Alex's Asian Adventure

Warning: Economic ranting ahead!

Seeing as yesterday I topped out on Illiniza Norte, and tomorrow I'm headig to Cotopaxi, I'm taking a rest day.

I started with breakfast on a patio. Now, there is nothing more satisfying when you're on vacation than a good, lazy breakfast, ourdoors in good weather, and with a funny book to read. And that's what I did. This leads me to something:

Ecuador, as a nation, has seen Supersize Me.

The portions here are enormous. I order a spinach crepe, thinking it'd be a relatively benign choice. Out come not one, but two massive spinache-laden crepes, doused in cheese. Ecuadorians love their cheese a lot more than their coffee, and it shows. Wow. I could barely finish the meal.

Also on this patio, obviously provoked by my laughter at reading Bill Bryson, a local English-speaking youth struck a conversation. This young fellow is 18 years old and studying languages. At 18, he speaks Spanish, Italian, French and of course English. I felt a great shame.

We had a fine chat. This particular young man is not happy with Ecuador's economic development and the presidency of one Rafael Correa. Now, I can see why a Canadian investor in Aurelian Resources would be unhappy with Senor Correa, but a local youth? Interesting. This young man, with no economic training in his past, plainly saw the dangers of alienating some of your biggest trading partners by nationalizing the oil & gas industry and leaving foreign mining firms in a state of limbo. Now, a single unit does not a sample make, but nonetheless this is anecdotal evidence that perhaps the political scene here has not totally galvanized around Correa.

He was also very adamant that the reason he's studying languages now, and the reason he wants to go into an international business program next year, is to leave Ecuador and live elsewhere. He mentioned Europe on the basis of the pretty chicas, but in my mind the ultimate destination doesn't matter. What matters is that this disaffected youth wants to leave on the basis of economic opportunity, and is investing in his (locally paid for) education to further this goal.

It doesn't take a genius to see the issues for the Ecuadorian people and the Correa government. This is not a rich country by any stretch of the imagination. There is a big problem with poverty. And it won't get richer overnight, either. For the government, there is a trade-off between helping the existing poor (with short term aids like massive mineral & energy royalties or outright nationalization of assets) and furthering long-term growth - socialist programs like what Correa is appears to be instituting help the former but in my mind severly undermine the latter, as people say "screw this" and move on to other places.

In first year economics, students are told that there is a trade-off between labour and capital. Students proceed to accept this as rote because it "makes sense". Where it really begins to make sense is when one visits a developing country, say Ecuador, and compare it with a developed country, say Canada. It's obvious to the naked eye the Ecuador has lots of Labour, but not too much Capital, as compared to Canada. There are a lot of people here doing jobs that have very limited value add. For instance, almost every intersection has someone directing traffic, even though there is a perfectly functional light in place. Where in Canada a construction crew busting open concrete would use jackhammers, here you find a gang of tired-looking men with hammers and chisels. And guess what? All these jobs are public-sector jobs. Thank you Senor Correa.

Not all jobs are created equal. Developed countries have relatively few manual labour jobs as compared to developing countries. Why? Because we've replaced a gang of 10 hammer & chisel labourers with a single jackhammer, and freed 9 of those guys to seek other employment. One could say it's cruel, sure, and yet unemployment rates in the developed world are much lower (and employment rates are higher) than in the developing world generally. A developed economy simply can't afford to have 10 guys doing the work of 1 jackhammer. I would argue that a developing economy can't afford it either.

Now, if you're a young man graduating from high school, and you look at your prospects, you might think twice about staying in a country where your prospects could very well include being a traffic-director, or a security guard, or a pavement-chiseller. Understanding these incentives isn't rocket science.

Now, how can Senor Correa take this country from hammer & chisel to jackhammer in anything less than an eternity? It's tough. What the Asian economies did starting in the 60s is invest in education and food production. They also, to this day, jealously guard their economies against highly volatile speculative capital flows, and this is a point worth belabouring.

There is a big difference between foreign direct investment (say, building a mine) and foreign investment in a foreign stock market. The former requires long-term committment, typically creates employment locally, and sends some money to the local government in the form of taxation. The latter is almost wholelly speculative. The former is generally what developing countries strive for. The latter can be, in the case of a developing economy, highly destabilizing and even dangerous. Many countries continue to practice capital controls to guard against speculative (hot money) flows despite being very open to trade; China is a great example - they don't even permit free flow of money between Hong Kong & the mainland!

And if you don't believe me when I say that capital controls can be beneficial, look into what Malaysia did in 1998. Compare their experence to that of, say, Indonesia. When Indonesia was permitting bailouts of Western hot money, Malaysia told the hedge funds to screw off and as a result had half the recession of Indonesia, Thailand, or South Korea. Funny that, eh?

I'll point out that Canada didn't finally abolish major capital controls until 2005, when the 30% foreign ownership cap on registered plans was dismissed as an anachronism. Canada is developed, with mature capital markets, and it took us this long. Makes it hard to argue that capital accounts should be fully liberalized in economies that lack the same level of financial infrastructure and sophistication.

Now, back to Ecuador. What Correa is doing is punishing foreign direct investment. He told the oil industry that the assets they purchased and found oil on are no longer theirs. However, the upgraders and refineries won't build themselves, and since Ecuador is still in the hammer & chisel stage they won't get built by Ecuador either. What infrastructure is in place now is a sunk cost to the Exxons of the world, and they will produce until it's no longer economic for the global oil firms to pump oil or the existing resources run out. Beyond that, nothing will get built. The same is true in mining. And gas. And textiles. And tourism. Why would you invest in Ecuador if you stand a good risk of having your assets expropriated?

Of course, if there is no safety for foreign direct investment, there is definitely no issue with hot money either. Foreigners are too scared to buy anything on the local bolsa - if there is one at all - and locals are hammering and chiselling and have no money to finance speculative enterprises through public equity. If you're an entrepreneur with grand plans and big cojones, you have a problem because the locals have no money, and the foreigners who do won't give you any. If your plan was to replace 10000 hammer & chisellers with 10000 jackhammer-wielding superworkers (same amont of labour, but way more capital!) you're SOL - no matter how lucrative the venure.

It's left to Correa to fund major capital projects. Meanwhile, the entrepreneureal types likely want to leave the country for better opportunities elsewhere.

Unfortunately, the examples of economic liberalization in Latin America seem to be associated with dictatorships. Pinochet is the ultimate reason why Chile grew as fast as it did, for as long as it did - but he wasn't a nice guy by any means. There has to be a middle way. For now, Latin America is in love with socialism, as it was in the 70s, but how long will it last?

This, in a nutshell, is my grievance with socialism in a developing economy.

Enough economic ranting for now.

I spent the rest of the day loitering through town, including an aborted plan to visit the equator - weather and an extended lunch sank those plans. Tomorrow I'm heading to Cotopaxi. I am departing Quito at 11 AM. The attempt on the mountain will begin around midnight tomorrow - a true alpine start. I am vaguely nervous, because I know this will be very difficult. I should be in Riobamba by midday Saturday. For now, I must continue resting.