAMU, strong
civil society groups representing women, and a new domestic violence
law are examples of the institutional and political structures in place.
Still, female political representation in Ecuador, although it has increased,
is still much lower than that of men, thus increasing the vulnerability of
women as a group.
3.4 Labor
Labor is one of the most important productive inputs of the poor every-
where, given that the poor tend to have less access to human and other
types of capital as well as to production inputs such as land. And in many
countries in the world, families still maintain a traditional division of
labor in which women specialize in home production and men specialize
in market production. Given the unpaid nature of home-based work,
women as a group are thus more vulnerable vis-A-vis employed men.
Also, an individual who, among other things, has obsolete skills, or lacks
skills, experience, and education, or is more susceptible to discrimination,
or has less mobility, and/or has constraints such as household responsi-


194                         CRISIS AND DOLLARIZATION IN ECUADOR
bilities, is less employable, thereby also making the individual more vul-
nerable.
During periods of insecurity and uncertainty, important household
coping strategies include increasing family members' labor-force partici-
pation either by working longer hours at the same job or by mobilizing
new household members-mostly women and boys--to enter the paid
labor force.
Economically.Active Population
In Ecuador, women's participation in the labor force remains, lower than
that of men, even though female participation has increased over the
decades. From 1970 to 1990, the female proportion of the economically
active population (EAP) increased fr6m 14 to 19 percent, whereas the male
proportion decreased from 74 percent to 69 percent. Women's labor-force
participation is greater in urban areas. By 1998,46 percent of urban women
were economically active, the proportion having increased from 44 percent
in 1993 according to NEC. In the same period, the proportion of urban
men who were economically active decreased from 74 to 72 percent.
Unemployment and Underemployment
The crisis has resulted in higher rates of unemployment and underem-
ployment for women. This said, both male and female unemployment
increased in the 1990s by about the same magnitude. The rate of unem-
ployment for women increased from 12 to 16 percent from 1993 to 1998
(CONAMU/INEC 1999), and averaged 18 percent in urban areas of
Quito, Guayaquil, and Cuenca from March 1998 to March 2000 (see table
5.1) (Larrea and Sanchez 2001). Male unemployment increased from 6 to
8 percent from 1993 to 1998 (CONAMU/INEC 1999) and to 10 percent in
the three urban centers of Quito, Guayaquil, and Cuenca from 1998 to
2000 (Larrea'and Sanchez 2001).
Underemployment rates also were greater among women than men
from 1998 to 2000; these rates were 52 percent for women compared with
44 percent for men (Larrea and Sanchez 2001). This relatively unfavorable
situation for women persists even though women have higher education
levels in all employment categories (see table 5.2).
For both women and men, the highest proportion of the unemployed
are those with secondary education; the figures are 60 percent and 59 per-
cent, respectively (see table 5.3). Men with primary education have the
second-highest level of unemployment, whereas, in the case of women,
those with superior education have the second-highest unemployment
rate.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS          195
Table 5.1 Structure of Employment by Sex and Status (Quito,
Guayaquil, and Cuenca Averages from March 1998 to March
2000)
Men        Women        Total
Status                           (percent)   (percent)   (percent)
Unemployeda                         8.1        12.5         9.9
Newly unemployedb                   2.2          5.3        3.5
Adequately employedc               43.1        28.9        37.3
Visible unemploymentd              10.8        19.8        14.5
Invisible unemploymente            30.1        29.1        29.7
Employed, nonclassified             5.8         4.2         5.2
Total                             100.0        100.0      100.0
a. Fired or laid off from work.
b. Never worked but looking for work.
c. Work as much as they would like to; earn at least a minimum wage.
d. Are unable to work the amount of time desired.
e. Work 40 hours a week or more but unable to earn the minimum wage.
Source: INFOPLAN based on Urban Employment Survey (Larrea and SAnchez
2001).
Table 5.2 Average Level of Education of the Labor Force by Sex
and Labor Market/Unemployment Segment (Quito, Guayaquil,
and Cuenca Averages from March 1998 to March 2000)
Men        Women        Total
Labor Market Segment              (percent)  (percent)   (percent)
Modem sector                       11.4         12.8       11.9
Informal sector                     8.6          9.0        8.8
Agriculture                         9.3         10.2        9.5
Domestic work                       7.5          6.4        6.6
Nonclassified                       9.9         11.6       10.4
Total                              10.5         10.6       10.5
Unemployed                          9.9         10.6       10.3
Newly employed                     10.7         10.5       10.6
Visible unemployment               11.7        12.2        11.8
Invisible unemployment              9.9          9.4        9.6
Employed nonclassified              8.7         9.5         9.0
Total                              12.3        12.8        12.5
Source: INFOPLAN based on Urban Employment Survey (Larrea and SSnchez
2001).


196                           CRISIS AND DOLLARIZATION IN ECUADOR
Table 5.3 Unemployed, According to Education and Sex (Quito,
Guayaquil, and Cuenca Averages from March 1998 to March
2000)
Men        Women        Total
Level of Education                (percent)   (percent)   (percent)
None                                 0.8         1.3         1.1
Primary                             23.0        18.1        20.3
Secondary                           59.3        60.1        59.7
Postsecondary                        0.4         0.7         0.6
Superior                            16.1        19.6        18.0
Postgraduate                         0.3         0.2         0.3
Total                              100.0       100.0       100.0
Source: INFOPLAN based on Urban Employment Survey (Larrea and SAnchez
2001).
Informality of Workers
Compared with men, women are more heavily represented in the infor-
mal sector. About 36 percent of the female EAP in urban Quito, Guayaquil,
and Cuenca are in the informal sector compared with 31 percent of men
(see table 5.4). Another 12 percent of women are in domestic services. The
proportion of women working in domestic services increased from 11 to
15 percent from 1998 to 2001, thus suggesting that women use domestic
work as a survival strategy to confront crisis (Larrea and Sanchez 2001).
Table 5.4 Labor-market Segmentation by Sex (Quito,
Guayaquil, and Cuenca Averages from March 1998 to March
2000)
Men        Women        Total
Sector                            (percent)   (percent)   (percent)
Modem sector                        66.1        50.8        60.1
Informal sector                     30.5        36.1        32.6
Agriculture                          1.9         0.8         1.5
Domestic                             1.4        12.4         5.7
Nonclassified                        0.1         0.1         0.1
Total                              100.0       100.0       100.0
Source: INFOPLAN based on Urban Employment Survey (cited in Coraggio et al
2000).


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         197
In urban areas of Ecuador, the informal sector absorbs a larger share of
the poor than the nonpoor labor force (World Bank 1996). In contrast,
informal-sector activity in rural areas is higher for the nonpoor than for
the poor (World Bank 1996). Rural off-farm employment-proportionally
a more important sector for women-plays an important role in supple-
menting income from agriculture, according to Lanjouw (1998). Just
under 50 percent of all rural women in the nonwage labor force have
either a primary or secondary occupation in the nonagricultural sector;
the corresponding figure is 37 percent for men. But women are also sig-
nificantly less likely to be employed in relatively higher-productivity
occupations. According to Lanjouw's analysis, a man is twice as likely to
be in a high-productivity activity than a woman.
The Entry of Wives into the Labor Force during Shocks
Evidence from Ecuador and other countries suggests that as economic
need arises, households respond by sending women into the workforce
to compensate for their husbands' 'unemployment or to supplement
shrinking household income (Moser 1997; Cunningham 2001; World
Bank 2001). This assertion is supported by the fact that more than twice
as many women vis-A-vis men who have never worked are now seeking
work, as shown in table 5.1. Women also make up about half of all work-
ers with no education and, at the other extreme, constitute about half of
those with superior and graduate level education.25 Female participation
is also lower among all workers with primary or secondary education.26
Among unemployed women, wives or daughters predominate; in con-
trast, household heads or sons predominate among the male unem-
ployed (see table 5.5). World Bank studies in Mexico and Argentina have
shown that wives typically attempt to use their labor as insurance when
the risk of a negative shock to income increases, such as during macro-
economic downturns, or in response to actual falls in household income
(Cunningham 2001).
According to Cunningham's analysis of the Mexican labor force, single
mothers begin to work in response to realized negative shocks to income,
but their entry is less elastic than that of wives. On the other hand, simi-
lar to husbands, single women's labor-force entry is not subject to eco-
nomic fluctuations. In the case of Argentina, Gill and Pessino (1998) used
aggregate data to show that labor-force participation rates of Argentine
women, especially young women, are counter-cyclical, that is, women are
more likely to be in the labor market when male unemployment rates are
higher (cited in World Bank 2000c).27 ,
Ecuadoran households unable to mobilize wives' labor tend to be
poorer (World Bank 1996). According to the most recent poverty study in


198                          CRISIS AND DOLLARIZATION IN ECUADOR
Table 5.5 Unemployed Population by Relationship with
Household Head (Quito, Guayaquil, and Cuenca Averages
from March 1998 to March 2000)
Men        Women        Total
Relation                         (percent)   (percent)   (percent)
Household head                     27.0         8.8       17.0
Spouse                              1.2        33.1       18.7
Son/daughter                       57.4        44.6       50.4
Son/daughter-in-law                 2.3         3.6        3.0
Parents or in-laws                  0.1         0.4        0.3
Grandson/daughter                   3.5         1.2        2.3
Other relative                      6.5         6.7        6.6
Not related                         1.9         1.5        1.7
Total                             100.0       100.0      100.0
Source: INFOPLAN based on Urban Employment Survey (Larrea and Sanchez
2001).
Ecuador, the proportion of poor households in which the partner or
spouse-usually a woman-of the declared household head does not
work was calculated to be 32 percent, in contrast to 22 percent for those
households in which the spouse or partner did contribute to household
income through paid employment.
Gender-based Wage Disparities
As evidenced by a persistent wage gap, women as a group are at a dis-
advantage vis-A-vis men in terms of earnings, thereby increasing their
vulnerability. Women's average salaries are about 68 percent of men's,
according to the most recent LSMS 98 data (CONAMU/INEC 1999).28
The gender gap is considerably wider in rural areas, however, with a rate
of 54 percent. The modem sector presents the smallest gap (89 percent)
compared with the informal sector (73 percent) and the domestic service
sector (64 percent). One explanation for the wage differential is that men
and women bring different levels of education and skills to the labor mar-
ket. An analysis carried out by Samaniego, FernAndez, and Pinz6n (1998)
found, however, that even after accounting for as many of,those differ-
ences as possible, differentials still remained between men and women.29
More recent data using urban data from Quito, Guayaquil, and Cuenca
show that women's salaries were 16 percent lower than that of men's
even after controlling for education, work experience, labor market inser-
tion, and position in the household (Larrea and SAnchez 2001).


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         199
Constraints to women's advancement on the job and greater pay are
institutional, and range from discriminatory practices, to attitudes
regarding the appropriateness of men and women holding positions of
power, to women's own reluctance to pursue such positions. For exam-
ple, a 1988 survey carried out in Quito and Guayaquil found that both
men and women considered men more appropriate for supervisory posi-
tions than women (IECAIM 1991). Moreover, 80 percent of those inter-
viewed judged the work of male supervisors to be good; whereas only 58
percent of men and 78 percent of women considered women supervisors
to be performing well (IECAIM 1991). Given that women continue to
bear the burden of care giving and domestic tasks, they are also likely to
seek flexible job situations, making it less likely that they will advance to
higher paying positions with greater responsibilities.
Child Labor
Child labor is both a result and a cause of poverty, to the extent that work-
ing reduces the time that children spend ir school and affects accumula-
tion of human capital. At the national level, 44 percent of boys and 17
percent of girls report work (excluding housework) to be the main reason
for not enrolling in school, according to LSMS 95 data.311 An additional 22
percent of girls mentioned the need to work at home, also according to
LSMS 95. Based on data collected in Cisne Dos, Guayaquil, Moser (1997)
found that poor households use children's labor to reduce vulnerability
in periods of economic crisis. Boys are more likely to earn income directly,
whereas girls tend to assist indirectly, taking on childcare responsibilities
to free women to work (Moser 1997). Although work does not necessar-
ily lead to school dropout, it has an obvious effect on educational perfor-
mance.
Home Production
Housework and childcare-which are for the , most part women's
responsibility in Ecuador-are key constraints to labor-force participa-
tion and income generation. Only 0.5 percent of those who declare
housework as their main occupation are men, compared with 48 percent
of women, according to 1998 INEC data (World Bank 2000a). While this
does not tell us anything about who carries out household activities on
a part-time basis, sources in Ecuador indicate that domestic work and
childcare continue to be mainly female roles, even though some regions
of the country tend to be more egalitarian, for example the Sierra. Child-
care facilities and early childhood education allow mothers and daugh-
ters, who have traditionally been the primary care providers, the chance


200                          CRISIS AND DOLLARIZATION IN ECUADOR
to participate in income-generating activities or go to school. Childcare
facilities are especially important for single mothers who are poor. In a
complementary way, the market for childcare provision creates addi-
tional employment opportunities, primarily for women. Childcare is
particularly important during periods of crisis and uncertainty because
of women's entry into the labor force as a household coping strategy. In
two studies carried out in low-income barrios in Guayaquil, Moser
(1997) found that women faced increasing pressures to earn an income
which, in turn, resulted in less time to dedicate to childcare and domes-
tic responsibilities. She also found that when women with young chil-
dren went to work, they often resorted to locking their children in the
house while they were away, or having older daughters miss school to
care for younger siblings. These data suggest that the positive externali-
ties of ECD programs justify their relatively modest costs.
Ecuador has three main public childcare programs, which are oper-
ated by the Ministry of Social Welfare and INNFA. Municipalities, civil
society organizations, and the private sector also provide childcare. The
public programs include: (a) the PDI, which is operated by INNFA and
provides services in urban marginal neighborhoods; (b) the ORI, which
is run by the Ministry of Social Welfare; and (c) the Ministry of Educa-
tion's Alternate Preschool Program (PRONEPE), which comprises two
urban-based schemes (community homes for children and community
centers for children) and a rural-based community promoter scheme.31
According to a World Bank review of social programs, all three pro-
grams have the advantage of facilitating female labor-force participa-
tion; ORI and PDI also have the advantage of providing nutrition for
children and PDI provides preschool education (World Bank 2000b).
However, programs have low coverage. Also, overlapping services com-
bined with the relatively small scale of programs translate into high
administrative costs, poor planning, and weak management controls
(World Bank 2000b). All three programs are continually threatened by
budget cuts and, in the case of PRONEPE, elimination (World Bank
2000b). A new IDB program called Nuestros Nilos (Our Children) offers
the potential to increase coverage and improve the coordination and
management of ECD services.32
Social Security
Social-security coverage is extremely limited for the population as a
whole but is even more limited for women, thereby increasing their vul-
nerability. In 1998, social security covered only 18 percent of Ecuador's
population, of which 56 percent were men and 44 percent were women
[Fundaci6n Mujer y Sociedad (Woman and Society Foundation) 1999, cited


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS       201
in CONAMU/INEC 1999].3 The gender gap among those who do have
coverage is most probably due to the fact that women are overrepre-
sented in the informal sector or in part-time jobs, while men are more
likely to be in the formal sector. In terms of urban/rural differences, the
existence of farmers' insurance (Seguro Campesino) allows rural families
from the Costa and the Sierra to resort to a minimum of social services, in
contrast to those families in urban areas and in Amazonia who do not
have access to this or other types of insurance.
In sum, women and particularly poor women find themselves in a
more vulnerable position because of their lower participation in the labor
sector. The high proportion of women working in the informal sector,
their lower wages and social benefits, and their home workload also con-
tribute to higher vulnerability. In parallel, the mobilization of women's
labor has proved to be an effective coping mechanism in the event of cri-
sis. Lastly, women have experienced higher levels of unemployment dur-
ing the crisis, which is probably because of the greater number of women
spouses looking for employment.
3.5 Land
Land can be a critical input for production; it can serve as collateral for
loans or can be sold as an asset. Thus, all other things being equal, the
more land owned, the less vulnerable the individual or household. Addi-
tionally, in terms of gender, land access and ownership determine an
individual's ability to bargain over the allocation of labor, income, and
other inputs into household well-being (Doss 1996)-that is, land is
related to household capital. Finally, for elderly men and women, land is
an important source of income security during old age, both directly (as
the basis for agricultural production and/or rental income) and indirectly
(insofar as adult children are more likely to assist their elderly parents if
they can expect an inheritance transfer).
Gender patterns of land ownership in Ecuador vary by region, with
land ownership being much more egalitarian in the Sierra than in the
Costa (see table 5.6). In the case of the former, despite an initial male bias
in land distribution, evidence suggests that traditional forms of equal
male and female inheritance-especially among the indigenous Quichua-
speaking population-have begun to equalize ownership of land-reform
properties, which are now being passed on to a second generation (Doss
1996).34 A detailed study of Cant6n Salcedo in the northern Sierra found
that women were as likely as men to own land, either via inheritance or
purchase. Moreover, men's and women's parcels were roughly equal in
size (about two hectares on average) and deeds of purchase were gener-
ally jointly registered in the names of both husband and wife (Doss 1996).


202                           CRISIS AND DOLLARIZATION IN ECUADOR
Table 5.6 Indicators of Land Ownership in Ecuador
Year     Sample          Women       Men     Couples/Joint  Total
1992-96  Titles issued by  1,596     2,135      8,685     12,416
PRONADER        (13%)       (17%)      (70%)     (100%)
Avg. size (ha)   1.19        0.81       1.21       1.15
1996     Sierra (n = 75)  23%        50%         57%       100%
Coast (n = 75)   6%          66%        28%       100%
Source: Constructed from Deere and Le6n (2000).
A larger survey of more than 32 rural Sierra communities confirms the
norm of equal inheritance to all children, regardless of age or gender: 90
percent of property owners claim that they intend to bequeath their land
equally to sons and daughters. Data from the same set of households,
however, indicate that inheritance practices may tend to favor male heirs:
Of the 158 parcels acquired through inheritance, two-thirds came from
men's families and only one-third from women's (Katz 1999).
Some evidence from the Sierra suggests that women's joint or inde-
pendent land ownership positively influences women's participation in
household decisionmaking, thereby reducing their vulnerability. Draw-
ing on a small sample from rural Salcedo, an innovative multivariate
analysis of the determinants of women's control of economic resources
(land use, household financial management, selection of agricultural
inputs, and the disposition of agricultural products for sale or consump-
tion) suggests that this control increases significantly with women's own-
ership of land (Hamilton 1998).
Gender ownership patterns of the Costa, however, are substantially
less egalitarian than those of*the Sierra. Historically, coastal agriculture
was dominated by cacao until the 1920s, after which rice, sugar, and
bananas became important crops. Land rental (precarismo) and a rela-
tively mobile, temporary agricultural labor force, with little direct
female participation in crop production, characterized the region prior
to agrarian reform. Land-reform legislation affecting the Costa was not
enacted until 1973, and it took' a different form than in the Sierra
(Phillips 1987). Much larger properties (up to 2,500 hectares plus 1,000
hectares of pasture) were allowed to remain intact, and the emphasis
was on formation of cooperatives as opposed to individual parceliza-
tion. Since the reform was geared toward former precaristas and pre-
cluded both spouses from becoming members of the same cooperative
(as well as requiring husbands' permission for wives to become mem-
bers), more than 90 percent of beneficiaries of coastal agrarian reform
were men (Phillips 1987). Evidence suggests that even women socias


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS        203
(cooperative members) rarely work cooperative land themselves, and
that there is a preference for male hired labor over female family labor
during peak seasons. Moreover, unlike the Sierra, it does not appear
that gender egalitarian inheritance customs have reversed the male bias
of the 1970s land distribution. An examination of the property registry
in Cant6n Vinces, Los Rios Province, showed that only 26 percent of all
agricultural production units were owned by women, and in the major-
ity of these cases, brothers or spouses actually managed the land
(Phillips 1989).
Thus, gender vulnerability based on access to land is not consistent
across groups. Evidence indicates that women in the Sierra would be less
vulnerable than those in the Costa. It also appears that the government
has been making important steps to balance land ownership. The major-
ity of titles granted by the government's Rural Development Program
(PRONADER)-70 percent-went to joint title holders, compared with
17 percent that went to men and 13 percent that went to women (Deere
and Le6n 2000).
4. Institutional Context
Government-funded social programs aimed at assisting the poor and
the vulnerable (see chapter 4) have important gender dimensions, with
women (and children) being the stated target of many of these pro-
grams. Of the myriad of government-funded social programs, the most
important is the Bono Solidario, which provides direct cash transfers to
poor women and the elderly.35 The government introduced the Bono
Solidario in September 1998 in part to compensate for the elimination of
a number of long-standing price subsidies (including cooking gas and
electricity).36 The Bono Solidario has provided a direct cash subsidy on
the order of US$15 per month for women and US$7.50 for the elderly (it
has varied on account of the exchange rate and adjustments).37 Other
social programs funded by the government can be categorized into the
following groups: those targeting women and children under age two,
those targeting children under age six, those targeting school-age chil-
dren, and those targeting the elderly Social infrastructure projects pro-
vide temporary employment as well as generate social benefits for the
poor. The Bono Solidario is the largest program, reaching about 1.3 mil-
lion people, followed by the School Meals program with about 650,000
beneficiaries. The four main ECD programs benefit about 120,000 chil-
dren, of which ORI is the largest.38 In March 1999, the government
announced the Integrated Social Plan, which identified as its main tar-
gets, street children, child workers, adolescents, pregnant and nursing
women, persons with disabilities, and victims of domestic violence.


204                          CRISIS AND DOLLARIZATION IN ECUADOR
5. Conclusions and Recommendations
Although Ecuadorans have experienced economic stagnation and deteri-
oration for almost two decades, the sharp deterioration since 1998 has led
to deeper levels of economic and social crisis and even greater income
disparities in a country that already had one of the highest degrees of
inequality in Latin America. In terms of vulnerability to the negative out-
comes of a crisis as well as actual effects, the information presented here
suggests some important gender differences.
First, in terms of human capital, the deteriorating education system
means that both boys' and girls' human capital is jeopardized, thereby
increasing their future vulnerability. But the current crisis has placed
boys in particular at risk because of the expectation that they work and
contribute to family income. The relationship between boys' education
and vulnerability is noteworthy. On the one hand, boys' exit from school
and entry into the labor market makes them more vulnerable to future
shocks (by reducing their human capital). On the other hand, mobilizing
sons to work in the labor market represents a key strategy for families to
cope with negative welfare shocks. In terms of the health consequences of
crisis, the incidence of teenage pregnancy, short birth spacing, and high
fertility-which are related to inadequate health services-places women
at risk of maternal mortality and morbidity. For men, precarious behav-
ior, accidents, violence, substance abuse, and depression-which are
linked to gender roles, male unemployment, and men's unmet societal
expectations of being the economic provider-increases male morbidity
and mortality. Homicides are now the second leading cause of death
among men in Ecuador. And alcoholism and substance abuse, which are
important male health issues in and of themselves, are linked to low pro-
ductivity, violence and homicides, family instability and disintegration,
and traffic fatalities.
Second, with respect to household capital, household structure and
relations are both a result of the protracted economic crisis as well as a
determinant of vulnerability. Households headed by women for exam-
ple-which have been increasing in number as a result of the crisis and
other factors-tend to be more vulnerable because they count on a single
adult earner and caregiver. Households with more family members can
represent a distinct threat to household financial security if these mem-
bers do not contribute to household income. For women, more depen-
dent children means fewer opportunities to participate in economic
activities, to generate income, and to negotiate within the household. For
men-who are considered the main breadwinners-more dependents
means greater pressure to bring in higher levels income, which in turn,
can lead to precarious behavior if men are unable to fulfill this role.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS         205
Lastly, household violence-which erodes household capital, lowers pro-
ductivity, contributes to health problems, creates psychological strain and
instability in the family, and can lead to family disintegration-is higher
among the least educated and has been linked to unemployment and eco-
nomic instability.
Third, in terms of labor and vulnerability, women's labor-force partic-
ipation over the decades has increased dramatically, thereby enhancing
their economic independence and reducing their vulnerability. However,
vis-A-vis men, women are overrepresented among nonremunerated fam-
ily workers, informal workers, the unemployed, and the underemployed
and on average, receive lower salaries than men. As in other countries,
women's specialization in home-based work and the transient nature of
their employment has contributed to these differences. During crisis, in
particular, households respond to negative income shocks and male
unemployment by mobilizing women's labor. For men, unemployment
and underemployment during periods of crisis can lead to destructive
behavior and depression.
Fourth, gender vulnerability based on access to land varies across
groups and regions. Studies suggest, for example, that land access is
more equitable in the Sierra than in the Costa, and thus women in the
Costa are to this extent more vulnerable. But, overall, evidence points to
important advances in gender equity in land programs in Ecuador. And
lastly, women have witnessed an increase in their political capital-as
evidenced by new institutional and legal reforms for women, greater
female political representation, stronger women's civil society organiza-
tions, and an improved gender perspective in government policies and
services-thus lowering their vulnerability as a group.
Information presented here also indicates that institutions-including
government programs, the political system, legal and regulatory systems,
and social systems and values-matter in terms of gender vulnerabilities,
outcomes, and well-being. Examples include the government's Bono Sol-
idario, which provides cash grants to women; the land component of the
government's Rural Development project, which favored joint-title hold-
ers; and government funded childcare programs, which facilitate
women's entry into the labor market and decrease the vulnerability of
women and children.
Recommendations
In the long term, gender policies and programs should center on chang-
ing the current model of gender roles and relations, which limits men's
and women's opportunities, results in power asymmetries between the
sexes, leads to suboptimal economic and social development, and


206                          CRISIS AND DOLLARIZATION IN ECUADOR
increases both women's and men's vulnerability, albeit in different ways.
Changes in gender roles are best achieved through socialization
processes that take place in the private and public spheres via, among
others, the educational system, media, family, and peer groups. In the
short term, as the crisis continues, however, interventions should focus
on the following:
BUILDING FAMILY AND HOUSEHOLD CAPACITY. Households act as important
insurance mechanisms and safety nets during periods of crisis. Thus,
interventions should be designed and realigned to strengthen the family
unit while at the same time tackling the negative gender roles and rela-
tions within the household that lead -to power asymmetries, violence,
inefficient resource allocation, and household instability. One possible
model is that of Family Resource Centers that have been established in
poor Latino communities in the United States to target mothers, fathers,
adolescent boys, and adolescent girls in dealing with issues such as
responsible fathering, male alcoholism, women's economic opportunities
and empowerment, pregnancy among teenage girls, and gang violence
and drug abuse among male adolescents. In particular, these centers have
played an important role for men by broadening their roles as fathers.
ADDRESSING LABOR-MARKET NEEDS OF HOUSEHOLD MEMBERS. Short-run
interventions should take account of the fact that wives will use their
labor, where possible, as insurance when the risk of a negative shock to
income increases, such as during macroeconomic downturns, or in
response to actual falls in household income. Thus, in the short run,
wives need unemployment insurance programs, job-matching services,
and short-term, income-generating opportunities. On the other hand, like
husbands, single women's labor-force entry is not subject to economic
fluctuations. Thus, programs that aid household heads, whether male or
female, should be directed toward employment that will last beyond the
economic shock, for example, small enterprise technical assistance and
credit programs. For both men and women, but in particular women,
improving the coverage and quality of childcare programs is a key prior-
ity. Possibilities include re-establishing the hogares comunitarios (commu-
nity households) model or putting in place after-school homework clubs
where children can be cared for throughout the day (Moser 1997).
STRENGTHENING SOCIAL CAPITAL. Lack of data has made it impossible to
carry out an in-depth analysis of the relationships between gender, social
capital, and vulnerability in this chapter. However, on the basis of the
results of other experiences to tackle vulnerability in the region, our rec-
ommendation is that in the short and long term, interventions should


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS             207
center on strengthening social capital at the community level. Experi-
ences throughout the region indicate that social capital serves as a coping
strategy during periods of crisis. A four-community study in Ecuador
clearly demonstrates that, all other factors remaining equal, those com-
munities that had stronger informal networks of solidarity and exchange
also had better well-being and fewer social ills (such as child malnutri-
tion, lack of childcare, teenage pregnancy, youth delinquency, and drug
use) (Arboleda 1998). Social capital is also a key ingredient for sustainable
development in the absence of a competent state efficiently able to pro-
vide services or resources to the public. A recent study carried out in
Panama comparing rural communities with and without social capital,
demonstrated that the former had better-maintained water systems,
schools, and infrastructure; a better-integrated community life; and chil-
dren who were more grounded and stable. Specifically, social-capital
interventions should attempt to break the culture of dependency,
strengthen community networks with both men and women, and work
toward building trust in government and public institutions. The decen-
tralized health program now operating in Cuenca and other municipali-
ties provides a model that could be applied by such government bodies
as the Ministry of Education to build social capital at the local level.
Notes
1. Projection for the first trimester of 2000.
2. World Bank 2000a.
3. Risk, exposure, and response capacity can vary by gender. For example, risk
of unemployment varies among men and women because they are in different
sectors of the labor force. Depending on the sector hardest hit by an exogenous
shock, therefore, either women or men as a group would suffer more. The likeli-
hood of having insurance-which is a way of minimizing the negative effects of
a risky event-can also differ by gender, with men tending to be concentrated in
the formal labor market and thus having more access to insurance, and land own-
ership being biased toward men Exarhples of gender differences in exposure
include the health risks to which women are exposed because of their maternal
roles and the male-on-male violence to,which men are exposed. Lastly, capacity
to respond to crisis varies among men and women because of gender roles. For
example, women specializing in housework and childcare are less marketable in
the formal labor force because they have less job experience and skills, and there-
fore less capacity to respond to income losses.
4. About 70 percent of men and women have completed primary education,
and only 25 percent have completed secondary education.
5. While gaps persist, gender appears to be less of a determinant of education-
al attainment than urban/rural residence, with dropout rates being significantly


208                             CRISIS AND DOLLARIZATION IN ECUADOR
higher in rural areas than in urban zones. More than 70 percent of girls drop out
of sixth grade in the Sierra and Oriente. For boys, rates are 64 percent and 62 per-
cent in the Oriente and Sierra, respectively. In the Costa region, boys' dropout
rates (70 percent) exceed those of girls' (64 percent).
6. The rates will probably decrease because younger generations have much
lower illiteracy rates than their older counterparts. For example, the illiteracy rate
for people between 15 and 24 years old is 3.2 percent compared with 17.2 percent
for those over 40 years old.
7. Comparative figures in the region for the same period were 390 for Bolivia,
265 for Peru, 56 for the Repdblica Bolivariana de Venezuela, 87 for Colombia, and
114 for Brazil (PAHO 1998a).
8. Consejo de la Salud de Cuenca (personal communication).
9. Data for 1994 according to ENDEMAIN (Demographic and Maternal and
Child Health Survey); data for 1999 were not yet available.
10. PAHO statistics, as cited in CONAMU/INEC 1999.
11. Spontaneous abortion (miscarriage) accounts for 85 percent of cases and
induced abortion for 15 percent, according to ENDEMAIN 94.
12. Women from urban areas and the Costa region who are in their latter pro-
ductive years, as well as more highly educated women, have the highest rate of
induced abortions (ENDEMAIN 94). There is little difference between the abor-
tion rates of teenagers and those of the general population.
13. Includes both modern methods and natural methods, the most common
methods being female sterilization (23 percent), contraceptive pills (11 percent),
IUDs (10 percent), the rhythm method (8 percent), withdrawal (7 percent), and
condoms (3 percent), according to ENDEMAIN 99.
14. Defined as women who do not report problems of subfertility, are not preg-
nant, do not wish to be pregnant, are sexually active, and are not using any form
of contraception.
15. Homicides rates are low in Ecuador compared with neighboring Replablica
Bolivariana de Venezuela and Colombia, and are about the same as Peru (rates in
those countries were 15.2, 89.5, and 11.5, respectively, in the late 1980s) (Madrigal
and Schiffer, 1992, cited in Pyne 2000).
16. According to the study, 7.04 percent of morbidity among men is a result of
alcoholism compared with 0.64 percent for women. Thus, at the time of the study,
one in every 13 Ecuadorans was an alcoholic.
17. According to Rosenhouse (1989), problems exist in the concept of headship
because it assumes a hierarchical relationship between household members. It
also implies that the head is the most important member in the household, is pre-
sent in the household, has overriding authority in important household decisions,
and provides consistent and central economic support. These commonly made
assumptions between the head and the household can result in a biased portray-
al of the internal dynamics of the household.


GENDER DIMENSIONS OF VULNERABILITY TO EXOGENOUS SHOCKS             209
18. The dependency ratio is defined asithe number of dependents divided by the
number of workers.
19. For example, results of a six-country rural study in the Region (Chile, El
Salvador, Colombia, Honduras, Paraguay, and Peru) indicated an inverse rela-
tionship between income and family size and dependency ratios (L6pez and
Vald6s 2000). The dependency ratio for the lowest income quintile was about one-
third larger than that of the total sample in each country (L6pez and Vald6s 2000).
20. This compares with 3.0 for Peru, 4.3 for Bolivia, 3.0 for Repilblica Boliviariana
de Venezuela, and 2.7 for Colombia.
21. Fertility rates have decreased since 1994 for both groups, and are 2.1 for
women with higher education and 6.2 for women with no education at all
(ENDEMAIN 94).
22. Sample sizes were 1,000 women (Chile), 5,390 women (Colombia), 1,312
(Costa Rica), and a national representative sample (Paraguay).
23. Ecuador was the first Latin American country to grant women the right to
vote, through the 1929 constitution. Women have been less likely than men, how-
ever, to exercise their voting privileges. Although voting was made compulsory
in 1967, less than half of the voters were women in recent elections, even though
there are more eligible women than men in the country as a whole.
24. Nationwide, 19 women's police stations have been established to date.
25. From the SIMUJER (Situation of Women and Gender Inequality Indicators)
database compiled by the National Council for Women.
26. This pattern suggests that individuals enter the labor market if the marginal
benefit exceeds the marginal cost. An educated woman has the ability to make
high earnings in the labor market and to hire an inexpensive domestic worker, so
her "cost" of working is low while her benefit is very high. An uneducated
woman has low earnings ability but her economic need is so great (that is, the
"benefit" of earning an income is very high) that even the benefits of earning a
low income exceed the value of her leisure and some homecare (cost).
27. Also see World Bank 2001.
28. According to estimates for other countries, Ecuador presents a moderate
salary gap. For instance, in 1994 women's average wage was 75 percent that of
men's average wage; in Brazil, women's wages were 60 percent that of men's
(FLACSO 1995).
29. These may be the result of unmeasurable productivity factors (for example,
differential treatment in schooling, family expectations, "old boys' networks",
and so on) that could not be statistically removed from the numbers, or from
"market-induced" differences, that is, discrimination. When the researchers
looked at industries that were typically female (food production, textiles, clothes,
small commerce, restaurants, public sector, teachers, medical, and domestic
labor), women actually earned more than men, with similar, observable charac-
teristics in the food, textile, teaching, and domestic services industries. However,


210                             CRISIS AND DOLLARIZATION IN ECUADOR
these trends turned around such that by 1997, women were earning less than men
in all the "female" industries. The increased disparity was most severe in the
food, textiles, clothes production, medical, and domestic service industries, while
the disparities, although still in favor of men, were lower in small commerce and
the restaurant business.
30. From the SIMUJER database compiled by the National Council for Women.
31. The two urban models have important elements in common: a concern for
incorporating families and the community and an emphasis on enhancing chil-
dren's health, nutritional, and psychological development. One model provides
care for children of working mothers within the community in the home of a
female neighbor. Children stay at the care centers between eight and nine hours
a day, five days a week. The childcare provider is a person selected by the com-
munity; she and an assistant are trained by the program. The children-general-
ly 15 per home-range in age from three months to six years. The second model
offers care for a maximum of 100 children. The community provides a communi-
ty center, church, or sports club as a location. Children from three to six years of
age attend these centers five days a week, from three to four hours a day, during
the morning or afternoon. Children are cared for by young people who are select-
ed by the community and trained by the program.
32. The program will fund improvements and expansion of public, private, and
NGO programs on a competitive basis. The aim is to improve the existing ser-
vices of childcare to 2000 centers, increase the number of children enrolled to
250,000, and improve community participation as well as the management of
sector institutions. The program includes training 8,000 mothers to care for chil-
dren (madres cuidadoras) and proposes integrated care for enrolled children. For
example, it provides nutritional and medical care to children, carries out educa-
tion programs at the family level, and gives special attention to children suffer-
ing from violence.
33. Based on IESS, Direcci6n Matemdtica actuarial data.
34. Ecuador's agrarian structure was fundamentally altered by the land reforms
of the 1960s and 1970s, with important implications for gender-specific property
rights and agricultural production. In the case of the Sierra, prior to the enactment
of the Agrarian Reform Law of 1964, land and labor relations were dominated by
the huasipungo system, in which large, privately owned farms retained semi-tied
labor to engage in generally low-technology crop and livestock production. Under
the 1964 law, huasipungueros who had occupied the same plot for at least 10 years
became entitled to ownership, and haciendas larger than 800 hectares (plus 1,000
hectares of pasture) were subject to expropriation. Land was adjudicated to house-
hold heads only, and although gender-disaggregated data on land reform benefi-
ciaries do not exist, it is clear that the vast majority who received land-in both
individual (parcela) and collective (comuna/cooperativa) forms-were men.
35. Although not designed for this purpose, the Bono Solidario has become the
backbone of the government's social-protection program. It is the only program


GENDER DIMENSIONS OF'VULNERABILITY-TO EXOGENOUS SHOCKS          211
currently available to large numbers of the poor, but targeting problems and the
low level of benefits limit its overall poverty impact (World Bank 2001).
36. Subsequent to the validation of this report in July 1999, these expensive and
regressive price subsidies for cooking gas and electricity had re-emerged.
37. The Bono Solidario represents about half of the amount required to meet the
caloric needs of one person per month (World Bank 2000b). The program repre-
sents nearly 8 percent of the central government's nondebt spending and about
1.3 percent of Ecuador's GDP (World Bank 2000b).
38.- Other main programs include PRONEPE, the School Lunch program, and
PACMI.
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Early in 2000, Ecuador, confronted with a serious economic crisis, adopted
the U.S. dollar as its national currency. Crisis and Dollarization in Ecuador
examines the conditions that led to this action, describing the repeated cycle,
of crisis and failed stabilization that fatally undermined confidence in the
Ecuadoran sucre. The book then analyzes dollarization's initial results and its
effects on inflation, growth, poverty, inequality, marginalization, gender, and
the Ecuadoran fanily. It also puts the Ecuadoran experience with dollarization
in an international perspective. Economists, policymakers, and anyone with
serious interest in Latin American affairs will find this book invaluable.
Jeannette Marie Smith
00803      ISN        TND
MC C3-301,    WASHINGTON DC
THE WORLD BANK
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Telephone: 202 473-1000
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ISBN 0-8213-4837-)