An interesting debate has arisen in Ecuador during recent weeks over the following proposition advanced by authors at a Quito think tank: a dollarized country shouldn’t reduce its tariffs when the dollar is overvalued relative to the currencies of its regional trading partners (according to purchasing-power-parity measures) because that would undermine its “competitiveness” in export market. As several commentators have noticed, this is reminiscent of the Mercantilist view that a country will lose too much of its gold if it does not discourage imports with tariffs or promote exports with subsidies, a view that David Hume and Adam Smith debunked long ago.
The debate began with the publication of an essay by José Hidalgo Pallares and Daniel Baquero for CORDES, a leading economic policy think tank in Quito. They proposed that it is not “convenient” to reduce the general level of tariffs at the moment, with a strong dollar already making imports cheaper and exports more expensive for Ecuador, and with the economy operating at below capacity. Their concerns were macroeconomic and balance-of-payments related: “In recent years, imports have also grown more than exports … [T]he trade balance, which is one of the main components of the current account, registered a deterioration: from a surplus of $227 million in the first quarter of 2018 to one of just $2 million in the same period of 2019.” Reducing tariffs across the board, they argue, “would mainly favor consumer goods,” whereas “to revive the Ecuadorian economy, it is more advisable to take measures that really allow some recovery of external competitiveness, in order to encourage exports. Here fits an efficient labor reform, the elimination of excessive paper work[,] and trade agreements” that give Ecuadoran products better access to foreign markets. (This and all other translations are mine, Google-aided.)
Critical response to the essay was swift. Gabriela Calderón tweeted incredulously that CORDES, for years a strong critic of the tariff surcharges imposed by then-President Rafael Correa supposedly to “safeguard” dollarization, was now adopting the Correa position: “Amazing! Spend 10 years complaining about Correa and then reproduce his erroneous arguments in favor of trade restriction.”
I will argue that the CORDES proposition – namely that the advisability of a unilateral general tariff reduction depends on macroeconomic conditions – is mistaken. In a nutshell: The stock of money and the price level are self-regulating for a small country under dollarization. The size of Ecuador’s economy (gross domestic product) is comparable to that of Mississippi. Both are dollarized. What is true for Mississippi, in regard to the balance of payments, is also true for Ecuador: When the local prices of traded goods are too high for equilibrium with neighboring countries, arbitrage will bring them down. The problem of overvaluation that reduces Ecuador’s export competitiveness will resolve itself by a combination of (1) internal adjustments (input price reductions or productivity increases) that lower the cost-covering prices local producers need to charge when exporting goods, and (2) rising nominal prices in the trading partners (Colombia, Peru) whose currencies are presently relatively undervalued in exchange markets because inflation higher than Ecuador’s is anticipated.