Abstract
Ecuador’s pre-COVID potential growth slowed substantially, from about 4 percent during 2001–2014, to just over 1 percent by 2015–2019, constrained by structural bottlenecks. The pandemic rendered a heavy hit to the economy in 2020, which, in the absence of structural reforms, could cause permanent scarring and sluggish potential growth of around 1.5 percent. Structural reforms in labor market, financial sector, external finance, and trade can boost growth up to 4 percent.
Raising Ecuador’s Growth Potential in a Post-Pandemic World>1
Ecuador’s pre-COVID potential growth slowed substantially, from about 4 percent during 2001–2014, to just over 1 percent by 2015–2019, constrained by structural bottlenecks. The pandemic rendered a heavy hit to the economy in 2020, which, in the absence of structural reforms, could cause permanent scarring and sluggish potential growth of around 1.5 percent. Structural reforms in labor market, financial sector, external finance, and trade can boost growth up to 4 percent.
A. Introduction
1. Ecuador’s potential growth has been low in recent years, and the pandemic dealt a severe blow to the economy. Before the Covid-19 pandemic hit the economy last year, Ecuador had recorded one of the lowest potential growth rates over the period of 2015–2019, at a meagre 1 percent A combination of factors related to the structural barriers and overvalued exchange rate have contributed to growth underperformance. The pandemic hit when the country was worst prepared to handle a crisis of such magnitude, given low reserve buffers and absence of borrowing space. As a result, the actual GDP collapsed by record 7.8 percent in 2020, pushing unemployment and poverty rates higher up. Many high-contact sectors are yet to recover to pre-pandemic levels, likely indicating fall in their potential output.
2. In the absence of significant structural reforms, there is a risk of significant scarring of potential output, with repercussions on employment and private investment. Episodes of past pandemics suggest potential long-term per capita output loss could be as high as 10 percent in the severest cases, while the average loss was around 7 percent (IMF, 2021). This analysis shows that Ecuador could permanently lose about 6 ½ percent of output relative to pre-pandemic trends, resulting in lower potential growth over the longer term. On the other hand, structural reforms can boost potential growth up to 4 percent. The rest of the note is organized as follows: Section B analyzes Ecuador’s pre-pandemic growth performance and summarizes key barriers to higher growth; Section C focuses on the impact of COVID-19; and Section D estimates growth dividends from reforms.
B. Pre-pandemic Growth Performance
3. Hodrick-Prescott (HP) filter and the production function (PF) approaches were used to estimate potential GDP growth. For the first method, the HP filter was applied to the annual real GDP series. On the other hand, the PF approach utilizes a Cobb- Douglas production function, Y= A * Kα(L * H)1-α where Y is output, K – capital, L – labor, and H—human capital inputs, and A is total factor productivity (TFP), which is calculated as residual. The parameters of the production function and methods to estimate TFP are based on Acevedo (2019). After deriving the components of the GDP, an HP filter was used to smooth the (univariate) time series for labor input (unemployment and participation rate), capital services and TFP. The smoothed estimates of factors inputs and productivity were then used to calculate potential GDP and its growth rate.
4. Potential growth slowed substantially after the 2014 oil price shock. Both estimates of potential growth indicate average potential growth of over 4 percent during 2001–2014. This has collapsed to a meagre 1 percent over 2015–2019. These results are broadly in line with what other studies have found for Ecuador (e.g., Alvarado, 2020).
Ecuador: Potential Real GDP Growth Estimates
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.Ecuador: Potential Real GDP Growth Estimates
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.Ecuador: Potential Real GDP Growth Estimates
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.5. The slowdown in potential growth was driven by TFP decline on the supply side. Weak aggregate demand and rigid labor markets implied any hit to factors of production would first take place through TFP decline, with slower subsequent capital accumulation. This indeed occurred in Ecuador, with TFP taking the brunt of the fall over 2015–2019. While the contribution of capital declined modestly, the gradual fall in labor contribution was more tangible. Similar pattern of growth decomposition holds once accounted for the size of the informal economy. There also exists positive correlation between growth/TFP and oil prices, similar to other oil exporting countries (IMF, 2016), as high oil prices helped finance greater public and infrastructure investment with positive spillovers to TFP.
Ecuador Contributions to Growth and Oil Prices
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: Haver, BCE, PWT v9.0, and IMF staff calculations.Ecuador Contributions to Growth and Oil Prices
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: Haver, BCE, PWT v9.0, and IMF staff calculations.Ecuador Contributions to Growth and Oil Prices
(In percent)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: Haver, BCE, PWT v9.0, and IMF staff calculations.6. Permanently lower fiscal spending from the demand side also played a role in the slowdown. Faced with the reality of lower oil prices and related lower revenues, government spending, particularly of public investment, adjusted to the new realities. Moreover, structural barriers and low competitiveness stemming from the rigidities in the labor market, difficult business climate and overvalued real exchange rate (Panel Figure 1, top four panel charts), implied that the private demand and net exports could not fill the void left by lower-for-longer public spending. Hence, lackluster demand due to weak public demand was the main factor of pre-pandemic actual growth slowdown, with repercussions on potential growth slowdown.
Ecuador: Pre-Pandemic Bottlenecks and Vulnerabilities
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Ecuador: Pre-Pandemic Bottlenecks and Vulnerabilities
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Ecuador: Pre-Pandemic Bottlenecks and Vulnerabilities
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Ecuador: Contribution to Real GDP Growth
(In annual percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.Ecuador: Contribution to Real GDP Growth
(In annual percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.Ecuador: Contribution to Real GDP Growth
(In annual percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.C. The Impact of COVID-19 Pandemic
7. The pandemic led to a record contraction of 7.8 percent in actual GDP. Ecuador was ill- prepared for COVID-19 crisis due to the lack of fiscal buffers and absence of adequate digital infrastructure to support the economy during the lockdown (Panel Figure 1, bottom two panel charts). As a result of mobility restrictions to contain the spread of the virus, economic activity fell by 12.8 percent (y-o-y) in 2020:Q2. The drop was led by a sharp decline in high-contact sectors’ output, as well as in petroleum output due to an idiosyncratic pipeline damage. Subsequent recovery was muted, especially in 2020:Q4, leading to an overall contraction in 2020 of 7.8 percent.
Ecuador: Quarterly Growth 1/
(In percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE and IMF staff calculations.1/ High contact sector: construction, trade, hotel, restaurants, transportation, professional services, education and health services. Low contact sectors: agriculture, shrimp, fishing, manufacturing, utilities, communications, finance, public administration, domestic and other services.Ecuador: Quarterly Growth 1/
(In percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE and IMF staff calculations.1/ High contact sector: construction, trade, hotel, restaurants, transportation, professional services, education and health services. Low contact sectors: agriculture, shrimp, fishing, manufacturing, utilities, communications, finance, public administration, domestic and other services.Ecuador: Quarterly Growth 1/
(In percentage change)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE and IMF staff calculations.1/ High contact sector: construction, trade, hotel, restaurants, transportation, professional services, education and health services. Low contact sectors: agriculture, shrimp, fishing, manufacturing, utilities, communications, finance, public administration, domestic and other services.8. High-contact service sectors were severely affected. High contact sectors, which accounted for about 43 percent of gross value added pre-pandemic, fell by about 12 ½ percent in 2020:Q2 (q-o-q), driven by sharp drops in transportation, accommodation and restaurant services. As of end-2020, most high-contact sectors failed to recover about 10 percent of their 2019 output. The crisis also led to elevated unemployment in the economy, driven by job losses in high-contact sectors. Even after the recovery in subsequent, unemployment remains elevated, while the quality of jobs is below the adequate levels (see accompanying SIP).
Ecuador: Sectoral Value Added, 2020 1/
(As a share of 2019 level)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.1/ Red bars indicate high-con tact sectors.Ecuador: Sectoral Value Added, 2020 1/
(As a share of 2019 level)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.1/ Red bars indicate high-con tact sectors.Ecuador: Sectoral Value Added, 2020 1/
(As a share of 2019 level)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: BCE, Haver Analytics, and IMF staff calculations.1/ Red bars indicate high-con tact sectors.9. In the absence of reforms, the COVID-19 crisis could lead to permanent scarring and further reduce potential growth. A prolonged period of unemployment in sectors severely affected by the pandemic can reduce related human capital, while some jobs, firms, and activities could be permanently lost, resulting in permanent unemployment and stranded capital. Moreover, an increased shift towards working from home in services industry could result in stranded physical capital, with repercussions on investment activity. In fact, past pandemics suggest average output loss of over 7 percent compared to pre-pandemic trends (IMF, 2021), driven by capital and TFP losses, at around 4 ½ and 2 percentage points, respectively.
Contribution to Per Capita GDP Loss from Pandemics 1/
(In percentage points)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source; PWT 10.0, and IMF staff calculations.1/ Past pandemics refer to modern eta pandemics and epidemics that include: Hong Kuncj flu, SARS, H1N1, MERS, tbola, and Zika.Contribution to Per Capita GDP Loss from Pandemics 1/
(In percentage points)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source; PWT 10.0, and IMF staff calculations.1/ Past pandemics refer to modern eta pandemics and epidemics that include: Hong Kuncj flu, SARS, H1N1, MERS, tbola, and Zika.Contribution to Per Capita GDP Loss from Pandemics 1/
(In percentage points)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source; PWT 10.0, and IMF staff calculations.1/ Past pandemics refer to modern eta pandemics and epidemics that include: Hong Kuncj flu, SARS, H1N1, MERS, tbola, and Zika.Ecuador: Growth Dividend from Structural Reforms
(In percentage points change in Real GDP growth after 5 years)
Ecuador: Growth Dividend from Structural Reforms
(In percentage points change in Real GDP growth after 5 years)
| Studies | IMF, 2015 | Biljanovska & Sandri, 2018 | IMF, 2019 | David et al., 2020 |
|---|---|---|---|---|
| Country samples | EMs | Brazil | EMs and LICs | LA and Caribbean |
| Labor market | Less than 1 | 1 | 0.8 | - |
| Product market | Less than 1 | 0.6 | 1 | 1 |
| Financial sector | 1 to 2 | 1.2 | 2 | 2 |
| External Finance | 1 to 2 | - | 1.3 | - |
| Trade Liberalization | Less than 1 | 0.5 | 1 | 3 |
| Governance | Less than 1 | 0.8 | 2 | - |
Ecuador: Growth Dividend from Structural Reforms
(In percentage points change in Real GDP growth after 5 years)
| Studies | IMF, 2015 | Biljanovska & Sandri, 2018 | IMF, 2019 | David et al., 2020 |
|---|---|---|---|---|
| Country samples | EMs | Brazil | EMs and LICs | LA and Caribbean |
| Labor market | Less than 1 | 1 | 0.8 | - |
| Product market | Less than 1 | 0.6 | 1 | 1 |
| Financial sector | 1 to 2 | 1.2 | 2 | 2 |
| External Finance | 1 to 2 | - | 1.3 | - |
| Trade Liberalization | Less than 1 | 0.5 | 1 | 3 |
| Governance | Less than 1 | 0.8 | 2 | - |
Ecuador: Potential Growth Decomposition Pre-and Post-Covid
(In percentage points change in Real GDP)
Ecuador: Potential Growth Decomposition Pre-and Post-Covid
(In percentage points change in Real GDP)
| Low-oil 1986 -2005 | High oil 2006–14 | 2015–19 | Pre-Covid 2026–2030 | Post-Covid 2026–2030 | ||
|---|---|---|---|---|---|---|
| No-reform | Reform | |||||
| Capital | 0.8 | 2 | 1.6 | 1.5 | 1 | 1.7 |
| Employment | 2.2 | 1.4 | 1.4 | 0.9 | 0.9 | 1.3 |
| Human capital | 0.3 | 0.2 | 0.1 | 0.1 | 0.1 | 0.2 |
| TFP | -0.4 | 0.7 | -2 | 0 | -0.5 | 0.8 |
| Total | 2.8 | 4.2 | 1.1 | 2.5 | 1.5 | 4 |
Ecuador: Potential Growth Decomposition Pre-and Post-Covid
(In percentage points change in Real GDP)
| Low-oil 1986 -2005 | High oil 2006–14 | 2015–19 | Pre-Covid 2026–2030 | Post-Covid 2026–2030 | ||
|---|---|---|---|---|---|---|
| No-reform | Reform | |||||
| Capital | 0.8 | 2 | 1.6 | 1.5 | 1 | 1.7 |
| Employment | 2.2 | 1.4 | 1.4 | 0.9 | 0.9 | 1.3 |
| Human capital | 0.3 | 0.2 | 0.1 | 0.1 | 0.1 | 0.2 |
| TFP | -0.4 | 0.7 | -2 | 0 | -0.5 | 0.8 |
| Total | 2.8 | 4.2 | 1.1 | 2.5 | 1.5 | 4 |
10. Ecuador could lose about 6½ in output relative to pre-pandemic trend. In an optimistic scenario—based on assumptions of no change in TFP, average fall in labor and lowest fall in capital from the past pandemics—permanent loss could only be 2½ percent by 2030. However, given the severity of the pandemic and magnitude of the recession, output loss could realistically reach 6½ percent of pre-pandemic levels. This estimate assumes TFP will be permanently lower by 1 percentage points, while capital and labor loss will be at the average of the past pandemics. In a more pessimistic scenario, the pandemic can cause a permanent loss of about 9 percent over the long-term, as the contributions from TFP and labor will be even lower. Therefore, structural reforms are key to boost potential growth, and ease the impact of the pandemic on output.
Ecuador: Potential Scarring from COVID-19
(In percentage point contribution to GDP loss)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: PWT 10.0, WEO, and IMF staff calculations.Ecuador: Potential Scarring from COVID-19
(In percentage point contribution to GDP loss)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: PWT 10.0, WEO, and IMF staff calculations.Ecuador: Potential Scarring from COVID-19
(In percentage point contribution to GDP loss)
Citation: IMF Staff Country Reports 2021, 229; 10.5089/9781513599274.002.A001
Source: PWT 10.0, WEO, and IMF staff calculations.D. Reform Options to Boost Long-term Growth
11. Previous studies have discovered significant growth dividend from structural reforms. The overall growth dividend from comprehensive structural reforms in Emerging Market economies (EMs) ranges from 1 to 2 percent (Table 1; IMF, 2015; IMF, 2019, Biljanovska & Sandri, 2018; David et al., 2020). The substantial boost comes from reforms in the financial sector— reforms that enhance financial inclusion and reduce cost of intermediation—and external finance—opening up to foreign direct and portfolio investments. The reforms in the labor market—such as, increasing labor market flexibility—and trade liberalization (e.g., reducing of trade barriers, deeper trade integration) bring the next big return. Several papers also cite hefty growth dividends from governance reforms that improve intuitions and policy frameworks.
12. Ecuador undertook significant reforms to restore macroeconomic stability and improve governance. The key achievements include fuel subsidy reform; amendments to the fiscal responsibility law to anchor medium-term fiscal sustainability; amendments to the anti-corruption framework to criminalize corruption; and amendments to the central bank law (COMYF) to restore the central bank autonomy and strengthen dollarization.
13. Analysis of structural barriers to growth indicate significant room for reforms. Constraints due to dollarized regime puts even more emphasis on the importance of structural reforms to increase labor productivity and private investment. As was shown in Panel Figure 1, there exist substantial room to enhance labor market flexibility (see accompanying SIP); increase access to finance, among others, by reducing domestic real interest rates (see accompanying SIP); and further streamline regulations and licenses. There could be additional benefits from integrating into US-linked global value chains and saving fiscal resources to finance infrastructure for digital economy, given the future of work will increasingly be online.
14. The suggested reforms could substantially increase growth relative to the baseline. If most of these reforms are successfully implemented, the long-term potential growth can reach 4 percent. This is 1.5 percentage points higher relative pre-Covid potential growth estimate and is about the average from past reform episodes in other countries. The higher potential growth will be fueled by significantly higher TFP and labor accumulation compared to pre-Covid potential growth, while the contribution of physical and human capital will be comparable to what was observed during 2015–2019. The presumption of higher labor and TFP growth is due to labor market reforms, which make labor more productive and allow firms hire more people. Physical capital, while comparable to 2015–2019, will still be much higher than the previous episodes of lower oil prices, as structural reforms will enable greater private investment and fill the void left by public investment during lower oil price periods. However, if none of these reforms are undertaken, there is risk of falling into mediocre growth rates, in an environment of projected lower oil prices and pandemic scarring.
References
Acevedo, S., 2019, “Potential Output, GDP Nowcasting and Forecasting”, Selected Issues Paper, IMF Country Report No. 19/80.
Alvarado, E. Y., 2020, “Estimación del Crecimiento Potencial para el Ecuador”, Revista Cuestiones Económicas Vol. 30 Núm. 2, Banco Central del Ecuador.
Biljanovska, N. and Sandri, D., 2018. “Structural Reform Priorities for Brazil” IMF Working Paper 18/224. International Monetary Fund, Washington, DC.
David, Antonio & Komatsuzaki, Takuji & Pienknagura, Samuel. (2020). The Macroeconomic Effects of Structural Reforms in Latin America and the Caribbean. IMF Working Paper 20/195.
IMF, 2015, “ Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund”, IMF, Washington, D.C.
IMF, 2016, “ More Bang for the Buck in the GCC: Structural Reform Priorities to Power Growth in a Low Oil Price Environment”, IMF, Washington DC.
IMF, 2019 “Reigniting Growth in Emerging Market and Low-Income Economies: What Role for Structural Reforms?” Chapter 3 of the October 2019 World Economic Outlook. International Monetary Fund, Washington, DC.
IMF, 2021. “Policies for the Recovery: Mitigating Persistent Damage from the COVID-19 Recession”, Chapter 2, World Economic Outlook, IMF, Washington DC.
Prepared by Botir Baltabaev (WHD).
