Ecuador’s Dollar Doldrums

September 25, 2007

In 2000, Ecuador became the first Latin American country to officially eliminate its own currency and adopt the U.S. dollar. The government hoped that “dollarizing” would stabilize the country’s economy, then experiencing its worst crisis since the 1920s. Other countries facing similar economic troubles have since considered dollarization an attractive policy option, but the social and economic impacts of dollarization in Ecuador demonstrate that the measure is no panacea.

After rapid growth stimulated by oil exports in the 1970s, Ecuador’s economy began to stagnate in 1982. By the late 1990s, floods induced by “El Niño,” a dramatic fall in oil prices and the international financial crisis sparked by developments in Southeast Asia combined to provoke the country’s near total economic collapse.

For Ecuadorans the crisis was disastrous. From 1998 to 2000, social deterioration was severe. Poverty increased by 13%, reaching 69%; urban unemployment increased by 9%, reaching 17%; and real wages dropped by 40%. Amid the crisis, foreign exchange speculation fuelled the devaluation of the national currency. To prevent hyperinflation of the kind that would have likely immiserated most Ecuadorans, the government dollarized the economy in January 2000.

Dollarization has favored a degree of price stability. But it has lowered inflation only slowly and partially. As a result, prices of domestic products have become too expensive, limiting the country’s export competitiveness. Dollarization has not fostered significant economic recovery. It failed to lower interest rates sufficiently and the resulting credit scarcity has hampered growth. Moreover, under dollarization the government cannot control exchange rates to compensate for external shocks, like natural disasters or export price fluctuations. Now it can only respond with recessive adjustments that bring high employment costs and increase poverty—by drastically reducing imports, for example.

After dollarization, a partial recovery took place from mid-2000 to 2001, but later flattened out. Poverty receded by 8%. Urban unemployment bounced back to 10% and real wages almost returned to their pre-crisis values. Poverty and extreme poverty, however, remain above their pre-crisis levels and the reduction in unemployment was mainly due to a massive spurt in emigration. At least 800,000 Ecuadorans emigrated between 1998 and 2003 mostly to Spain, the United States and Italy, and foreign remittances have become a chief recovery factor. No clear signs of job expansion appear.

The limited recovery was also partly attributable to the construction, at high environmental cost, of a new oil pipeline from the Amazon basin to the Pacific coast, as the state promoted oil investments to attract foreign exchange. An oil-driven recovery, though, is doubtful given the country’s limited reserves and the low distributive reach of oil income, which remains concentrated in few hands.

Dollarization is hardly the cause of Ecuador’s ongoing socioeconomic malaise. Ecuador has for decades ranked among the least developed countries in Latin America, with levels of social inequality long among the worst in South America and deeply entrenched regional and ethnic disparities. Persistent structural factors are primarily to blame for Ecuador’s disappointing post-1982 economic performance.

But dollarization does not address the underlying problems. Nor, after four years, has it managed to meaningfully ameliorate their effects. Instead, dollarization has introduced its own problems as new imbalances emerge: exchange rates are undervalued, dependence on the export of primary products is deepening, export competitiveness is eroding and painful recessive adjustments loom ahead.

In the long term, only a prolonged effort to promote education, labor training, employment generation and improved income distribution will create the conditions for sustainable human development in Ecuador. Dollarization is not even an effective Band-Aid, much less a cure, for its socioeconomic problems.

Carlos Larrea is professor of development economics at the Faculty of Latin American Social Science (FLACSO), Ecuador, where he also heads a research project on “The Economic, Social, and Environmental Consequences of Dollarization.” He is author of several books and articles on social development and sustainability in Ecuador and Latin America.


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