34198 May 2005 No. 71 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region POVERTY IN ECUADOR Carolina Sanchez-Paramo Macroeconomic developments and poverty The 1998/99 crisis, the 2000 dollarization and their effect on poverty Between 1980 and 2001, Ecuador's real GDP grew at 2 percent The 1998/99 macroeconomic crisis had devastating and lasting annually, slower than population growth and among the effects, particularly in rural areas in the Costa hurt by El Niño, lowest in Latin America. Real GDP per capita declined by half and among the urban middle-class. In the short run, adopting a percentage point per year between 1980 and 1990 and the US dollar as the national currency in response to the crisis remained almost constant afterwards. The main reason for helped control inflation. It caused prices of tradable goods to poor performance is not external shocks--volatile oil prices decline relative to non-tradable goods, and prices of durable and capital flows and natural disasters, or goods (many of which are imported) to even poor economic management (fiscal fall relative to non-durable goods. The deficits and monetary surprises) but weak resulting lower cost of the average productivity growth. Throughout 1980- consumption basket benefited non-poor 2002, GDP moved hand in hand with Total households especially­ their Factor Productivity (TFP) ­ a measure of consumption basket, comprising 46 economic efficiency or productivity that percent durable goods, fell in cost by 19 captures the quality of inputs, percent compared to only 2 percent for institutions, and various economic poor households. The medium term policies. Negative TFP growth rates offset effects of dollarization on growth, positive labor and capital accumulation, consumption and poverty are still dragging growth rates down. uncertain. Policies to maintain stability with fiscal discipline and Characteristics of the poor and poverty trends, increase economic productivity and competitiveness hold 1990-2001 promise for promoting positive, sustained growth. Fiscal income could be made less dependent on oil revenues by improving compliance and collection effectiveness of non- From 1990 to 2001, national consumption-based poverty rose oil tax revenues and modifying the way the oil-price from 40 to 45 percent, and the number of poor people increased stabilization fund is managed. Less pre-allocation and from 3.5 to 5.2 million.1 Poverty increased by over 80 percent earmarking of revenues would increase spending flexibility, in urban areas in the Costa and Sierra, was stable in the rural although key program allocations, such as certain social Costa and rose 15 percent in the rural Sierra. and pro-poor programs, need to be ensured. Several fiscal policies could improve the efficiency with which resources Poverty rates continued to be highest in rural areas, but rapid are use, including: harmonizing and simplifying the tax urbanization increased the number of poor people living in system by repealing some minor taxes while simplifying and urban areas from 1.1 million to 3.5 million, more than in rural strengthening business, income and sales taxes; and areas. This poses challenges for urban job creation and eliminating various public enterprise subsidies that income generation and basic service provision. Moreover, artificially protect against competitive forces and people will continue to migrate if large urban-rural income and discourage accountability and efficiency. poverty differentials persist, exacerbating these pressures. . 1 Poor people live in larger households, are less educated, have technology are 30 percent more productive. Each 10 percent higher unemployment and lower access to basic services. increase in labor productivity generates a 1 percent increase in High poverty rates among indigenous and Afro populations employment; each 10 percentage points increase in the share and among women are linked to poor endowments-- of educated workers is correlated with 5 percent higher education (especially in urban areas) and low access to land productivity. and or access to low-productivity land in rural areas. A death of reliable and consistent quantitative information on ethic Labor productivity and employment generation could be groups is a barrier to designing effective policies targeted to increased through: these groups. Ethnic identification questions should be included in all surveys and other institutions. · Ratifying free trade agreements and rationalizing and reducing tariffs and non-tariff barriers to help eliminate Urban poverty, labor market dynamics and the anti-export bias associated with years of import employment creation substitution policies. · Simplifying licensing agreements and promoting Employment is the main income source, frequently the only foreign direct investment, combined with effective one, for most urban families. Thus policies that generate property rights and patent protection. employment and wage income are crucial for reducing urban poverty. The 1998/99 crisis sent employment and real labor · Investments in secondary education and radical reform income plummeting, urban poverty rose, and poor urban of Ecuador's public training institute, SECAP, and households resorted to various coping strategies, such as stimulating competition in training provision. increased labor force participation and migration. Poverty declined slowly after 2000, reflecting weak formal employment The poor are less educated and tend to be employed in small, creation (Table 1). informal firms with low access to technology. So explicit pro- poor measures are needed to: Table 1 - Labor market trends were sensitive to the 1999 crisis and the 2000 · Promote linkages between large and small firms to help dollarization distribute the gains associated with access to foreign 1997 1998 1999 2000 2001 2002 markets and technology, transfer technology to small Labor Force Participation 56.8 58.5 60.2 57.5 63.6 58.5 firms, while providing large firms with additional degrees of flexibility. Male 71.1 71.8 73.2 70.4 74.5 70.3 Female 43.3 46.2 48.0 45.2 53.0 46.9 · Create service centers or small-firm incubators that Employment Rate 90.8 88.5 85.6 91.0 89.1 90.8 enable small businesses to share cost of a technology Male 93.3 92.1 89.7 94.0 93.2 94.7 or service. Female 87.6 84.4 80.7 87.2 84.1 87.0 Create incentives and special training programs for Unemployment Rate 9.2 11.5 14.4 9.0 10.9 9.2 · informal worker training. Male 6.6 7.8 10.2 5.9 6.7 5.2 Female 12.4 15.5 19.2 12.7 15.8 12.9 Institutional constraints or uncertainty can inhibit labor Hourly labor income (2000 US$) 1.06 0.72 0.48 0.55 0.70 0.83 productivity increases from generating new jobs. The Male 1.08 0.74 0.52 0.59 0.77 0.95 Investment Climate Survey (2002) found that most firms in Female 1.03 0.68 0.44 0.48 0.60 0.64 Ecuador would like to hire more permanent workers but are deterred by high firing costs and non-wage costs. Costly and scarce credit, poor infrastructure, and uncertainty about the economic and institutional environment appear Labor productivity, employment creation and urban poverty to be the main constraints to business expansion. Forty percent of surveyed firms declared having trouble finding Employment creation, especially formal employment creation, qualified labor, more than 60 percent reported being forced is closely linked to labor productivity improvements. to reconsider expansion plans due to lack of credit, poor Productivity improvements depend on the quantity and public utility provision, and economic and institutional quality of inputs used in production, and the institutional uncertainty. There is a clear need to reform labor legislation framework in which firms operate. The extent to which the poor to remove disincentives to permanent hiring, and consider benefit from job creation depends on whether they have the special contractual forms, such as apprenticeship or re- skills firms need. entry contracts for vulnerable, hard-to-employ groups. Credit access could be improved through credit unions Exposure to international competition and access to better sponsored by "gremios" (industrial associations) or technologies are correlated with higher labor productivity and Chambers of Commerce, and promoting venture capital employment. Exporting firms and firms with access to foreign enterprises and linkages between large and small firms. 2 Rural poverty, agricultural productivity, and Land distribution and rural poverty land distribution In Ecuador, as elsewhere in LatinAmerica, land distribution is very inequitable (Figure 1). This reflects historical legacy, and Forty percent of Ecuador's population lives in rural areas, 60 legal and economic barriers to well functioning land markets. percent of whom are poor. The rural poor tend to work in Ecuador has one of the most rigid land markets in Latin agriculture, have limited or no access to land, and work low- America (FAO 2002), exacerbating inequity and inefficiency. productivity land. Policies to increase agricultural Policies to improve land market functioning in rural Ecuador productivity and access to land hold promise for reducing are critical, especially to promote tenure security and facilitate rural poverty. land transactions. Specific measures needed are: removing legal and other barriers to land titling, updating land registries, Each 1 percent rise in agricultural output increases per capita eliminating uncertainty about the threat of land expropriation, consumption 0.16-0.30 percent among households whose implementing an effective system for resolving land disputes, head is self-employed in agricultural ­ almost a one-to-one removing blanket restriction against share-cropping and other increase for the average rural households with 4 or 5 members. rental restrictions and transferability restrictions, and For agricultural laborers, a 1 percent increase in agricultural designing standard land rental contracts to reduce transaction productivity increases wages by 0.10-0.30 percent. costs. Figure 1 - Land distribution Simulations of the potential impact of various policy interventions aimed at increasing agricultural efficiency­ including access to credit, formal and agricultural technical education, markets and sale intermediaries; use of fertilizer and pesticides; and technical assistance--show that access to credit and agricultural education have the largest impact on small-farm productivity. Access to rural credit could be enhanced by strengthening existing small savings and loans cooperatives and women's credit groups (cajas solidarias), and allowing family assets, such as land and livestock, to be used as collateral. Access to technical assistance and agricultural education could be increased by supporting the National Institute for Training of Rural Farm Workers (Capacitacion Campesina), operated by the Ministry of Agriculture in a fairly decentralized fashion, as well as agricultural research and development initiatives. Farms of all sizes in a particular canton tend to have similar productivity levels, so targeting policy interventions to Social services and the poor cantons with low productivity and high poverty, could be effective in decreasing poverty (Table 2). Ecuador's health and education outcomes are low relative to international standards, even after controlling for differences in development levels. Infant Table 2 - The relative returns to land, capital and labor vary with farm size. mortality, at 43/1000, is 10 points higher than the Small-scale Medium-scale Large-scale predicted level. Chronic malnutrition (wasting farms farms farms and stunting) is also above its predicted level. Cobb-Douglas production function estimates Results are mixed for education outcomes: relatively good for primary enrolment, average Labor 0.05 0.17 0.45 for secondary enrolment. Capital 0.08 0.07 0.08 Non-irrigated land 0.14 0.04 0.08 Outcomes vary significantly across provinces, correlated with, but not fully explained by Irrigated land 0.14 0.00 0.08 poverty differences. Provinces in the Sierra Input use on non-irrigated land 0.72 0.77 0.37 under-perform in health; provinces in the Costa under-perform in education. This requires Input use on irrigated land 0.40 0.70 0.39 careful decisions about targeting and where Scale (Irrigated land) 0.99 1.04 0.99 and how to invest (additional) social sectors expenditures. Scale (Non-irrigated land) 0.67 0.94 1.01 3 Social expenditures: Trends and cyclicality a large-ticket item in the government budget, benefits better-off households (Vos et al. 2003). Ecuador's relatively poor social outcomes probably result from low, highly volatile social expenditures and poor Social programs exhibit poor targeting, resulting in high targeting of some expenditure. Social expenditures, especially leakage of resources to non-poor households, a key cause education and health expenditures, were lower in 2002 than of their relatively low effectiveness. The Government of 1980 (Table 3). Volatile, pro-cyclical expenditures choke off Ecuador has made good progress recently in improving the targeting of the Bono Solidario, now called Bono de Desarrollo Humano, but attempts to reform the gas subsidy have Table 3 - Social expenditure (as a percentage of GDP) has fallen dramatically over time yet to succeed. Simulation results 1973 1979 1981 1984 1988 1992 1996 1998 2000 2002 show that retargeting the gas subsidy using the SelBen (a Total 3.8 4.6 6.3 4.9 4.7 5.2 3.8 3.4 3.6 4.5 welfare index) would improve Education 3.2 3.5 4.8 3.7 3.2 3.8 2.5 2.4 1.7 2.4 significantly on the status quo, and direct most of the spending to Health 0.5 1.0 1.3 1.1 1.3 1.1 0.8 0.7 0.6 1.2 poor households. The poorest Social Assistance 0.1 0.1 0.2 0.1 0.2 0.3 0.5 0.2 1.3 1.0 two quintiles would receive 44 Bono Solidario 0.0 0.8 0.4 percent of program resources instead of only 15 percent now. Other 0.1 0.1 0.2 0.1 0.2 0.3 0.5 0.2 0.5 0.6 Re-targeting could also generate savings of up to 76 percent of the resources when they are need most, compromising continuity total current subsidy--approximately US$275 million, of social programs and effectiveness of long-term social equivalent to 60 percent of the 2003 health sector budget investments (Vos et al. 2003). and more than 4 times the education sector investment budget (Figure 2). Several tools could restore social expenditure levels at least to historical levels, and dampen social sector budget volatility: Figure 2 - Re-targeting the gas subsidy using the SelBen is pro-poor and progressive · The budget management process needs improving, so that funds disburse regularly. Fiduciary contracts, as 1.0 used for the Bono de Desarrollo Humano, would mitigate Subsidy acc. Treasury cash-flow problems, and guarantee that funds SelBen for (selected) social programs are available when required. Benefits · 0.5 New guidelines for using the oil-stabilization fund and revised price triggers to divert more oil revenues into the Current Cumm. Subsidy fund could provide substantial counter-cyclical funding. 0 Also, social expenditures could be used more effectively. 0 0.5 1.0 Significant improvements are needed in education provision and quality, especially in rural areas. Health service coverage Current Population must be expanded and integrated better across different sub- systems and providers. *********** Social expenditures: Incidence and recent initiatives to improve targeting About the Author Carolina Sanchez-Paramo is a Senior Economist with the Overall, social spending is progressive (benefiting the Poverty Group of the LACPREM unit in the World Bank's poor relatively more than the rich), but this varies Latin America and the Caribbean Region. significantly across programs and services. Expenditure on primary and secondary education is progressive, both at the household and provincial level; health About "en breve" spending is progressive at the household level and almost neutral across provinces, with similar transfers Access the new "en breve" website at http:// per capita. The Bono Solidario, the largest social www.worldbank.org/en_breve. You can now subscribe and assistance program, is progressive, but the gas subsidy, receive "en breve" electronically every two weeks 4