El Milagro Ecuatoriano

Latin American Social Science Institute (FLACSO), Quito: marzo 17, 2014

William K. Black

Associate Professor of Economics & Law

University of Missouri-Kansas City

Ecuador was in terrible shapeWhat were the experts saying in 2006?

“Ecuador: The Continuing Challenge of Democratic Consolidation and Civil-Military Relations” US Naval Postgrad.

1. Long-term “political paralysis”

2. Gov’ts “do not function effectively”

3. Oil revenues “weakened” Ecuador

4. “Extremely serious economic ‘meltdown’ in 1999” “econ. disaster”

More dismal facts5. “500,000 had already left five years ago, mainly to Spain and the United States, with the pace increasing since then”

6. Author recounts all the heads of state forced out of office since 1997.

7. “By observing the behavior of the elite and talking with them, it is clear to me that they have not embraced democracy, and vast majority of the population are apathetic”

A conservative US author

More facts, all grim

8. Government is in “serious debt”

9. The people of Quito show “total disgust” with the government in 2005

10. Which prompted “serious discussion within the military to create a civil-military group, or junta, to rule”

11. “The Continuing Vicious Circle of Illegitimacy and Political Paralysis”

“el dueno del pais”12. “In this situation of institutional disintegration, the personal power of Leon Febres Cordero, historic leader of the Social Christian Party and President from 1984 to 1988, looms large. He wields tremendous power in the judicial system and to a great extent in the legislature. He is frequently referred to, even in public, as ‘el dueno del pais’—or owner of the country.”

Author’s “Conclusion”“Ecuador is a challenged … democracy… [T]he political institutions of a civilian-led democracy are extremely weak and highly personalized. [D]emocratically elected presidents are periodically forced from office, and the military is pulled in to play a passive or complicit role in what are clearly unconstitutional changes of power.” “Many of the legal control mechanisms of a democracy are … still not in place.”

By 2008, Challenges GrewThe Great Recession: Ecuador’s leading trading partner

Price of oil rises, then collapses

Doha Round of WTO fails – supposed to bring justice to developing nations

Ecuador lacks a sovereign currency

Left fractures

Economic TreasonPrice for oil sales designed to benefit oil companies at Ecuador’s expense

Odious debt/corruption

Contract clause with Texaco excusing it from liability to Nation of Ecuador

The looting of the banks and their collapse in 1999: the banks go bankrupt and the bankers get wealthy [My book]

“Free trade” deals expose Ecuador to massive damage awards

Virulent Opponents

The oligarchs that the author warned had no attachment to democracy

The United States: the National Endowment for Democracy – a cynical title

The IMF: Washington’s “hammer” that forced Ecuador to conduct the privatization and the three “de’s” that create criminogenic environment. Result was ‘99 bank crisis.

Hard Work Makes Miracles

President Correa’s policies came from a sophisticated understanding of economics and politics. The policies work together, but for clarity I first treat them in isolation.

One of the most important steps he took seemed small to many but it was critical because the IMF’s policy demands would have prevented the miracle & produced disaster.

Step 1: Repay the IMFIMF debt is conditional – extorts policy

IMF demands Washington Consensus

Austerity trumps other factors and would block Correa’s social/budget changes

Fierce supporters of the three de’s – particularly in finance. Poses grave risk.

Repaying the IMF removed its leverage and most U.S. leverage over Ecuador

Privatization: monopoly & crony capitalism

Correa wrote the “book” on this

Warned of dangers of the “Washington consensus” in his dissertation

Privatization and lack of anti-trust agencies lead to monopolies & cartels that harm economy & create corrupt crony capitalism

“Accounting control fraud” explains paradox of bankrupt banks & billionaire bankers

Race to the bottom & ideology maximize the “three de’s”

The three “de’s”Deregulation, desupervision & de facto decriminalization

The regulators have to serve as the “cops on the beat” to prevent a “Gresham’s” dynamic in which bad ethics drive good ethics out of the markets & professions: Cheaters prosper

That dynamic creates fraud epidemics/crises

Good regulators help honest banks

“Now we know better”?“Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (George Akerlof & Paul Romer.1993: 60). Before ‘99 Crisis

Gresham’s dynamic: Akerlof

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.” George Akerlof (1970).

The Irish beat the Economists“The Lilliputians look upon fraud as a greater crime than theft. For, they allege, care and vigilance, with a very common understanding, can protect a man’s goods from thieves, but honesty hath no fence against superior cunning. . . where fraud is permitted or connived at, or hath no law to punish it, the honest dealer is always undone, and the knave gets the advantage” (Swift, J. Gulliver’s Travels).

Accounting: The CEO’s “weapon”

Accounting: finance’s “weapon of choice”

Fraud “recipe” for optimizing (fake) income

1. Grow extremely quickly, by

2. Make (buy) bad loans at premium yield

3. While employing extreme leverage, and

4. Grossly inadequate allowances for loan and lease losses (ALLL)

The Recipe’s Three Sure Things

1. The lender (buyer) will report record income in the near term

2. Modern executive compensation will promptly make the CEO wealthy

3. The lender (buyer) will suffer very large losses because the loans have a “negative expected value”

Recipe Solves the ParadoxCorrea asks why the banks go bankrupt while the bankers become wealthy.

Akerlof & Romer’s title solves the paradox. “Looting: The Economic Underworld of Bankruptcy for Profit.”

By repaying the IMF Correa freed up his ability to use revenues wisely and prevented a renewed banking crisis in Ecuador.

Washington Consensus Games

As the Washington consensus sparked massive fraud epidemics the economist who authored it tried to airbrush history.

His original document shows that he was familiar with the U.S. savings and loan debacle.

That crisis proved that his plan was deeply criminogenic.

Fraud in the S&L Debacle

“The typical large failure [grew] at an extremely rapid rate, achieving high concentrations of assets in risky ventures…. [E]very accounting trick available was used…. Evidence of fraud was invariably present as was the ability of the operators to “milk” the organization” (NCFIRRE 1993)

Original re Deregulation“Another way of promoting competition is by deregulation. [It was] carried forward by the Reagan administration. It is generally judged to have been successful within the US, and it is generally assumed that it could bring similar benefits to other countries.

The potential payoff from deregulation would seem to be much greater in Latin America….”

Revisionism re Regulation

Williamson now admits that bad financial regulation causes crises. He claims “Skeptics may … point to the recommendation to deregulate. [T]his was intended to endorse freeing entry and exit, rather than to advocate an absence of regulations intended to protect the consumer, or the environment, or to supervise the banking system. With that interpretation there is no contradiction.”

Correa avoided this trapWilliamson, stung by criticism from scholars such as Correa declared his ideas perfect:

“I submit that it is high time to end this debate about the Washington Consensus. If you mean by this term what I intended it to mean, then it is motherhood and apple pie and not worth debating.” Correa understood the parts that were good v. rotten apples.

What Williamson got wrongHe admits that privatization often went wrong. He favors disastrous austerity. He claims that Reagan’s disastrous deregulation – which was S&Ls – was “generally judged … successful” by economists. Williamson doesn’t realize what a devastating admission he has made about the dishonesty and incompetence of those economists. Correa got it right; both the good & bad.

Step 2: Getting the Revenue

Ecuador was faced with a revenue disaster.

Net revenue is the key so one must manage revenues and debt.

I will begin the discussion with Ecuador’s debt. Ecuador lacks a sovereign currency so it could not borrow in its own currency. This puts it at the mercy of the “bond vigilantes.” The eurozone crisis shows how dangerous they are to a nation.

The Debt Doomed Ecuador

If Correa had attempted to pay Ecuador’s debt he would have killed any chance to achieve the miracle.

“In 2007 the Ecuadorian government paid $1.75 billion in debt service alone, more than it spent on health care, social services, the environment, and housing and urban development combined.” It was essential to reduce the debt service.

Correa pares down the debt

Correa broke sharply with prior debt policies. He took four vital actions. He paid off the small debt to the IMF because it would have blocked the next two actions. He used the audit of odious debt to reduce the debts (e.g., Norway renounced Ecuador’s debt to it).

Negotiating the debt

Correa used the debt audit strategically to provide a basis for a legitimate default and to put the bondholders on notice that they could be wiped out. He then used an auction system to buy back 91% of the debt at issue at a 65% discount. He then negotiated an alternative line of credit from China. Correa knew it was politically impossible to drop dollarization so he wasted no time trying.

The Right Man at the Right Time

Just as his expertise with the Washington Consensus’ weaknesses and strengths and his rejection of failed economic dogma made Correa the right man at the right place and time to make possible the miracle, an economist and former finance minister was the ideal person to handle the debt renegotiations.

Two Proofs of the Point

First, the financiers went berserk in denouncing Correa, which proves they lost enormous profits on the odious debt.

“Ecuador had ‘lived up to its reputation as a banana republic’ (Investor’s Business Daily).  Ecuador was ‘one of the axis of evil in Latin America’ (Financial Times).

There is no sincerer compliment!

The 2d Compliment

“Hans Humes, chief executive of Greylock Capital, said.

“Ecuador’s move was a ‘brilliantly run and managed process. They nailed the timing’”.

Increasing RevenueReducing bond interest expenses was essential, but not sufficient to produce the dramatic change in public spending required for the miracle. Correa worked at the same time to greatly increase revenue and integrity. He renegotiated the percentage of oil revenues that went to Ecuador. Many oil companies left, but enough remained to prove Correa’s point that the prior share was absurdly low.

Tax Compliance

Correa made a major, also successful, effort to transform the rate of compliance on corporate and other taxes both to increase revenue and integrity. He also instituted an excess profits tax on banks.

Step 3: Spend Wisely

Even ideas promoted by Washington are not always bad. Correa proved to be very well suited to the task of spending wisely because he had the skills and the temperament to be pragmatic and wise in choosing the priorities and energetic in implementing those policies. He spent on the development trinity: education, health & infrastructure.

Washington Agrees!Williamson: “there are three major expenditure categories on which views are strongly held: subsidies, education and health, and public investment.”

“Education and health are regarded as quintessentially proper objects of government expenditure. They have the character of investment (in human capital) as well as consumption. Moreover, they tend to help the disadvantaged.

Step 4: Aid Entrepreneurs

A conservative Peruvian economist, Hernando de Soto, is best known for emphasizing the need to speed the ability to start an honest business.

Correa agrees – Ecuador has just adopted a law (and technology) to revolutionize the process. It is inescapable that Correa’s default position is to be friendly towards honest businesses.

Step 5: Competitive Markets

Correa warned of the market power abuses that could result from privatization under the Washington Consensus. (This is another area in which Williamson has reinvented history.) Even Williamson now agrees that Correa was correct. Correa has appointed a vigorous, skilled economist, Pedro Paez to create and run the competition agency.

Step 6: Creating a Team

Ecuador was wise to choose a leader who had the best skill set to bring about the miracle, but the work that created the miracle was done by millions of citizens. I have met a number of the officials who are helping to make and implement the policies and their general level of care and skill is very high.

Head, Spine, Heart & Fire in the Belly

The miracle took four key traits that we often use our bodies to exemplify. The miracle took top analytical abilities (head), the courage (spine) to face down even armed police officers and powerful special interests, the heart to keep the poor as the lodestar, and the fire in the belly to stay committed to sometimes boring details required to make good ideas real.

The Miraculous Results

Unemployment has fallen sharply

Poverty has fallen sharply

Inequality has fallen sharply

The Nation is at peace

There has been political stability

There’s a well functioning democracy with peaceful transitions of power after elections

And you, and trucks can drive

Much more safely and quickly

Critical to critical care and health

Living the good life, not simply a longer life in great pain and disability

People Vote with their Feet

In economics we stress “revealed preferences” – what do people actually do as opposed to what they say they’ll do.

Ecuador, as a percentage of its population, was the leading exporter of citizens in Latin America.

Today, the citizens of Ecuador are often choosing to live here.

Correa is Right about Finance

The central problem is the agents – bank CEOs too often run a bank for their benefit at the expense of the bank & people

In the U.S., finance takes 40% of total corporate profits. Wall Street harms Main Street. This leads to massive inequality and crony capitalism.

Need to create a race to the top of integrity.

Stop Pandering to Power

Ethics: “Speaking truth to power”

“When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it.” (Frederic Bastiat)

Citicorp’s Ode to PlutonomyCiticorp (2005): “In early September we

… introduced the idea that the U.S.is a Plutonomy - a concept that generated great interest from our clients.”

Citigroup’s wealthy clients were thrilled to hear that the U.S. was ascending to the exalted state of “plutonomies, where economic growth is powered by and largely consumed by the wealthy few.”

Glorifying Inequality“[T]he top 1% of households in the U.S., (about 1 million households) accounted for about 20% of overall U.S. income in 2000, slightly smaller than the share of income of the bottom 60% of households put together. That’s about 1 million households compared with 60 million households, both with similar slices of the income pie! Clearly, the analysis of the top 1% of U.S. households is paramount.”

Obscene Wealth Inequality

“[T]he top 1% of households also account for 33% of net worth, greater than the bottom 90% of households put together. It gets better (or worse, depending on your political stripe) - the top 1% of households account for 40% of financial net worth, more than the bottom 95% of households put together.”

The Top 1/10 of One%

Citi then warns that focusing on the top 1% masks the fact that their share of the pie is “almost entirely driven by the fortunes of the top 0.1% (roughly 100,000 households).” Citi praises the lower taxes and changes in senior executive compensation that have driven the tremendous increase in the share of the pie taken by these 100,000 households.

Managerial Aristocracy

“[W]hile in the early 20th century capital income was the big chunk for the top 0.1% of households, the resurgence in their fortunes since the mid-eighties was mainly from oversized salaries. The rich in the U.S. went from coupon-clipping, dividend-receiving rentiers to a Managerial Aristocracy indulged by their shareholders.”

Correa & Bastiat’s Warnings

“Society and governments need to be amenable to disproportionately allow/encourage the few to retain that fatter profit share. The Managerial Aristocracy, like in the Gilded Age, the Roaring Twenties, and the thriving nineties, needs to commandeer a vast chunk of that rising profit share, either through capital income, or simply paying itself a lot.”

Greed is Insatiable

“We project that the plutonomies … will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization.”

You Can’t Make This Stuff Up

“The earth is being held up by the muscular arms of its entrepreneur-plutocrats, like it, or not.”

The Multitudinous Many

“In a plutonomy there … are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the “non-rich”, the multitudinous many, but only accounting for surprisingly small bites of the national pie.”

Bonfire of the Inanities

“Since we think the plutonomy is here, is going to get stronger, its membership swelling from globalized enclaves in the emerging world, we think a “plutonomy basket” of stocks should continue do well. These toys for the wealthy have pricing power, and staying power. They are Giffen goods, more desirable and demanded the more expensive they are.”

Bastiat was an Optimist

“At the heart of plutonomy, is income inequality. Societies that are willing to tolerate/endorse income inequality, are willing to tolerate/endorse plutonomy.

[A]n examination of what might disrupt Plutonomy - or worse, reverse it - falls to societal analysis: will electorates continue to endorse it, or will they end it, and why.”

Simetría

Simetría

Asimetría

Detroit: Bankrupt Romney: 1 of 6 Houses

Romney’s Six Homes

He forgot how many homes he owned!

Family received government aid for the poor when it moved to U.S. from Mexico

Became wealthy in Detroit: auto industry

Picture: his $12 MM La Jolla beach home

“Romney filed…to bulldoze the single-story beachfront home and replace it with a larger, two-story home.” (After election.) http://realestate.aol.com/blog/2012/01/24/slideshow-see-mitt-romneys-6-homes/#!slide=4773192

Detroit: Largest Bankruptcy$16-20 billion in net liabilities

Unemployment 3X 2000; 2X national rate

78,000 city structures: abandoned

Picture of “Zombieland”

“[Population] exodus left behind …nearly 83% African-American” “Detroit the nation's largest black-majority city.”

Detroit citizens lost all political powerhttp://www.usatoday.com/story/news/nation/2013/07/18/detroit-files-for-bankruptcy/2567159/

Asymmetrical Coverage: Correa

1. Technocrat v. Leftist

2. Mediocre v. superb growth

3. The smear that wasn’t

4. The great compliment – ignoring Ecuador

5. The thing they will never forgive Ecuador for is its miracle