Professors of Economics, School of Economics and Institute of Economics, Universidad San Francisco de Quito
In
this post we refute the imprecise and false macroeconomic statements (or the
so-called “alternative facts”) presented in the post written by Ha-Joon Chang
and James K. Galbraith and signed by other 50+ economists that was published on
March 26th, 2017 at CommonDreams.
The goal of this post is to provide a simple but rigorous analysis to try to
eliminate the misinformation and correct the distorted view of Ecuador’s
economy presented in that post.
In
particular, we focus on four “alternative facts” mentioned in that post regarding
the following aspects of Ecuador’s economy: 1) the impact of oil prices in the
economy’s performance, 2) the role of the central bank in the economy, 3) the fiscal
policy cyclicality, and 4) the economic growth rate for selected periods.
Alternative Fact 1, from
Chang and Galbraith post: “It has all but become conventional wisdom that the
economic and social progress in Ecuador, such as it is recognized, resulted
simply from a commodities boom and a spike in oil revenues. This
explanation ignores the innovative and important reforms that the Ecuadorian
government has enacted that have played an instrumental role and allowed the country to emerge, relatively
unscathed, from the 2009 Global Recession and the more recent collapse in oil
prices”.
Claiming that Ecuador’s economic progress as a result of the
spike in oil prices is just conventional wisdom is an understatement. Claiming
that the last collapse in oil prices (starting on the second half of 2014) left
Ecuador’s economy unscathed denotes an absolute ignorance of Ecuador’s reality
and also of the data. During Correa’s administration, oil prices explain not
only Ecuador’s economic growth but also the economic downturns. The correlation
between real GDP growth and oil prices during that period is 0.94. In contrast,
between 2001 and 2006 the correlation falls to 0.27. Graph 1 shows the real GDP growth and the WTI price from 2001 to
2016.
It is also important to note that the collapse in oil prices in
2008-2009 and in 2014-2016 resulted in a severe slowdown of the economy in 2009
and in a deep recession in 2015 and 2016. This is not only clear from the data.
Taxi drivers, hairstylists, owners of small, medium, and large businesses or
even the informal sector could also date the beginning of the current recession
within months after the collapse in oil prices and provide further evidence of
how unscathed this collapse has left
Ecuadorians.
Graph 1. Annual
Real GDP Growth and Oil Prices, 2001-2016
Alternative Fact 2.
From Chang and Galbraith post “This explanation ignores the innovative and important
reforms that the Ecuadorian government has enacted […]. These reforms included bringing the central bank into the
government’s economic team, […]”.
The
central bank involvement consisted of lending resources to the government in
the amount of about US$5,300 million between 2014 and March 2017, coinciding
with the collapse in oil prices beginning the second half of 2014. This amount
represents about 63% of the central bank’s liabilities and about 5% of GDP. Graph 2 shows the evolution of this
credit to the government. Weisbrot,
Johnston, and Merling (2017),
which this post also references, refer to this policy as “innovative and
surprising” (page 15). What is surprising is that anyone would call this
“quantitative easing”—it is not. It is the central bank funding government
deficits. The government uses these funds on a weekly basis as a line of
credit. Therefore, this “policy” does not have any impact on the interest rate,
which is actually controlled by the government. It is not even innovative since
other countries have attempted this in the past. Argentina implemented similar policies
in the second half of the 19th century that ended with the decapitalization
of the government’s bank and the abandonment of the gold standard (see Della
Paolera and Taylor, 2001).
Graph 2. Ecuador’s Central Bank Credit to
the Government, January 2006-March 2017
Source: Central Bank of
Ecuador.
A more accurate description of what
is really happening with the central bank is the following. The two main
sources of funds of Ecuador´s Central Bank are i) the required reserves from
the banking sector and ii) deposits from local governments and public
companies, which are obligated to deposit in the central bank. Graph 3 shows the evolution of these
two types of deposits (“bank reserves” and “public sector deposits”), which are
a liability for the central bank, and the dollar reserves backing these
obligations (“international reserves”). As graph
3 shows, since the end of 2009 the gap between these liabilities and the
international reserves has been widening. Currently, only 38% of the central
bank obligations are backed up with liquid assets. Even more worrisome is the
fact that since January 2016 the international reserves are not even enough to
cover the required reserves associated with bank deposits. As of March 24th,
2017 only 81% of these reserves were covered. Additionally, due to the low
level of coverage reached in May 2016, the government recapitalized the central
bank with new borrowing from China in May ($1,500 million), and tapped international
financial markets four times (in August, September and December 2016, and
January 2017) totaling $3,750 million. These international bonds pay interests between
9% and 10.75% and have maturities of 5 and 10 years. Thus, this
practice goes against the Central Bank’s mission, represents a
breach of its contract with society, and is not a prudent management of the Central
Bank balance sheet. In a dollarized economy the only monetary tool that should
be available for the central bank is the required reserve ratio. Lending money
that belongs to people, companies, or local governments (which ultimately
belongs to people) to the central government is a risky and irresponsible
practice since it puts the dollarization regime under threat.
In
conclusion, “bringing the central bank
into the government’s economic team’ does not seem a measure of success as
much as it is a reason to worry. In fact, one of the causes of Ecuador’s1999
crisis was the participation of the central bank in the government’s economic
team.
Graph 3. Central Bank Obligations and International
Reserves, January 2006-March 2017
Source:
Central Bank of Ecuador.
Alternative Fact 3: “This explanation ignores the innovative and important
reforms that the Ecuadorian government has enacted […]. These reforms included […], countercyclical fiscal policy”.
Arguing
that Correa’s administration has implemented countercyclical fiscal policy could
not be further from the truth. Empirical evidence shows that the last ten years
have been one of the most pro-cyclical fiscal periods in Ecuador over the past
50 years. We prove this by examining the cyclicality of government expenditure
(see Kaminsky, Reinhart, and Vegh (2004) for a detailed discussion of why this
variable can be useful when analyzing fiscal cyclicality).
We present both cycles for the period 2007:Q1 - 2016:Q3 in graph 4A. As it can be seen, the government spending cycle almost perfectly matches the economic cycle. It increases during expansionary periods and declines during slowdowns. In fact, the correlation between these two series is 0.51 (vs. -0.00 for the period 2000:Q1 - 2006:Q4). Additionally, we test the statistical significance of this result by running an OLS regression of both cyclical components. The specification of this regression is as follows
cycle
log(government expenditure) =α+β* cycle log(real GDP),
where
β is our parameter of interest. A positive β means that fiscal policy is pro-cyclical.
Our estimation shows that the coefficient of interest is positive and statistically significant, proving that the statement that fiscal policy in Ecuador has been countercyclical is absolutely false. Graph 4B) shows the scattered plot with the data and the estimated regression and Table 1 presents the results of our estimation and the correlation coefficient for Correa’s administration, the period before Correa’s term during dollarization (i.e., 2000-2006), and the decade before dollarization (i.e., 1990-1999). In all the subsamples the conclusion is that fiscal policy has always been pro-cyclical, but even more so while Correa has been in office.
Graph 4A: Cyclical components of government expenditure and
real GDP from 2007:Q1 to 2016:Q3
Graph 4B: OLS fitting of cyclical components of government expenditure and real GDP from 2007:Q1 to 2016:Q3
Note: We use quarterly data of government expenditure and real GDP filtered with the HP filter after taking logarithms for the period 1965:Q1 to 2016:Q3. Source: Central Bank of Ecuador and Gachet et al. (2011).
Table 1: Correlation coefficients and OLS estimations for
the relation between the cyclical components of government expenditure and real
GDP.
1980:Q1 to 1999:Q4
|
2000:Q1 to 2006:Q4
|
2007:Q1 to 2016:Q3
|
|
Correlation
|
0.51
|
-0.00
|
0.51
|
OLS Coeff.
|
0.46***
|
-0.00
|
0.77***
|
S.E.
|
(0.11)
|
(0.12)
|
(0.26)
|
Note: *** indicates that
the estimate is significant at 1%, ** indicates that the estimate is
significant at 5%.
Alternative Fact 4: from
Chang and Galbraith post “Compared to 1.5 percent annual per capita
GDP growth from 2006 to 2016, per capita GDP growth averaged just 0.6 percent
from 1980 to 2006. From 1980 to
2000, a period during which Ecuador had a number of loan agreements with the
International Monetary Fund, Ecuador experienced a considerable economic
failure, as GDP per capita fell by 1.5 percent over those two decades. This
failure almost certainly resulted at least in part from the neoliberal policies
of cutting spending, privatization, inflation-targeting, deregulation, and
others that also made the Ecuadorian economy increasingly vulnerable to
external shocks. In the 1960–1980 period, by contrast, per capita GDP
growth was 110 percent.”
We
need to point out two limitations in this analysis. First and most importantly,
arbitrarily choosing the period from 1980 to 2006 generates a bias in the
average growth rate since Ecuador dollarized its economy in 2000, which
represents a major structural break in any economic series. Second, although
Correa won the election in 2006, he took office on January 15th,
2007, so Correa’s government started in 2007 and will finish in May 2017.
Instead
of using annual data as Chang and Galbraith do, we use quarterly GDP data for
the period 1965:Q1 to 2016:Q3 to calculate the average annual growth rate of
total and GDP per capita. We study five periods: Correa’s administration which
is defined between 2007:Q1 and 2016:Q3; the period post-dollarization before
Correa took office, between 2000:Q1 and 2006:Q3; the decades before
dollarization between 1980:Q1 and 1999:Q4; and finally, we also compute the annual
average growth rate from 1965:Q1 to 1980:Q4; and from 1980:Q1 to 2006:Q4. Table 2 presents our results.
Table 2: Average Annual Growth Rates for selected
periods
Period
|
Average Annual Growth of GDP (%)
|
Average Annual Growth of GDP per capita (%)
|
Correa’s administration
|
3.42
|
1.89
|
2000:Q1 to 2006:Q4
|
4.52
|
2.76
|
1980:Q1 to 1999:Q4
|
2.30
|
-0.06
|
1965:Q1 to 1980:Q4
|
7.11
|
4.39
|
1980:Q1 to 2006:Q4
|
2.87
|
0.66
|
Note: We assumed that
population remains constant through the year to compute quarterly GDP per
capita. Source: Central Bank of
Ecuador and Gachet
et al. (2011). Population data was
taken from the World
Bank.
Interestingly,
the average GDP per capita growth rate during the period 2000-2006 (during
dollarization and right before Correa’s administration) was larger (2.76%) than
that of Correa’s term (1.89%). This result is robust when considering total GDP
instead (4.52% from 2000:Q1-2006:Q4 and 3.42% during Correa’s administration).
It is also important to point out that oil prices and revenue during 2000:Q1 to
2006:Q4 were much lower than those during Correa’s administration, suggesting
that Correa´s Revolucion Ciudadana fell
short in producing economic growth through government intervention, even in the
presence of extraordinary revenue flows.
The
authors also mention that the fall in GDP per capita from 1980 to 2000 is
explained entirely by the loan agreements with the IMF, disregarding other
significant exogenous shocks to the economy. In this regard, it cannot be
ignored that on March 5th 1987 two major earthquakes hit Ecuador
resulting in 1,000 deaths and collapsing the oil infrastructure. This
translated into a GDP contraction of 15.8% (13.7% in per capita terms) in that
year, the lowest growth rate registered since 1965. Additionally, in the period
1997-1998 Ecuador suffered the effects of El
Fenomeno del Nino. By no means do we pretend to explain the negative growth
from 1980 to 2000 as a consequence of these two natural disasters, but it is
something that should be considered or at least mentioned in a rigorous
analysis.
Concluding Remarks
We
have provided simple but conclusive evidence that in the last 10 years
Ecuador’s economic performance depended greatly on oil prices, fiscal policy has
been pro-cyclical, the involvement of the central bank in the economy is
putting the dollarization regime at risk, and that during the dollarization period the largest economic
growth was achieved between 2000-2006, not during Correa’s administration. All of these
conclusions are the exact opposite to those presented in Chang and Galbraith’s
post and signed by other 50+ economists.
We
finally would like to highlight with this post that economic analysis should be
done with more professional rigor even when it is published in blogs. When
describing stylized facts such as the ones in the CommonDreams post, the economic
analysis should at least attempt to eliminate the ideological veil. For another
critique to some of the similar conclusions drawn in Chang and Galbraith post
see Manuel
Gonzalez post.
Finally,
we have sent an email with the link to this post to Chang and Galbraith, as
well as to the 50+ economists signing the post (or the one’s for whom we found
their emails). We have offered them the opportunity to respond through comments
in this blog. We will publish all the comments that they may have, or if they
require more space, we will be happy to publish in our blog any posts related
to these issues.
Acknowledgements:
We would like to thank Lorena Castellanos, Luis Espinosa, Santiago José
Gangotena, Melissa Paredes, Pablo Lucio Paredes, Mónica Rojas, and Pedro Romero
for their excellent comments and suggestions.
Note: We found a coding mistake that drove us to make a mistake in the calculations of the level of pro-cyclicality of government expenditure. In the current text we have corrected this. Although the correlation coefficient is significantly lower (down from 0.93 to 0.51), the conclusions remain the same.
Note: We found a coding mistake that drove us to make a mistake in the calculations of the level of pro-cyclicality of government expenditure. In the current text we have corrected this. Although the correlation coefficient is significantly lower (down from 0.93 to 0.51), the conclusions remain the same.
REFERENCES
Gachet I., Maldonado
D., Oliva N., and Ramirez J., “Stylized Facts of the Ecuadorian Economy: The
Economic Cycle 1965-2008”. Munich
Personal RePEc Archive manuscript (2011).
Kaminsky, Graciela L., Carmen M. Reinhart, and
Carlos A. Végh. "When it rains, it pours: procyclical capital flows and
macroeconomic policies." NBER
macroeconomics annual 19
(2004): 11-53.
Paolera, Gerardo della, and Alan M. Taylor. "Straining
at the Anchor." National
Bureau of Economic Research Books (2001).
Weisbrot,
Mark, Mark Johnston, and Lara Merling. “Decade of Reform: Ecuador’s
Macroeconomic Policies, Institutional Changes, and Results.” Center for
Economic and Policy Research (February 2017).
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