T H E W O R L D B A N K

W A S H I N G T O N , D C

Marcelo Giugale Vicente Fretes-Cibils Eduardo Somensatto

ECUADORAn Economic andSocial Agenda in theNew Millennium

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Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv

Editor Biographies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii

Acronyms and Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xix

Context and Executive SummaryEduardo Somensatto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1II. Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2III. Preserving Stability and Accelerating Growth . . . . . . . . . . . . . . . . . . . . . . . 6IV. Promoting Sustainable and Equitable Social Development . . . . . . . . . . . . 24V. Improving Governance and Strengthening Institutions . . . . . . . . . . . . . . . 32

Chapter 1. Fiscal Sustainability and Debt Management in EcuadorVicente Fretes Cibils, Rashmi Shankar, and Elizabeth Currie . . . . . . . . . . . . . . . . 43I. Background and Current Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44II. Fiscal Trends and Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49III. Fiscal Policy and Public Debt Sustainability . . . . . . . . . . . . . . . . . . . . . . . 53IV. Public Debt Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56V. Policy Options to Strengthen Fiscal Sustainability. . . . . . . . . . . . . . . . . . . 62Annex. Public Debt Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

Chapter 2. Tax Policy and AdministrationOsvaldo Schenone, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73I. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74II. Three Primary Problems of Ecuador’s Tax Policy. . . . . . . . . . . . . . . . . . . . 76III. Modernization of the Tax Administration—Two Priority Reforms . . . . . . 83IV. Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

Contents

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iv ECUADOR: AN ECONOMIC AND SOCIAL AGENDA IN THE NEW MILLENNIUM

Chapter 3. The Banking System: Current Context and Remaining ChallengesRashmi Shankar and Jean Clevy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95I. Profile of Ecuador’s Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95II. Structure of the Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102III. Liquidity Management and Solvency . . . . . . . . . . . . . . . . . . . . . . . . . . . 106IV. Risk Profile of the Banking System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112V. Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126

Chapter 4. The Oil and Gas SectorEleodoro Mayorga-Alba, Alfredo Monge, Oscar Arrieta, Jorge Albán, and Horacio Yépez . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127I. Current Situation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127II. Principal Aspects of Sector Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137III. Final Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157

Chapter 5. Economic Growth through Improved Competitiveness and an Enhanced Investment ClimateMike Goldberg, Juan Carlos Mendoza, José Guilherme Reis, and Eric Palladini . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159I Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160II. Competitiveness Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160III. The Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171IV. Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

Chapter 6. Electricity SectorSusan V. Bogach and Eduardo H. Zolezzi . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183I. Overview of the Current Situation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184II. Key Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194III. Policy Options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219

Chapter 7. Boosting Sustainable and Equitable Social DevelopmentMonique F. Mrazek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222II. Sector Overviews, Trends, and Diagnostics . . . . . . . . . . . . . . . . . . . . . . 223III. Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

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Chapter 8. The Pension SystemRafael Rofman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253I. System Diagnostic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254II. Proposed Policy Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265III. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

Chapter 9. Sustainable and Inclusive Rural DevelopmentFrancisco Pichon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273I. The Context for Sustainable and Inclusive Development

in Ecuador. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274II. The Agricultural Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279III. The Institutional Setup for Rural Development . . . . . . . . . . . . . . . . . . . 286IV. Ethnicity in Rural Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289V. Environmental and Natural Resources Policy Challenges . . . . . . . . . . . . 292VI. Conclusions and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314

Chapter 10. Enhancing Public Sector Transparency and AccountabilityEdgardo Mosqueira. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319I. Three Key Governance Problems: Corruption, Lack of Transparency in

Public Management, and Weak Delivery of Justice . . . . . . . . . . . . . . . . . 320II. Foundations for Further Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327III. Policy Alternatives to Increase Transparency and Accountability in

Public Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

Chapter 11. Labor Market and Civil Service in EcuadorJeffrey Rinne . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351I. Labor Market in Ecuador . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352II. Civil Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372

Chapter 12. DecentralizationJonas Frank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376II. Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377III. Moving Forward: Strategy and Policy Options . . . . . . . . . . . . . . . . . . . . 385Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

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Chapter 13. Basic Infrastructure: Water Supply and Sanitation, Telecommunications, Transport, and Urban PlanningFranz Drees-Gross, Eloy Vidal, Emmanuel James, and Alexandra Ortiz . . . . . . . . 403I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404II. Description of the Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405III. Diagnosis of the Main Problems and Challenges. . . . . . . . . . . . . . . . . . . 411IV. Sectoral Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433Annex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 446

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454

TablesSummary of Some Policies for Improving Economic and Social Development . . 411.1 Ecuador Macroindicators, International Comparisons . . . . . . . . . . . . . . . 451.2 Banking System Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461.3 Key External Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481.4 Main Fiscal Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501.5 Evolution of Public Wages and Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . 521.6a Assumptions Underlying Debt Simulations, 2007–10 . . . . . . . . . . . . . . . 551.6b Sensitivity of Debt Projections to Fiscal Assumptions . . . . . . . . . . . . . . . 551.7 Net Central Government Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571.8 Credit Sovereign Debt Rating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 571.9 Total Debt, by Source of Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 591.10 Public Debt by Currency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622.1 Total Income by the Nonfinancial Public Sector and the

Central Government, 1995–2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742.2 Selected Tax Administration Indicators, 2001–03 . . . . . . . . . . . . . . . . . . . 762.3 The Structure of the Tax System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 772.4 Estimated Tax Cost of the Internal VAT Exemptions in 2001. . . . . . . . . . 792.5 Tax Cost of Exemptions on Customs Tariffs and on the

VAT on Imports, 2000 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 802.6 Preallocation Percentages of the ICE Tax Revenues, 2006 . . . . . . . . . . . . . 82

Summary Table of the Estimated Tax Revenue Effects of the Recommendations in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87Summary Table of the Priority of the Recommendations . . . . . . . . . . . . . 87Recommendation Matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

A.1 Value of VAT Exemptions, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90A.2 Value of VAT Exemptions, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913.1 Number of Entities in the Financial System . . . . . . . . . . . . . . . . . . . . . . . 963.2 Private Banking System: Consolidated Balance Sheet . . . . . . . . . . . . . . . . 993.3 Private Banks: Income Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1003.4 Private Bank Financial Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1003.5 Number and Size of Institutions in the Financial System . . . . . . . . . . . . 1033.6 Integration with Global Financial Markets (November 2006) . . . . . . . . 106

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3.7 Analysis of Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1073.8 Banking System: Sources and Uses of Funds . . . . . . . . . . . . . . . . . . . . . . 1083.9 Liquidity in the Banking System (Dec. 2006) . . . . . . . . . . . . . . . . . . . . . 1093.10 Ecuador: Liquidity Stress Testing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1113.11 Risk Indicators for the Banking System. . . . . . . . . . . . . . . . . . . . . . . . . . 1154.1 Ecuador Hydrocarbon Reserves. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1284.2 Production, Imports, and Exports of Refined Products . . . . . . . . . . . . . . 1314.3 Estimate of 2006 Subsidy Levels (without VAT) . . . . . . . . . . . . . . . . . . . 1314.4 Average Gasoline and Diesel Prices Paid by Domestic Consumers . . . . . 1324.5 Institutional Structure Proposed for the Oil and Gas Sector . . . . . . . . . . 1385.1 Changes in Competitiveness Rank, 2005–06 . . . . . . . . . . . . . . . . . . . . . 1615.2 Constraints to Doing Business in Ecuador . . . . . . . . . . . . . . . . . . . . . . . 1625.3 Cost and Difficulty of Starting a Business . . . . . . . . . . . . . . . . . . . . . . . . 1625.4 Business Licensing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1635.5 Employment and Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1635.6 Tax Burden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1645.7 Requirements and Costs for Importing and Exporting . . . . . . . . . . . . . . 1645.8 Dimensions of Investor Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1655.9 Contract Enforcement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1655.10 Closing a Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1666.1 Comparative Energy Statistics in Latin America . . . . . . . . . . . . . . . . . . . 1896.2 Energy Balance of Distribution Companies 2001–05 . . . . . . . . . . . . . . . 1906.3 OLADE Electricity Prices in LAC (US¢/kWh), 2004. . . . . . . . . . . . . . . 1926.4 Average Price of Electricity for Distributors in Spot Market

and Fixed-Term Contracts (US¢/kWh) . . . . . . . . . . . . . . . . . . . . . . . . . . 1926.5 Estimated Renewable Energy Potential for Electricity Generation . . . . . 1936.6. Efficiency Indexes of Distribution Companies, 2005 . . . . . . . . . . . . . . . 1956.7 What Happens to 100 kWh Purchased by a Distribution

Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1966.8 Distribution of Tariff Deficit and Arrears to the MEM . . . . . . . . . . . . . . 1986.9 Options to Eliminate Accumulated and Annual Tariff Deficits . . . . . . . 2106.10 Options to Ensure Adequate Investment in Generation . . . . . . . . . . . . . 2116.11 Options to Improve Sector Regulation for Price and Tariff Setting . . . . . 2126.12 Options to Improve Governance to Facilitate Efficiency

in the Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2126.13 Options to Develop Cost-Effective New and Renewable

Energy Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2136.14 Options to Maximize Energy Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . 2147.1 Increase in Social Spending by Expenditure

Group, 2002–2005 (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2247.2 Real Change of Priority Program Budgets (constant 2000 US$) . . . . . . . 2257.3 Net Enrollment Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2267.4 Internal Efficiency Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

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7.5 Total Education Sector Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2277.6 Trends in Selected Health-Related MDG Indicators . . . . . . . . . . . . . . . . 2297.7 Social Assistance Spending, 2003–2006 . . . . . . . . . . . . . . . . . . . . . . . . . 2337.8 Nutrition Outcomes of Children Under Five

in Selected Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2347.9 Overview of Social Security Network . . . . . . . . . . . . . . . . . . . . . . . . . . . 2388.1 Average Monthly Pension Benefits, 2000–06 . . . . . . . . . . . . . . . . . . . . . 2619.1 Selected Characteristics of Ecuadoran Subregions . . . . . . . . . . . . . . . . . . 2769.2 Characteristics of Core Rural Territories . . . . . . . . . . . . . . . . . . . . . . . . . 2779.3 Total Productivity Contribution of Labor and Capital

to the Value-Added Growth, 1994–99 . . . . . . . . . . . . . . . . . . . . . . . . . . 2819.4 Sources of Farmers’ Technical Assistance . . . . . . . . . . . . . . . . . . . . . . . . . 283A.1 Selected Characteristics of Ecuador’s Rural Zones . . . . . . . . . . . . . . . . . . 312A.2 Ecuador: Main Dynamic Rural Territories. . . . . . . . . . . . . . . . . . . . . . . . 31310.1 Public Institutions Perceived as Most and Least Transparent . . . . . . . . . . 32510.2 Key Areas and Activities of CSOs in Ecuador . . . . . . . . . . . . . . . . . . . . . 32810.3 Average Duration of a Civil Case in Quito (days) . . . . . . . . . . . . . . . . . . 33410.4 Clearance Rate in Pilot Courts (Incoming Cases Adjudicated) . . . . . . . . 334A.1 Ecuador Governance Indicators. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345A.2 Comparison of Governance Indicators with Other

Countries of the Region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 346A.3 Regulatory Quality, Selected Countries . . . . . . . . . . . . . . . . . . . . . . . . . . 347A.4 Rule of Law, Selected Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34711.1 Economic Growth and Key Indicators for Labor Market . . . . . . . . . . . . 35311.2 Employment Distribution by Sector and Employment Situation . . . . . . 35511.3 Real Monthly Labor Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35711.4 Structure of Government Jobs under the Public Employees

System, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36512.1 Basic Services Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377A.1 Special Laws Governing the Transfer of Resources and

Revenue-Sharing for the Benefit of Municipalities and Provincial Councils . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

13.1 Institutions Related to the Water Supply and Sanitation (WSS) Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 406

13.2 Service Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40713.3 Coverage of Potable Water Supply and Sewerage Services, 2001 . . . . . . 41213.4 Operational Efficiency of Water Supply Companies in a Selection

of Large and Medium-Size Cities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41413.5 Machala: Monthly Expenditure on Water Supply and Sanitation

Services—Families with and without Home Connection, 2002 . . . . . . . 41513.6 Characteristics of the Ecuadoran Road System, by Region . . . . . . . . . . . 423A.1 Measures of Migration as a Proportion of Total Population,

by Province . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 448

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A.2 Characteristics of Poor and Nonpoor Urban Households in Ecuador,1997–2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450

A.3 Access to Basic Services in 12 Intermediate Cities in Ecuador . . . . . . . . . 451A.4 Populations, Built-up Areas, and Densities in Five Intermediate

Cities in Ecuador, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453A.5 Population, Density, Built-Up Area, and Urban Area Projections

for 2030 for the Five Intermediate Cities in Ecuador . . . . . . . . . . . . . . . 453

Figures1.1a Non-oil Exports, 1995–2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491.1b Noncommodity Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491.2 NFPS Oil Revenues and Primary Expenditure . . . . . . . . . . . . . . . . . . . . . 511.3 Ecuador’s Share of Transfers and Subsidies in GDP . . . . . . . . . . . . . . . . . 531.4 Total Debt Levels as a Percentage of GDP . . . . . . . . . . . . . . . . . . . . . . . . 561.5 EMBI Plus Ecuador and Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . 581.6 Composition of Total Public Debt, by Interest Rate . . . . . . . . . . . . . . . . . 611.7 Amortization Profile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613.1 Bank Assets, Loans, and Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 973.2 Financial Depth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 983.3 External Lines of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1013.4 Concentration Ratios (HH Index) for Ecuadorian Banking Systems. . . . 1053.5 Evolution of Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1133.6 Banking System’s Capital Adequacy, 2006. . . . . . . . . . . . . . . . . . . . . . . . 1163.7 Risk Perception Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1174.1 Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1424.2 Consumption of Petroleum Products . . . . . . . . . . . . . . . . . . . . . . . . . . . 1454.3 Balance of Trade, Oil and Gas Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . 1454.4 Sector’s Contribution to Public Revenues . . . . . . . . . . . . . . . . . . . . . . . . 1456.1 Institutional Setup of the Electricity Sector . . . . . . . . . . . . . . . . . . . . . . . 1846.2 Cross-Subsidy Scheme for Bolivar and CATEG-D . . . . . . . . . . . . . . . . . 2016.3 Maximum Demand Balance, 2006–11 during Critical

Month in Dry Season . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2036.4 Energy Balance, 2006–11 during Critical Month in Dry Season. . . . . . . 2037.1 Ecuador Real Per Capita Social Expenditure . . . . . . . . . . . . . . . . . . . . . 2237.2 Ecuador Social Sector Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2247.3 School-Age Population without Teacer Coverage . . . . . . . . . . . . . . . . . . 2288.1 Overall Financial Performance of the IESS Pension System,

1993–2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2588.2 Financial Performance of the IESS Pension System, 1993–2004 . . . . . . . 2598.3 Government Contribution to IESS Pensions. . . . . . . . . . . . . . . . . . . . . . 2608.4 Percentage of the Labor Force Participating in Contributive

Pension Programs in South America . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262

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8.5 Pension Coverage of Economically Active Population, 1965–2005 . . . . . 2638.6 Coverage of Pension Systems, by Age Group and Gender . . . . . . . . . . . . 26410.1 Respondents Who See Progress in Fighting Corruption, 2005 . . . . . . . . 32110.2 Respondents’ Perception of Percentage of Corrupt

Public Officials, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32110.3 Governance Indicators, 2005 versus 1998 . . . . . . . . . . . . . . . . . . . . . . . . 32210.4 Average Delay Reduction in Pilot Courts . . . . . . . . . . . . . . . . . . . . . . . . 33310.5 Number of Cases Adjudicated by Civil Court Per Month . . . . . . . . . . . 33411.1 Emigration from Ecuador . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35411.2 Labor Force Informality in Latin America . . . . . . . . . . . . . . . . . . . . . . . . 35611.3 Labor Regulation in Ecuador . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35711.4 Constraints for Job Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35811.5 Public Employment in Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . . 36411.6 Personnel Expenses in the Nonfinancial Public Sector. . . . . . . . . . . . . . . 36512.1 Vertical fiscal Imbalances, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37812.2 Intergovernmental Transfers, 1996–2005 . . . . . . . . . . . . . . . . . . . . . . . . 38012.3 Execution of Payments to Municipalities and Provincial Councils

under 15 percent Law, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38112.4 Subnational Government per Capita Expenditures and

Consumption-Based Poverty, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385A.1 Subnational Government Per Capita Expenditures and Poverty . . . . . . . 39413.1 Mobile and Fixed Telephony, 1999–2006 . . . . . . . . . . . . . . . . . . . . . . . . 40813.2 Access to Water Supply (connection), by Income Level . . . . . . . . . . . . . . 41313.3 Water Treatment by Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41313.4 Fixed-Line Density and GDP Per Capita . . . . . . . . . . . . . . . . . . . . . . . . 41613.5 Fixed-Line Density Rate, by Province . . . . . . . . . . . . . . . . . . . . . . . . . . . 41713.6 Mobile Line Penetration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41913.7 Internet Users in the Region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42013.8 Global System for Mobile Communications (GSM) Coverage in

Ecuador. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42113.9 Participative Planning Process for Rural Roads . . . . . . . . . . . . . . . . . . . . 431

Boxes3.1 Liquidity Management and Payment System . . . . . . . . . . . . . . . . . . . . . 1134.1 Fiscal Terms Applicable to Oil and Gas Production . . . . . . . . . . . . . . . . 1304.2 Reducing Flaring of Associated Gas in Ecuador . . . . . . . . . . . . . . . . . . . 1364.3 The Energy, Environment, and Population (EAP) Program . . . . . . . . . . 1374.4 Efficient State Oil Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1414.5 Sensitivity Analysis: The Impact of Lower Oil Prices. . . . . . . . . . . . . . . . 1464.6 Criteria of the Extractive Industries Transparency Initiative (EITI) . . . . . 1485.1 Successful Clusters in Nicaragua: Gains in Income, Exports, and Jobs . . 1696.1 Explanation of Tariff Deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190

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6.2 Payment Priorities from Distribution Companies and Accumulating Debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199

6.3 Peru’s Fondo de Compensación Social Eléctrica (FOSE) . . . . . . . . . . . . . 2007.1 Expanding Health Coverage to the Poor: Lessons from Columbia . . . . . 2327.2 Major Causes of Malnutrition in Ecuador. . . . . . . . . . . . . . . . . . . . . . . . 2357.3 Chile’s Use of Monitoring Systems—A Nutrition Success Story . . . . . . . 236

10.1 Progress in Implementing the Law of Transparency and Access to Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323

10.2 Preconditions for the Development of a Financial Management Information System. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 336

10.3 Quick Gains: The Case of Ceará, Brazil . . . . . . . . . . . . . . . . . . . . . . . . . 33810.4 International Best Practices for Improving Procurement Systems . . . . . . 33911.1 Government Plan 2007–11 and its Relation to Labor Markets . . . . . . . . 35211.2 Tripartite Table Dialogue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36211.3 The New Civil Service Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36611.4 Human Resources Management Systems: Some Examples of

Positive Fiscal Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368

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Ecuador is at a crossroads in the early years of the new millennium. Political, economic,and social instability have long affected the country’s path of development. Thoughit is rich in cultural traditions and natural endowments, the stop-and-go cycles of pastpublic policies have prevented the country from realizing its potential for economicprosperity and social equity. Ecuador has the opportunity to define a developmentagenda that will benefit all of its citizens. In this agenda, stability, growth, competi-tiveness, social development, decentralization, and transparency would constitute themileposts. We at the World Bank feel honored to contribute to the public policydebate through publishing the second edition of Ecuador—An Economic and SocialAgenda in the New Millennium. We have updated this book to provide an account ofEcuador’s current key development challenges, many of the reasons behind thosechallenges, and some options to overcome them. The analysis here does not claim toprovide definitive solutions to all of Ecuador’s challenges. Rather, we hope that thissecond edition can enrich the national discussion among Ecuadorans as they searchfor their own solutions to these challenges.

The work presented here is organized around three overarching themes: fiscalconsolidation and growth, social development, and quality of government. The mainmessages within each of these themes are summarized and brought together in anopening synthesis. The importance of these three broad themes has become increas-ingly evident all around the world during the past decades and has been accentuatedby global integration (financial and commercial) and by the information technologyrevolution. Understanding those forces is critically important because, in the end,their value will be measured by one simple yardstick—their impact on people’s qual-ity of life, especially among the poor.

This second edition is the product of the analytical work of a large number ofWorld Bank staff members. It documents Ecuador’s main development trends, poli-cies, and options, and places the country in the context of relevant internationalcomparisons. Extensive dialogue, reflection, and direct operational work with ourcounterparts in Ecuador and elsewhere are detailed in this volume, which spells outcritical lessons and challenges that are relevant for the country and for Latin Americaas a whole. Finally, the book’s second edition proposes policy matrices for each sectorand topic, including a proposed sequencing of policy steps.

I am extremely grateful for the cooperation and contributions of our many friendsin Ecuador to this very important endeavor, both directly and through several years

Preface

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of working side by side with us. I would like to thank the staff members who havecompiled this book—editors, authors, and producers. Their work reveals not onlytheir professional talents, but also, and more importantly, their passion for povertyreduction.

Pamela CoxVice President

Latin America and the Caribbean Regional OfficeWashington, D.C.

June 6, 2007

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This volume is the result of a team effort and, as such, it has benefited from an arrayof invaluable contributions. Thanks are therefore due to a large number of people.First, the chapter authors not only provided material of outstanding technical quality,but also made a remarkable effort, working in record time and thus enriching theEcuador debate at a critical period. We consider ourselves fortunate to share thisbook with these principal authors—Susan Bogach, Jean Clevy, Elizabeth Currie,Franz R. Drees-Gross, Jonas Frank, Conrado Garcia-Corado, Michael Goldberg,Christopher Humphrey, Julio Ricardo Loayza, Eleodoro Mayorga-Alba, EdgardoMosqueira, Monique F. Mrazek, Francisco J. Pichon, Rashmi Shankar, and EloyEduardo Vidal. All authors are affiliated with the World Bank Group unless other-wise indicated in the respective chapter. Other authors of individual chapters are rec-ognized in the credits of each specific chapter.

While this book reflects the authors’ views (and not necessarily the views of theWorld Bank, its Board of Directors, or its member countries), its production wasinstitutionally housed at the World Bank. We thus benefited greatly from the generalguidance of Guillermo Perry (Chief Economist for the Latin America and theCaribbean Region) and from the auspices of the office of Pamela Cox (Vice Presidentfor Latin American and the Caribbean Region).

This volume commenced with an internal workshop held on January 18, 2007, inWashington, DC. The discussion allowed all the authors to present their findings ina friendly forum and to explore various synergies. In addition to the authors, manyothers participated. Our thanks is extended to: Alejandro Alcala Gerez, MariaDolores Arribas-Banos, Garry Charlier, Henry Forrno, Fernando Lecaros, JeffreyRinne, Marco Scuriatti, Samuel Taffesse, Marco Varea, Eduardo Velez Bustillo, IanWalker, and David Warren. During this initial exercise, the early stages of the volumebenefited from the comments of peer reviewers who were: Robert Bacon, FranzDrees-Gross, Pablo Gottret, Jose Luis Guasch, James Hanson, Jorge Munoz, and Fer-nando Rojas. We also recognize the importance of and thank the participants of theworkshop held on March 19th and 20th, 2007 in Quito, Ecuador. This workshopnot only brought together a majority of the authors under one roof for a day of can-did discussions but also, and more important, included officials and consultants fromgovernment administration. Of the consultants and government officials present atthe workshop, we would especially like to thank the following: David Alorris, VictorArrar, Manuel Badillo, Winston Balanos, Gustavo Bedon, Caria Caiero, Nicholas

Acknowledgments

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Castellianos, Rita Decy, Sylvia Diaz, Roberto Esteves, Grace Fuerrgo, Doris Gordon,Carlos Julio Jarce, Fausto Jordain, Diego Manchero, Jose Martinez, Julio Oleas,Pedro Montalvo, Pabel Munoz, Viviano Munoz, Juan Nieto, Jorge Orbe, RubenPaez, Nicolay Pastelanos, Rene Ramirez, Guido Rivadeneira, Paulina Romau,Wladimir Rosero, Hugo Ruiz Coral, Malki Saenz, Maria del Pilar Trayat, EugeniaVallejo, Galo Viteri, Katiuushka Yanez, and Guido Zambrano. Their comments,suggestions, and input along with those from the many others who attended thisworkshop added greatly to this volume.

We are especially thankful for the work of Marcelo Romero and Nelson Gutiérrezfor their exceptional work in preparing the Spanish version of this publication as wellas piecing together the English version. We are especially grateful for the work ofMichael Geller, who gave key administrative and logistical support to the process ofthis work, as well as to Chris Humphrey for having collaborated on the technicalediting of the English version of various chapters. The World Bank team in Ecuadorshould also receive a well-deserved thank-you for their outstanding support and helpin coordinating the March 19–20 workshop in Quito: Alexandra Del Castillo,Cinthia Guzmán, Daniela Jaramillo, Pilar Larreamendy, Vinicio Valdivieso, LucyVargas, and Ana Maria Villaquirán. Without them, achieving the right environmentfor these important discussions would not have been possible. The World Bank teamin Washington was also a strong component during this whole process.

Finally, we would like to thank the World Bank publication team. SantiagoPombo-Bejarano and Stuart Tucker supervised the entire process and provided keyinformation and assistance at all stages of publication. We extend our sincerethanks to all.

Vicente Fretes Cibils, Marcelo M. Giugale, and Eduardo SomensattoWashington, D.C.

May 2007

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Marcelo Giugale, an Argentine/Italian national, holds a PhD and MSc in economicsfrom London School of Economics, and a BA in economics from UniversidadCatolica Argentina. After a spell in academia, he joined the World Bank’s Young Pro-fessionals Program in 1989 as an economist in the financial research department.From 1990 to 1994, he was a Senior Economist in the Middle East Operations VicePresidency, supervising Egypt’s structural adjustment program and leading the Bank’sreconstruction work in postwar Lebanon. From 1994 to 1998, Mr. Giugale wasPrincipal Economist in the Europe and Central Asia Region, responsible for theBank’s lending and analytical economic work in Lithuania and Kazakhstan. In Sep-tember 1998, he became the Lead Economist for the Colombia-Mexico-VenezuelaDepartment. From December 2002 to June 2007, he was the director of the Bank’sAndean Countries Department (Bolivia, Ecuador, Peru, and República Bolivarianade Venezuela). Currently Mr. Giugale is the Bank’s Director for Poverty Reductionand Economic Management in the Latin America and the Caribbean Region. He hasheld teaching positions at London School of Economics and American University inCairo, and has many publications in the areas of applied econometrics, finance, busi-ness economics, and economic development.

Vicente Fretes-Cibils, a native of Argentina, completed his undergraduate work atthe Universidad Nacional del Nordeste, in Argentina, and subsequently pursuedpostgraduate studies at the University of Pennsylvania and North Carolina StateUniversity, where he received, respectively, a master’s degree in business administra-tion and a PhD in economics. Following his university studies, he joined the WorldBank in 1987 through the Bank’s Young Professionals Program. Following stints inthe Bank’s Office of the Vice President for Europe and the Middle East and its Trea-sury Department, he served from 1988 to 1992 as Economist in the Office of theVice President for West Africa Operations. Later, from 1992 to 1996, he served asChief Economist in the Department of Operations for Andean Countries, supervis-ing adjustment programs and heading up economic and analytical missions toBolivia. From 1996 to 2002, Mr. Fretes-Cibils served as Senior Economist forRepública Bolivariana de Venezuela, and subsequently for Colombia and Mexico.From 2002 to 2007 he was Lead Economist in the Poverty Reduction and EconomicManagement sector for the Andean Countries Department (Bolivia, Ecuador,Peru, and República Bolivariana de Venezuela). He is currently a Division Chief of

Editor Biographies

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Fiscal and Municipal Management, Institutional Capacity and Finance at the Inter-American Development Bank. Additionally, he has taught at Argentina’s UniversidadNacional del Nordeste and at North Carolina State University, and has publishednumerous works addressing topics in finance, applied econometrics, public finance,international economics, and economic development.

Eduardo Somensatto, a Brazilian national, did his doctoral work at GeorgetownUniversity (1980), where he also earned his MA (1977) and a BS in EconomicsDevelopment at the University of Michigan (1974). He joined the World Bank inJanuary 1988 as an economist in the Development Economics and Chief Econo-mist’s Office. He has since held various positions in the Bank and the IFC; he hasbeen responsible for the preparation of several economic studies and country strate-gies, mostly for Latin America and Eastern European countries. Most recently, hewas Country Manager in Guatemala and Country Manager in Ecuador. Before join-ing the Bank, Mr. Somensatto taught at Georgetown University and was AssistantDirector of Economic Policy Studies at the American Enterprise Institute.

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AADT annual average daily trafficAADR alternative dispute resolution

ADV Added distribution value AE Eat Well Ecuador (Alimentate Ecuador)

AFTA American Free Trade Agreement AGD Deposit Guarantee Agency (Agencia de Garantía de Depósitos)

ALADI Latin American Integration Association AME Association of Municipalities of Ecuador

API American Petroleum Institute APRENDO Academic achievement testing

APTDEA Andean Trade Partnership and Drug Eradication AgreementARPEL Asociación Regional Petrolera Empresarial Latinoamericana

AUS Universal Health InsuranceBCE Central Bank of Ecuador (Banco Central de Ecuador)BdE Banco del Estado

BDH Conditional cash transfer (Bono de Desarrollo Humano)BE Beca Escolar

BEDE Ecuadoran Development BankBEV Banco Ecuatoriano de ViviendaBNF National Development Bank (Banco Nacional de Fomento)BPD Barrels per day

BS Bono SolidarioCAE Ecuadoran Customs Corporation (Corporación Aduanero de

Ecuador)CAN Andean Community of Nations (Comunidad Andina de

Naciones)CATEG-D Corporación para la Administración Temporal Eléctrica de

Guayaquil (formerly Empresas Electricas del Ecuador—EMELEC)

CCCC Comisión Civica de Control de la CorrupciónCEDEGE Center for Development of the Guayas Basin

CEL Special Bidding Committee CELADE Latin American Demography Center Centro (Latinoameri-

cano de Demografía)

Acronyms and Abbreviations

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CEMs Educational Matrix Centers (Centros Educativos Matrices)CENACE National Center for Energy Control (Corporación Centro

Nacional de Control de Energía)CEREPS Special Account for Productive and Social Reactivation

(Cuenta Especial de Reactivación Productiva y Social)CESA Central Ecuatoriana de Servicios AgrícolasCET Common External Tariff

CETES short-term Treasury CertificatesCETUR Ecuadoran Tourism Corporation

CFN National Finance CorporationCNJ National Council on the Judiciary

CNRH National Council on Hydraulic ResourcesCNPC China National Petroleum Company

CNTTT National Land Transit and Transport Council CODAE

CODENPE Council for the Development of the Indigenous Nations andPeoples of Ecuador

COICA Coordinadora de Organizaciones Indígenas de la AmazoniaCONADES National Wages Council (Consejo Nacional de Salarios)

CONAM National Modernization Council CONAREM National Council for Public Sector Remuneration

CONARTEL National Council of Radio and TelevisionCONATEL National Telecommunications Council

CONCOPE Consortium of Provincial Councils of EcuadorCONELEC National Electricity Council (Consejo Nacional de Electricidad)

CONSEP National Council for the Control of Substances COPEFEN Coordinator of the Emergency Program to Cope with the

El Niño Phenomenon CORPEI Exportation and Investment Promotion Corporation

(Corporación de Promoción de Exportaciones e Inversiones)CPC Code of Civil ProcedureCPI Consumer Price IndexCPI Corruption perception index

CREA Center for the Economic Reconversion of AzuayCRM Center for the Reconversion of ManabíCSO Civil society organizationCTI Technical Commission on Investments of the IESS (Comisión

Técnica de Inversiones)CTH Mortgage Titling CompanyDAC Civil Aviation Office

DECEVALE S.A. Depository institutionDGVD Decentralized Roads Management Unit

DIGMER Maritime transport administration

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ACRONYMS AND ABBREVIATIONS xxi

DINEPP National Directorate of Continuing Popular Education(Dirección Nacional de Educación Popular Permanente)

DNP National Personnel DirectorateDRC Domestic resource costsDVP Delivery versus Payment EAP Population, Environment, and Energy ProgramEAP economically active population

ECOPETROL Colombian Petroleum Company (Empresa Colombiana dePetróleo)

EDAP Pension Savings Deposit Institutions (Entidades Depositariasdel Ahorro Previsional)

EEQ Empresa Eléctrica de QuitoEMAPS Environmental Management Action Plans

EMPROVITENACENAP National Petroleum Enterprise (Empresa Nacional del Petróleo),

ChileENDEMAIN Survey on Demographics and Maternal and Infant Health

(Encuesta Demográfica y de Salud Materna e Infantil)ENFE Ecuadoran National Railway Company ENSOEPHF Essential Public Health Functions

EPR Effective protection rateFAC Savings and Continguency Fund (Fondo de Ahorro y

Contingencia)FASBASE Strengthening and Expanding the Scope of Basic Health Ser-

vices in Ecuador (Fortalecimiento y Ampliación de los ServiciosBásicos de Salud en el Ecuador)

FEIREP Fund for Stabilization, Social and Productive Investment, andReduction of Public Debt (Fondo de Estabilización, InversiónSocial y Productiva, y Reducción del Endeudamiento Público)

FEISEH Ecuadorian Fund for Investment in the Energy and Hydro-carbons Sectors (Fondo Ecuatoriano de Inversión en los SectoresEnergéticos e Hidrocarburos)

FENAJE National Federation of Judicial OfficialsFEP Petroleum Stabilization Fund (Fondo de Establización Petrolera)

FEPP Fondo Ecuatoriano Populorum ProgressioFERUM Rural and Marginal Urban Electrification Fund

FISE Social Investment Fund (Fondo de Inversión Social Ecuatoriano)FLAR Latin American Reserve Fund

FODESEC Sectional Development Fund (Fondo de Desarrollo Seccional)FODETEL Fondo de Desarrollo de las TelecomunicacionesFONDIFA National Children’s Fund

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FOPEDEUPO Permanent Fund for University and Polytechnic DevelopmentFOSE Fondo de Compensación Social Eléctrica (in Peru)FRTL Fiscal Responsibility LawFTAA Free Trade Agreement of the Americas

FTA Free trade agreementGCR global competitiveness reportGDP Gross domestic product GEF Global Environmental Facility

GGFR Global Gas Flaring ReductionGOE Government of EcuadorGSP General System of Preferences

GSRT Gross Settlement in Real Time GUO Global Urban Observatory of the United Nations

HACCP Hazard Analysis and Critical Control PointHDI Human Development Index

HRM Human resources management ICE Special Consumption Tax (Impuesto sobre Consumos Especiales)

ICSID International Center for Settlement of Investment DisputesICT Information and communications technology

IADB Inter-American Development BankIEOS Ecuadoran Institute for Water and Sanitation Works IESS Ecuadoran Social Security Institute (Instituto Ecuatoriano de

Seguridad Social)ILDIS Instituto Latinoamericano de Investigaciones Sociales

ILO International Labour OrganisationIMCI Integrated Management of Childhood IllnessIMF International Monetary Fund

INEC Survey on Employment, Unemployment, and Under-employment

INECEL National power companyINEN Ecuadoran Standardization InstituteINIAP National Institute for Agricultural Research

INNFA National Child and Family InstituteINTERAGUA International Water Services Guayaquil

IOC International oil companiesISP Internet service providerISR Income Tax (Impuesto Sobre la Renta)

ISSFA Social Security Institute of the Armed Forces (Instituto deSeguridad Social de las Fuerzas Armadas)

ISSPOL Social Security Institute of the Police (Instituto de SeguridadSocial de la Policia National)

ITT Ishpingo-Tambococha-TiputiniITU International Telecommunications Union

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IVA Value-Added Tax Impuesto al Valor Agregado, JAPS water users associations (Juntas de Agua Potable y Saneamiento)JASS Water and sanitation councils LAC Latin America and Caribbean RegionLEXI Law on Foreign Trade and Investment

LIBOR London interbank offered rate LMG Law on Free Maternity Care (Ley de Maternidad Gratuita)

LOAFYC Law on Financial Administration and Control (Ley Orgánicade Administración Financiera y Control)

LPG Liquid petroleum gasLRFP Law on Reform of Public Finances LRSE Reform Law of Electricity Sector Legislation (Ley Reformato-

ria de la Ley de Régimen del Sector Eléctrico)LSCCA Civil Service and Administrative Career Law

MAG Ministry of AgricultureMBS Ministry of Social Welfare

MCCH Maquita CusinchiMDMQ Municipality of the Metropolitan District of Quito

MDGs Millennium Development GoalsMDOGs Government ministries, departments, and agencies

MEC Ministry of Education and Culture MEF Ministry of Economy and Finance

MEM Ministry of Energy and MiningMICIP Ministry of Industry, Commerce and Fisheries

MIDUVI Ministry of Urban Development and Housing (Ministerio deDesarrollo Urbano y Vivienda)

MIVI Ministry of Housing MODERSA Modernization and Development of Comprehensive Health

Services Networks (Modernización y Desarrollo de Redes Inte-grales de Servicios de Salud)

MOP Ministry of Public Works MSP Ministry of Public Health NAP Network access point

NFPS Non-financial Public SectorNOC National oil companiesNTB Nontariff barrier OCP Heavy crude oil pipeline (Oleoducto del Crudo Pesado)

ODEPLAN Planning OfficeOECD Organisation for Economic Cooperation and Development

OLADE Latin American Energy OrganizationONN National Standardization Agency

OPEC Organization of Petroleum Exporting CountriesORI Children’s Rescue Operation (Operación Rescate Infantil)

ACRONYMS AND ABBREVIATIONS xxiii

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xxiv ECUADOR: AN ECONOMIC AND SOCIAL AGENDA IN THE NEW MILLENNIUM

OSCIDI Civil Service and Institutional Development OfficePACMI Supplementary Food Program for Mothers and Infants

(Programa de Alimentación Complementaria Materna-Infantil)PAE School Meals Program (Programa de Alimentacion Escolar)

PAHO Pan-American Health Organization PANN Food Program for Boys and Girls (Programa de Alimentacion

de Niños y Niñas)PDI Children’s Development Program (Programa de Desarrollo

Infantil)PDM Municipal Development Program

PPS Programa de Protección SocialPRAGUAS Water and Sanitation Program for Rural Communities and

Small Municipalities—financed by the World BankPROAUS Universal Health Insurance Program (Programa de Asegu-

ramiento Universal en Salud)PROBONA Native Andean Forests Program

PRODEPINEPROJUSTICIA Unidad de Coordinación para la Reforma de la Administración

de JusticiaPROLOCAL Poverty Reduction and Local Rural Development ProjectPROMECEB Program for Better Quality Basic Education (Programa de

Mejoramiento de la Calidad de la Educación Básica)PROMSA Agricultural Services Modernization Program

PRONEPE National Preschool Education Program (Programa Nacional deEducación Preescolar)

PROST Pension Reform Options Simulation Toolkit PSP private sector participationPT Transmission toll

PUCE Catholic University of EcuadorRER Real exchange rateRGP Referential generation priceRISE Ecuadoran Simplified Tax System (Régimen Impositivo Simpli-

ficado Ecuatoriano)ROA Return on assets

ROAA Return on average assets ROAE Return on average equity

RUC Centralized taxpayers registry (Registro Único de Contribuyentes)SAPYSB Sub-secretariat of Potable Water and Basic Sanitation

SAPSyRS Sub-secretariat of Water Supply, Sanitation and Solid WasteSBS Superintendency of Banks and Insurance (Superintendencia de

Banca y Seguros)SCP Sub-secretariat of Public Credit (Secretaría de Crédito Público)

SelBen Ecuadoran Beneficiary Identification and Selection System(Sistema de Identificación y Selección de Beneficiarios)

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SENATEL National Secretariat of Telecommunications SENDA Secretariat for National Administrative Development

SENDOSEP National Secretariat for Organizational Development of thePublic Sector

SENRES National Technical Secretariat for Human Resources Devel-opment and compensation in the Public Sector

SESA Ecuadoran Animal and Plant Inspection ServiceSGO General Obligatory Insurance (Seguro General Obligatorio)

SG sectional governmentSIAN Integrated System of Food and Nutrition (Sistema Integral de

Alimentacion y Nutricion)SICA Agricultural Information and Census Service

SIGEF Integrated Financial Management SystemSIISE Integrated System of Social Indicators of Ecuador Social

Indicators System of Ecuador (Sistema Integrado de IndicadoresSociales de Ecuador)

SIMPREM Public Sector Compensation Budgetary SystemSINOPEC China Petrochemical Company

SIV Housing Incentives SystemSME Small- and medium-sized enterprise

SODEM MDG Secretariat (Secretaria de Objectivos del Milenio)SOTE TransEcuadoran Pipeline System (Sistema de Oleoducto

Transecuatoriano)SP Service provider

SPC Service-providing company SPNF Sector Público No Financiero (see NFPS)SPNG Galápagos National Park Service (Servicio del Parque Nacional

Galápagos)SRI Service of Internal Income (Servicio de Rentas Internas)SSC Rural People’s Social Security Program (Seguro Social Campesino)SSO Obligatory Social Security (Seguro Social Obligatorio)

STFS Secretaría Técnica del Frente SocialSUMA Single Environmental Management System (Sistema Unico de

Medio Ambiente)SUPTEL Telecommunications Authority TROLE Economic Transformation Law

TFP Total factor productivityUCV Local Road Works Unit

UDENOR Development Unit of the NorthUOST Trolleybus System Operating Unit

URC Credit Restructuring Unit (Unidad de Reestructuración deCréditos)

USAID United States Agency for International Development

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VAD Value-added DistributionVAT Value-Added Tax

WLL Wireless Local LoopWRM water resource management

WTI West Texas Intermediate WTO World Trade Organization

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Context and Executive Summary

1

Eduardo Somensatto

I. Introduction

The World Bank has prepared this series of notes as a contribution to the policydebate in Ecuador. The notes were written by experts from both within and outsidethe World Bank, who offer a broad perspective on the issues confronting Ecuador,while taking into consideration international experiences. The notes presented hereare not intended to be exhaustive, but rather analyze and present policy optionsfor a limited number of topics considered to be critical for the country’s social andeconomic development. The policy notes for Ecuador are part of a series of booksthat the Bank prepares periodically summarizing its accumulated knowledge on theeconomic and social issues of member countries. The timing of the notes, early 2007,coincides with a new presidential period, which offers the country the opportunity toconsolidate many of the gains of the past few years, while building the basis for amore dynamic, equitable, and inclusive growth process.

The current volume updates the policy notes prepared four years ago, presentedin the book Ecuador: An Economic and Social Agenda for the New Millennium.Much of the analytical work presented in the earlier book remains relevant today, andas a result, certain sections of the current document essentially update that material.The conditions in many sectors have not changed dramatically, and many of thepolicy recommendations presented in the previous notes are still applicable. Thus,while the current volume can be read as a freestanding work, it has greater analyticpower and policy impact when used in tandem with the previous policy notes.

Several of the notes in the current volume are based on recently producedWorld Bank studies. In the past few years the Bank prepared analytical work forEcuador in several areas. The list is quite extensive and includes an Ecuador povertyassessment, a public expenditure review (jointly with the Inter-American Development

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Bank—IDB), a country financial accountability assessment, a country procurementassessment (jointly with the IDB), a social security analysis, a rural developmentstrategy, a labor market study, a country economic memorandum, and a nutritionstudy. These studies represent a wealth of analytical work and contain greater detailthan some of the notes presented here.

The policy notes that follow cover many areas and issues and are groupedunder three broad themes:

• Preserving stability and accelerating growth. The topics addressed include (i)maintaining fiscal discipline to ensure the continuity of a stable macroeco-nomic framework; (ii) accelerating and broadening economic growth throughincreased competitiveness, expanded opportunities, and greater employmentgeneration; (iii) dealing effectively with the myriad problems affecting theenergy sector; and (iv) broadening the benefits of growth through more inclu-sion, particularly for the rural sector of the economy.

• Promoting sustainable and equitable social development. The discussions coverhuman, natural, and social capital. Particular attention is devoted to the educa-tion and health sectors, as well as the social protection system, all sectors thatoffer the greatest opportunities for reducing the country’s deep and ingrainedinequalities. The notes also cover other facets of the development challenge,such as ensuring the sustainability of reforms and preserving Ecuador’s uniqueenvironmental and natural resource base. In a country with such a rich anddiverse cultural base, broadening the benefits of development will entail givinggreater voice to the country’s increasingly empowered ethnic and social groupsand making the state more accountable.

• Improving governance and strengthening institutions. The topic encompasses abroad range of issues, including institutional reforms aimed at building a high-quality and efficient system of government, the challenges of decentralization,and effective measures to reduce corruption.

II. Overview

The analysis contained in the policy notes indicates that Ecuador is a countrywith great potential, with a society that has exhibited incredible resilience andthe ability to adapt to new challenges. The Ecuadoran society has overcome adversitywith great determination in the past few years. Periodic economic crises, externalshocks, and even natural disasters tested the country’s ability to cope with difficulties.Despite these challenges, the country has maintained a forward-looking perspectiveand has achieved some important goals. Economic stability in the past few years hasgiven Ecuador the opportunity for a period of sustained economic growth. Duringthis period several development indicators have improved, and several sectors of theeconomy have demonstrated the dynamism and entrepreneurship that are present in

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the Ecuadoran culture. In general, surveys show that Ecuadorans feel that theirindividual conditions are likely to improve in the future.

Many factors have precluded the country from fulfilling its full economicpotential. Foremost among them is political instability. A major obstacle to achievinga higher level of development has been the lack of political constancy and policycontinuity. Frequent changes of authorities and policy reversals have stifled economicperformance by generating uncertainty and harmful economic cycles. Political insta-bility and discord have precluded the country from agreeing on a long-term nationalagenda and have prevented the pursuit of consistent policies to reduce Ecuador’slong-time problems of exclusion, inequity, and lack of opportunity for much of thepopulation. Among the factors driving this instability are deep social, ethnic, andregional divisions, along with weak political institutions. In the past 10 years, thepolitical environment has been particularly volatile in Ecuador. Starting in 1996,none of the elected presidents have been able to complete their constitutionallymandated term. There have been no fewer than six presidents and numerous cabinetministers during this period. Several factors contributed to this volatility, includingquestioned ethical conduct, economic crisis, the loss of public confidence, and unstablecoalitions. The developments of the past 10 years reveal the challenges the countryfaces in strengthening its democratic institutions.

Today Ecuador has a unique opportunity to consolidate and improve on therecent economic gains. The country is currently experiencing a period of improvedeconomic and social conditions unmatched since the return of democracy in 1979.Thanks in part to greater macroeconomic stability achieved through dollarization in2000, the increase in petroleum prices, and greater remittance flows, social and eco-nomic indicators have risen considerably in the past five years. The improvement hasbeen particularly noteworthy in levels of consumption; in the growth of imports andnontraditional exports; and in investments, housing, construction, and the recoveryof the financial sector. The economy seems to have sufficient momentum to ensurecontinuity in these trends. The financial situation of the government is also better. Infact, the current administration, of President Rafael Correa, is the first, during thenew democratic period, that will inherit a relatively favorable fiscal position. Thoughthe financing requirements of the central government will be significant, ways couldbe devised to finance many of the newly proposed initiatives and to enhance the roleand design of those programs that benefit the needy. Several layers of the stateapparatus are in better condition to assume certain responsibilities. In particular, thesubnational governments have shown the ability and the competence to handle manyof the public sector services and have been extremely successful in responding to theirconstituencies. This trend, which has given rise to calls for greater regional and localautonomy, offers an opportunity to build a new, more efficient and effective systemof political administration and public service delivery.

However, important challenges remain to be tackled if Ecuador is to takeadvantage of the current favorable economic environment. These challenges rangefrom implementing policies that will sustain and broaden the benefits of current

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growth, to dealing with inequality and institutional weakness and modernizing thepublic sector. Other major areas include expanding and improving the quality ofpublic services, ensuring a more inclusive development pattern, and addressing theneeds of the rural areas. An overarching objective is to make effective use of the country’srich natural resources, particularly of its diminishing hydrocarbon resources. Thecurrent windfall from higher petroleum revenues offers a major opportunity to usethose resources more equitably and efficiently. From an intergenerational perspective,equality may require using the current revenues from extracting resources to endowfuture generations with the higher level of assets and greater opportunities. Today, alarge proportion of the petroleum revenues are being enjoyed by the current genera-tion and are financing large universal subsidies, increases in public spending, and apro-cyclical fiscal policy. Ample opportunity exists to consider alternatives, such astargeting the subsidies, saving some of the additional revenues, pursuing counter-cyclical fiscal policy, and investing in activities that are certain to have high rates ofreturn for society.

To broaden and sustain the benefits of the recent economic performance, thecountry could spur growth in sectors that promote employment creation andimprove its competitiveness. Ecuador, as all countries that are participating in theinexorable process of global integration, will confront increasingly competitive marketsfor its products. Special efforts made now would improve the investment and businessclimate in the country, which is ranked one of the worst in Latin America. To preservethe effects of dollarization under such an environment, it will be crucial to adoptmeasures to increase productivity, particularly since the country’s cost structure isbeing artificially lowered by significant subsidies that might not be sustained. In addi-tion, the lagging performance of the agricultural sector and the special needs of smallrural producers will require specific programs to incorporate the sectors more effectivelyinto the national and international markets.

Expanding the benefits of development and making opportunities moreequitable will work only if the country devotes special attention to those whohave been excluded in the past. Ecuador is a country with deep social and regionaldivisions. It has historically excluded large segments of its society from the benefits ofdevelopment. This is especially true for the case of indigenous peoples and Afro-Ecuadorans. Both exclusion and inequality fuel much of the resentment and discon-tentment that prevail in some segments of society that are looking for new politicaldirections. While many parts of the country have seen great improvement, manyprovinces did not get the assistance necessary to lift their population from poverty.Most of those are predominantly rural provinces, with an inefficient agricultural baseand a large number of small producers who lack access to credit and services. Besidesthe support those sectors require, the regions have deficient infrastructure that canonly be improved by significant public investment.

To reduce inequality and break the intergenerational poverty trap, it will beimportant to make more effective use of the country’s social programs. Despitethe improvements of the past few years, Ecuador still lags behind many Latin American

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countries in terms of its social indicators. An important segment of the population,essentially the poor, lacks access to basic services. However, the country has an arrayof social programs that, if properly managed, could be the foundation for helping thepoor to become more active participants in the development process. For example,Ecuador has in place the largest cash transfer program in Latin America, in terms ofpercentage of population covered. Making the program conditional, requiringbeneficiaries to demonstrate that their children are attending school and using thehealth services available, can help reduce school desertion, particularly at the crucialsecondary level. Ecuador is also just starting to ensure health access to the poorestpeople through a universal health insurance program that will change the budgetingfor the sector, basing reimbursements on services provided. These programs, alongwith the effective use of the free maternity care program, can help accelerate the veryimportant trend of reduced infant and child mortality rates, as well as reduced fertilityrates, which have declined dramatically in the past two decades. This trend of smallerfamilies is becoming one of the most important factors in improving conditions ofmany families.

Another critical challenge will be to strengthen the institutional and deliverycapacity of the public sector. Currently, many of the government agencies andpublic enterprises face organizational difficulties that prevent them from providingeffective and efficient public services. In particular, several social sector programs canbe reformed and be structured with the aim not only of improving services, but alsoof helping to expand opportunities and becoming more inclusive. The country nowhas an opportunity to take greater advantage of the management abilities that havebeen demonstrated by several municipalities and provinces, and begin to considerusing a more decentralized process of service delivery.

These challenges will be encountered in an environment of increasingexpectations, in a country full of contrasts. In the past few years, individuals andhouseholds have seen their welfare improve. Polls show that individuals and house-holds anticipate that their economic conditions will continue to get better, particularlygiven the prospect of petroleum revenues and remittances remaining high. This positiveindividual expectation, however, does not seem to be reflected in the attitude ofsociety as a whole. Polls also show a certain level of collective pessimism. There is aninteresting contrast of collective uncertainty versus a more positive individual out-look. A dichotomy exists whereby individuals feel they might be better off in thefuture, but they do not necessarily feel that the country will. One possible explana-tion is that dollarization has introduced stability, which now allows for longer-termplanning and reduces individual uncertainty. The public also now has a sense thatthe economy is shielded from political instability, the factor that had created mostindividual uncertainty in the past.

The policy notes presented in this book take into consideration the contextpresented above, and identify many of the challenges the country will face in thenear future. The notes cover many areas and subjects but are grouped into threebroad themes: preserving stability and accelerating growth, promoting sustainable

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and equitable social development, and improving governance and strengtheninginstitutions. The remainder of this chapter summarizes the main findings and recom-mendations of the policy notes.

III. Preserving Stability and Accelerating Growth

Many individual policy notes cover issues that come under the broad umbrella ofstability and growth. This summary focuses on macroeconomic policies, growth andjob creation, the business climate, labor markets, the financial sector, trade and com-mercial policy, the energy sector, agriculture, and rural development. Each chapterfollows a similar pattern, with a description of recent and current developments inthe sector, along with policy proposals.

Recent Economic Developments

Despite political difficulties, Ecuador’s economic performance of the past fewyears has been impressive. Fueled by increasing oil revenues and recovery from thedeep financial crisis of 1998–99, the economy has grown at an average of 5 percentper year since 2000. Consumption has grown even faster, averaging close to 6 percentper year. Inflation, which peaked in the middle of 2000 at 100 percent, declined to 3percent in 2006. Several other economic indicators reveal widespread improvementin economic conditions. Deposits in the banking sector, along with credit, have morethan doubled and now are above the precrisis level. Many sectors of the economy,such as construction, agriculture, and nontraditional exports, also have recovered,with nontraditional exports growing at an impressive 15 percent a year since 2002.

The recovery during the current decade is in sharp contrast to the performanceof the 1990s. The economy at the time had experienced protracted fiscal, inflationary,and financial difficulties that were fueled by external shocks, lax policies, and naturaldisasters. Those conditions culminated in the deepest financial and foreign exchangecrisis in the country’s recent history, leading to financial costs of 15 percent of GDP.To address the crisis, the government enacted a series of policies, the most drastic ofwhich was to replace the domestic currency with the dollar in 2000. Other measuresincluded a series of laws that improved the flexibility of markets and allowed forgreater participation of the private sector in certain sectors of the economy. Moreimportant, the Fiscal Responsibility and Transparency Law that was passed in 2002called for saving extra resources from increased petroleum revenues and reducing thebudget financing vulnerabilities. The law was based on fiscal policy rules that placedlimits on the growth of expenditures, while providing for priority programs even inthe face of cyclical changes in revenues.

The outcome of the dollarization and the supporting policies has been a periodof macroeconomic stability. The country has enjoyed the benefits of a favorable

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external environment, which has meant low rates of inflation and declining interestrates. Domestic interest rates have fallen to single digits, and a more stable economicenvironment has given rise to a rapid extension of long-term financing, includingmortgages. Real wages have grown by more than 20 percent in the past four years, ashas GDP per capita. Employment has grown in line with the growth of the labor force.

Macroeconomic stability and growth have also been driven by increases in boththe production and the price of petroleum, Ecuador’s largest export product. TheSeptember 2003 opening of a privately financed heavy crude oil pipeline allowedprivate companies to increase exports from around 20,000 barrels a day in 1998 toabout 350,000 barrels a day in 2005. Coupled with the output from PetroEcuador,total production in the past three years has averaged around 550,000 barrels per day,an increase of more than 50 percent from the levels at the beginning of the decade.This increase in production was accompanied by a surge in prices, which have almostdoubled in the past three years.

Both the fiscal positions and external accounts have improved substantiallyas a result of the higher oil revenues. The primary balance of the central govern-ment reached 5.5 percent of GDP in 2006 (while the overall balance rose to 3.3 percent), compared with about 1 percent in 2001. Ecuador also recovered credit-worthiness, with the decline in its debt burden. Public sector debt as a share of GDPfell from 90 percent in 2001 to 33 percent in 2006. In the external sector, the tradebalance showed a surplus of over 4.5 percent of GDP in 2006, despite significantincreases in imports. The current account balance also recovered and now has asimilar surplus, after having reached a deficit of over 2 percent of GDP in 2001. Foreignexchange reserves now exceed US$2.3 billion, compared with the dangerously lowlevels of 2000.

The confluence of higher oil revenues, dollarization, and the accompanyingpolicies established the basis for a rapid recovery from the financial crisis of thelate 1990s. The improvements in the economy have been steady and fairly broadsince 2000. Some of the examples are the impressive increases in imports, which havedoubled in the past five years. Their strong growth has been present in all categories,particularly imported capital goods, which grew at a remarkable 30 percent annuallyduring this period. The latter reflects the strong performance of investment, especiallyforeign investment, which has been assisted by greater opportunities in infrastructureand natural resources development, and by better financing mechanisms. The economy’simprovements also generated new jobs and helped lower the unemployment rate toapproximately 10 percent of the labor force.

The prospects in the near term are favorable. With the price of petroleumexpected to remain at current levels for the foreseeable future, the economic outlookis still positive in the near term. Growth is likely to remain above 4 percent for theyear. Many of the other macroeconomic indicators are also expected to remain withinreasonable ranges. Inflation seems to be under control for the moment, and the externalposition of the country should be sound enough to preserve the dollarization.

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Despite the recovery of the economy, a general perception persists that thepolicies of the past few years have not benefited all of the groups in society. Thisis one of the factors that led the new administration to change the course of economicpolicy in 2005. The thrust of the new policy is to use public spending to reactivatethe economy and to channel the additional petroleum revenues to social programsand projects that could benefit the most disadvantaged of the population.

Macroeconomics: Risks and Policy Proposals

Uncertainties challenge the sustainability of the recent trends. Part of the goodeconomic performance of the past few years has been a recovery from depressed eco-nomic levels during the 1998–99 crisis. Once that process, now in its final stages, iscompleted, continued economic growth will depend much more on the expectedpolicy environment. Given the variability in policies and the lack of definition of alonger-term national agenda, the path of future policies is uncertain. The main con-cerns are the preservation of macroeconomic stability, improvement in the businessclimate, and a more stable legal and regulatory framework.

The relaxation of fiscal policy in the past couple years could strain macro-economic stability in the future. Recent measures to raise expenditures and reducethe savings of the public sector have placed fiscal policy in a more vulnerable position.Expenditures have risen by more than 50 percent in the past four years. This has beendriven in great part by impressive increases in revenues, owing to additional petro-leum income. The expenditure structure, however, is fairly rigid, and any possibledecline in the price of petroleum could wipe out the current surpluses being generatedby the nonfinancial public sector. Containment of expenditure increases that haveaveraged close to 10 percent a year will be essential to maintaining macroeconomicstability, since in a dollarized economy, fiscal policy is the primary policy tool formacroeconomic management.

Recent policy measures have liberalized the fiscal management framework aswell as liquidity of Ecuador’s treasury and public debt management. The amend-ment of the Fiscal Responsibility and Transparency Law, along with many othermeasures to ease the use of the oil stabilization funds, lifted the limitations onexpenditure growth and modified the allocation of oil revenues in a manner thatdiscouraged public savings. While the funds can now be used for public investments,it is essential that the fund be channeled for productive alternatives, and not currentexpenditure. As such, the use of the savings could facilitate short-term liquiditymanagement, while making fiscal management more vulnerable to adverse inter-national conditions or other adverse shocks.

The key to ensuring continued stability will be to consolidate Ecuador’s fiscalposition. In a dollarized economy, fiscal policy is the centerpiece of macroeconomicmanagement. In a petroleum-based economy, fiscal policy is also a key collectiveinstrument to generate savings for future generations. In this context, the course offiscal policy depends on the decision of how much to save from the current petroleum

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revenues and how those savings will be allocated. The creation of many savings fundsin the past has obscured fiscal decisions and has added to the already saturated systemof earmarking. Consolidating the funds and easing the earmarking would aid themanagement of fiscal policy. It would give greater flexibility and also a clearer pictureof the overall surplus of the nonfinancial public sector. Such surplus is necessary if thecountry decides to transfer current wealth to future generations, which can also beeffected by bequeathing a lower public debt. The country has made great progress inthe past few years in lowering the debt burden, when measured as a share of GDP.This does not mean the country has reached a manageable level of debt. The centralgovernment still confronts considerable financing needs, given the scheduled amorti-zations, particularly of domestic debt. To deal with this condition, there are differentoptions, including lengthening the amortization schedules of domestic debt and relyingon lower-cost and longer-term-maturity external debt. To carry out such policy, itwould be important to have a group of professionals, equipped with the tools and thelegal basis, to carry out an active debt management program. The note on debt man-agement in this book highlights the need to develop a strategy to minimize risks andbetter develop both the primary and secondary markets for public debt.

Achieving the goals of fiscal consolidation will require restraining the growthof expenditures while continuing to improve tax administration. The trend ofgrowing expenditures of the nonfinancial public sector has been accelerating in thepast few years. Most of this growth has taken place in current expenditures, withoutmuch consideration of their social effectiveness. The continuation of such a trend isnot consistent with the objective of using the petroleum windfall for the benefit offuture generations. It would be preferable to devote more to public investments, buteven in that case, it is essential to ensure that those outlays have high social rates ofreturn and are properly managed.

Much of the increase in the cost of public investment in Ecuador is due to aninefficient system of procurement, deficient administration, and delays in con-struction. Many of these problems could be overcome by introducing a transparent,more technologically advanced, and more competitive system of procurementthroughout the public sector. Similarly, the country has an excellent opportunity,given the advancements in technology, to introduce a system of monitoring theadvancement of public works. This system could be coupled with a better processfor evaluating the merits of individual components of the public investmentprogram, that is, by consolidating those responsibilities within a single agency orvice ministry.

The past few years’ improvements in the management of tax administration are anexcellent example of what can be accomplished in the Ecuadoran public sector. Itsmodernization process has been an unparalleled success, mainly as a result of thecontinuity in the administration and the determination of its leaders to effectchanges. As a result, tax revenues have increased fourfold in seven years, and theefficiency of the tax administration system is one of the best in Latin America.Despite these improvements, much remains to be done, such as reducing tax evasion

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and avoidance, and incorporating into the formal systems a large segment of theeconomy that is still operating in the informal markets and not paying taxes. Esti-mates show that up to 60 percent of the Ecuadoran economy is still laboring outsidethe formal structures. As discussed in the next section, incorporating informal activitiesinto the economy will require reducing the barriers to formality, such as businessregistration and tax administration burdens. Another major policy change willinvolve the effective joint management of customs administration, with the propercross-checking of information, and the application of systems similar to those intro-duced in the tax administration area.

Economic Growth and Job Creation—Current Conditions and Policy Proposals

Perhaps Ecuador faces no greater challenge than to improve its growth prospectand promote greater employment generation. The growth of the average real percapita income in the past decade has been extremely low, around 1 percent per year,essentially the same as productivity growth. With such performance it would take morethan 70 years to double per capita income. Whereas, if the country could raise percapita income growth to 4 percent per year, incomes would double every 17 years andwould rise eight times over the 70-year period. Ecuador has all of the natural andhuman conditions to achieve higher growth rates, but it needs to improve the env