Petroleum in Ecuador: The Management of Natural Resource Wealth A curse or a blessing?

Transcription

1 2015 Petroleum in Ecuador: The Management of Natural Resource Wealth A curse or a blessing? MSc. Political Science International Relations Development in Comparative Perspective GSSS Jonathan Salazar Supervisor: Dr. Farid Boussaid Word count: 23,969

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3 Petroleum in Ecuador: The Management of Natural Resource Wealth 3 Acknowledgements This master s thesis is not only the reflection of a personal effort, but it is also the reflection of the sacrifice of all my loved ones. Therefore, I would like to first thank God for his blessings and immense wisdom. I would like to thank my sister for giving me the motivation to be a good professional. I would like to thank my girlfriend for her support throughout this difficult year. I would like to thank my mother for her unconditional support, her prayers, and for her loving words in the most determining moments. I would like to thank my father for his always- encouraging words, for making me belief that everything is possible in life. I would also like to thank him for challenging me in all aspects to become the best version of myself. I would like to thank my friends who were always present with laughter and supporting words. Finally, I would like to thank my supervisor Farid Boussaid for his patience, advice, and expertise throughout this academic year.

4 Petroleum in Ecuador: The Management of Natural Resource Wealth 4 Table of Contents Acknowledgements.. 3 Table of Contents 4 Abstract.6 List of Abbreviations....7 List of Figures...8 PART 1 1. Introduction Natural Resource Curse Thesis Economic Explanations Political Explanations Theoretical Framework & Research Design Institutions Methodology Case Selection Data 32 PART 2 4. Historical Background of Resource Management The Military Regime ( ) The Management of Petroleum Resources Ecuadorean State Petroleum Corporation (CEPE) Discussion The Democratic Neoliberal Period: (1980s- 2007) The Management of Petroleum Resources The Decade of The Decade of The New Millennium Subsidies Policy CEPE & PETROECUADOR..70

5 Petroleum in Ecuador: The Management of Natural Resource Wealth Discussion The Socialism of the 21 st Century: ( ) The Management of Petroleum Resources EP PETROECUADOR Discussion Conclusion..96 Bibliography. 100

6 Petroleum in Ecuador: The Management of Natural Resource Wealth 6 Abstract During recent decades, extensive literature has provided strong evidence about the negative effects that natural resource abundance has had on natural resource- rich developing countries. This phenomenon has been referred as the resource curse. Much of this research has focused on the economic and political explanations of this curse. Yet, an agreement has not been reached with regards to the occurrence of this phenomenon. A promising line of research, however, is based on political explanations that point out to the quality of institutions. More precisely, a prominent institutionalist view considers that countries with extractive political and economic institutions are not able to attain good developmental outcomes. In that sense, this research analyzes the occurrence and the dynamics of the resource curse in Ecuador. Moreover, by taking a closer look at the institutional structure of the country this research draws conclusions about the management of the petroleum sector. The analysis is divided into three critical junctures: the military regime ( ), the democratic neoliberal period ( ), and the socialist regime of the 21 st century ( ). The results of this research point out that the quality of the political institutions has been detrimental for the management of the petroleum sector. That is, the country has had extractive political institutions that have affected the oil sector through economic institutions molded by the preferences of the dominant elites. Yet, variations at these institutions have resulted in turn in different economic paths at the three periods in question. Ultimately, in light of this adverse institutional structure, some troubling aspects of the resource curse have become clear and recurrent in the country.

7 Petroleum in Ecuador: The Management of Natural Resource Wealth 7 List of Figures Figure 1: Oil Rents as % of GDP from Figure 2: International Oil Prices from Figure 3: WGI: Government Effectiveness and Control of Corruption from Figure 4: WGI: Voice & Accountability and Political Stability from Figure 5: International Oil Prices from Figure 6: Oil Rents as % of GDP from Figure 7: Public Social Spending as % of GDP from Figure 8: Public Social Spending as % of Total Public Spending from Figure 9: Public Social Spending per capita from Figure 10: Property Rights from Figure 11: Gini Index (Distribution of Resources) from Figure 12: Income Distribution from Figure 13: Poverty Headcount Ratio from Figure 14: WGI: Government Effectiveness and Control of Corruption from Figure 15: WGI: Voice & Accountability and Political Stability from Figure 16: International Oil Prices from Figure 17: Oil Rents as % of GDP from Figure 18: Public Social Spending as % of GDP from Figure 19: Public Social Spending as % of Total Public Spending from Figure 20: Public Social Spending per Capita Figure 21: Property Rights from Figure 22: Gini Index (Distribution of Resources) from Figure 23: Income Distribution from Figure 24: Poverty Headcount Ratio from

8 Petroleum in Ecuador: The Management of Natural Resource Wealth 8 List of Abbreviations Alianza Pais BCE Bpd CEPE DNH ECLAC FLOPEC FONADE GDP IVA LPG MMbbl OCP OPEC RDP SOTE WB WC WGI Alianza Patria Altiva I Soberana Banco Central del Ecuador Barrels per day Ecuadorean State Petroleum Corporation Direccion Nacional de Hidrocarburos Economic Commission for Latin America and the Caribbean Ecuadorean Tanker Fleet National Development Fund Gross Domestic Product Value Added Tax Liquefied Petroleum Gas Million Barrels of Oil Heavy Crude Oil Pipeline Organization of the Petroleum Exporting Countries Refineria del Pacifico Transecuadorean Pipeline System World Bank Washington Consensus World Governance Indicators

9 Petroleum in Ecuador: The Management of Natural Resource Wealth 9 PART 1 1. Introduction On June 1972, members of all social classes were gathered euphorically in Esmeraldas to witness the extraction of the first barrel of oil from the Ecuadorean Amazon. In a symbolic act that would mark the modern history of Ecuador, the president, General Rodriguez Lara filled his hand, with what he had called the black gold that would bring economic prosperity to the country. For many, this event would represent the state s opportunity to pull Ecuador out from poverty. Yet for others this event would represent the start of a curse of underdevelopment. Ecuador primarily sustains its development model through the extraction of its abundantly available natural resource wealth. Since Ecuador started its export- led model, the country has moved from dependence on one major commodity to another major one. The country has gone through significant boom periods in different commodities, with petroleum as the most representative commodity. This has enabled the country to get through critical periods of crisis with modest economic growth. Nevertheless, this continual trend of reliance on the emergence of one commodity to finance the development model has led the country to a dependent path of extraction of natural resources. More importantly, despite this abundance in several areas and products, across time the country has not experienced major progress in terms of development. This marks a notorious contrast with the conventional wisdom on development strategy, which argued that natural resources would serve as a push for economic prosperity. Therefore, during the last decades prominent researchers have wondered about the reasons behind this phenomenon. Many of them have analyzed countries that have not been able to achieve major economic benefits from its resource wealth. For that reason, Ecuador among many other resource- rich developing nations, has served as empirical evidence to corroborate the existence of what has been framed as the resource curse thesis. This line of thought proposes that resource rich nations tend to be outperformed by less resource rich nations. More specifically, researchers in this field argue that countries that

10 Petroleum in Ecuador: The Management of Natural Resource Wealth 10 possess an abundance of resource wealth, like Ecuador and many other Latin American countries, are more likely to be hampered by slow economic growth leading up to negative political, economic and human development outcomes. Nevertheless, although the evidence of the curse is compelling, no comprehensive economic and political explanations of the curse have emerged from the literature 1. Notwithstanding major contributions, a consensus has not emerged. Therefore, taking the above puzzle as a departure point, the case of Ecuador will be analyzed in an attempt not only to contribute to the resource curse thesis but also to elucidate the specifics of this curse for the Ecuadorean society. More precisely, it is fundamental to dig deeper into the institutional structure across key periods of transition or change. Petroleum extraction has been a fundamental pillar of the Ecuadorean developmental model ever since its exploitation activities were set in motion by the military regime during the early 1970s. From this date up to now, the country has faced booms and crisis in the management of petroleum resources. Mismanagement of oil revenues has been a recurrent problem for Ecuador. Political instability has also characterized Ecuadorean history. Indeed, this has revealed a weak institutional structure. Moreover, the excessive extraction of oil has not only affected the development process of the country, but it has also exacerbated social issues related to oil extraction such as environmental damage and social unrest. Therefore, the current regime has proposed alternatives to move Ecuador from an extractivist development model into what the government has framed as a sustainable model 2. In this fashion, the current Socialist regime intends to overcome the resource curse. Nevertheless, to achieve this change, first the government requires further exploitation of the extractivist model 3. Ultimately, the notion 1 There are several case outliers such as Botswana, Indonesia, and the noteworthy Norwegian example that point to potential flaws of the paradigm (see Iimi, 2007; Steinar, 2013). 2 Under the guidelines of the 2008 constitution, the ancestral indigenous notion of Suma Kawsay is proposed as an alternative to reconcile equilibrium between the environment, the society and the economy (for more on this, see Gudynas, 2011). 3 This time, oil extraction will be expanded to protected parks and previously unexplored areas, such as: the protected areas of the Yasuni ITT fields (Ishpingo, Tambococha and Tiputini). In addition, the mining sector, which has mostly been informal and short- scale, will be developed at a larger scale.

11 Petroleum in Ecuador: The Management of Natural Resource Wealth 11 behind this plan is that with the increase in revenues, the country will be able to move progressively out from the extractivist model and hence avoid the curse. Potentially, it represents a strengthening of Ecuadorean institutional structure. Certainly, Ecuador s alternative offers an interesting case for future research. Time will determine whether the curse is avoided through the strengthening of the institutional structure Thus, with the above- mentioned puzzle in mind, the following question will be addressed in this thesis: How has the institutional structure of the country affected the management of petroleum resources? And in light of this, to what extent has Ecuador been affected by the resource curse? To unravel the reasons behind mediocre developmental outcomes, the analysis will take a closer look at the management of natural resource wealth and the institutional structure in which this takes place throughout the country s history of dependence on petroleum resources. More specifically, by looking at the synergistic relationship between the regime type (political institution) and the state petroleum company (economic institution) across time, the analysis will shed light on the management of the petroleum sector. This in turn will serve as a cornerstone to comprehend the continual path that Ecuador has followed towards disconcerting outcomes in terms of development and the effects of the resource curse. To answer this question, the analysis will proceed as follows. Chapter 2 will provide an overview of the resource curse thesis. This section will highlight this widespread phenomenon by including the main economic and political explanations. Particular emphasis, however, will be placed on the political domain, as this will provide the basis for our theoretical framework and case study analysis. In Chapter 3, our analytical framework will be elaborated. Drawing on the political standpoint on the resource curse, the focus will revolve around the institutions as a mean to explain the occurrence of this curse in developing countries. This section will outline the distinctive features of inclusive and extractive institutions and their role on economic development. Chapter 4 will provide an explanation about the methodology, case selection, and data gathering.

12 Petroleum in Ecuador: The Management of Natural Resource Wealth 12 Then, in Part 2 the core of the case study will be discussed. This part will consist of three chapters with respective subsections. Three crucial episodes within Ecuador s history of petroleum management will be discussed in these chapters. Within this timeline, this research will go back to the very beginnings of oil exploitation up to the present date. Chapter 5 will explore the management of oil resources under the military regime of the 70s. It will then move to Chapter 6, in which the Democratic- Neoliberal period will be analyzed 4, to eventually conclude in Chapter 7 with the so- called 21 st Century Socialism of the current regime. In each chapter, various subsections will be discussed with the same timeline approach. In the subsections, the state- owned oil company will be thoroughly analyzed. Then, based on our theoretical framework, the end subsections will present the corresponding discussions. Finally, Chapter 8 will present the major findings. Here the dynamics of the institutional structure, the management of petroleum resources, and the effects of the curse will be clearly illustrated. 4 As this chapter elaborates on almost four decades, it will be presented with more subsections than the other two periods. In order to provide more clarity, it will be divided by decades (1980s, 1990s and early 2000s) and one overall subsection corresponding to the subsidies policies.

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14 Petroleum in Ecuador: The Management of Natural Resource Wealth Natural Resource Curse Thesis In the early 1950s, academics conventional view considered that natural resource abundance, as part of a country s stock of natural capital could have a positive effect on economic development. According to development economists, natural resources could be turned into an output that could be utilized for investing in other forms of capital such as physical capital and human capital; this in turn could be translated into future output in other strategic sectors (Davis, 2005: 235). Resource abundance could give a big push to the economy through investment in economic infrastructure and social development. This view was supported by successful experiences of resource abundant developed countries such as Australia, Finland, and the United States (see Iimi, 2007; Rostow, 1961). Nevertheless, in recent decades, numerous developing resource rich countries have not replicated this experience. Thus, contrasting with this widely accepted view of the 1950 s on development strategies, an extensive literature emerged in political science and economics that provides strong evidence of the potential detrimental effects of the abundance of natural resource wealth (Kurtz & Brooks, 2011: 748). Prebisch and Singer are among the earliest researchers who laid down the foundations for the subsequent theorizing of the resource curse. These authors argued that an economy reliant on the specialization in exports of a primary commodity could suffer from a decline in terms of trade. Accordingly, this would lead to a widening of the gap between the rich industrialized nations and the poor resource- rich nations (Ross, 1999; Prebisch, 1950; Singer, 1950). Yet, the resource curse thesis, as coined by comparative studies on resource- rich countries gained momentum by major contributions in the 1990s: Jeffrey Sachs & Andrew Warner (1995, 1997, 1999), Alan Gelb (1988), and Richard Auty (1993) and Karl (1997). Using a cross- country analysis of 97 countries from 1971 to 1989, Sachs and Warner (1997) concluded that countries well- endowed with natural resources tend to grow relatively slower than their resource- poor counterparts. Although the literature provides robust evidence that natural resource abundance has resulted in negative development outcomes for resource- rich developing countries, this evidence has not been categorically conclusive. The reasons for the

15 Petroleum in Ecuador: The Management of Natural Resource Wealth 15 occurrence of this phenomenon have not yet been widely agreed upon (Rosser, 2006: 27). Various efforts however have been made to elucidate the reasons behind the resource curse; in that sense, a substantial amount of literature has been particularly focused on the economic aspects of the curse. 2.1 Economic Explanations Among the extensive literature based on economic explanations for the curse, the most relevant are: Dutch disease, a decline in the terms of trade for primary commodities, the volatility of world prices of primary commodities that are particularly high such as oil and minerals, the dead- end of nonresource sectors due to poor economic linkages between the resource and the nonresource sectors (Frankel, 2010; Ross, 1999). According to Dutch disease models, the booming of the natural resource sector will have a negative impact on the economy. A substantial increase in revenues affects the distribution of employment, pulling resources in and out of the non- resource sectors (Sachs & Warner, 1997: 5). Furthermore, massive resource flows lead to an overvaluation of the exchange rate and a decline in competitiveness, which harms the manufacturer and the agricultural sectors. Hence, resources flow from the secondary sectors of the economy to the primary- exporting booming sector (Schuldt & Acosta, 2006: 73). Regarding the aforementioned effects, the volatility that characterizes the prices of primary commodities makes the resource abundant countries more prone to suffer recurrent problems in their trade balance and fiscal accounts. This not only generates a dependency on foreign aid but also subjects the economy to erratic fluctuations (Schuldt & Acosta, 2006: 75). Moreover, Gelb et al (1988) studied six mineral- based economies, and argue that primary- exporting countries have more difficulties in the formation of domestic capital as opposed to the non primary- exporting countries. In addition, according to empirical studies on the curse, as a result of positive shocks in the primary commodity sector, resource dependent countries led to dysfunctional state behavior characterized by large public sectors and unsustainable budgetary policies (Robinson et al., 2005: 2).

16 Petroleum in Ecuador: The Management of Natural Resource Wealth 16 Other studies contend that natural resource abundant countries tend to be more vulnerable to rent- seeking behavior on the part of prominent elites. According to this view, rent- seeking behavior may take different forms. For instance, Baland and Francois (2000) argue that rent- seeking activities depend upon the initial level of entrepreneurship that a country has during a resource boom. Therefore, an increase in the value of resource s revenues increases rent- seeking activities when the initial level of entrepreneurship is low. Conversely, when the country has a high level of entrepreneurship, a resource boom tends to reinforce entrepreneurial activities (528). Also, rent- seeking activities may exacerbate corruption in the public and private sector, thereby affecting the redistribution of resource revenues and reducing economic prosperity and social development (Gylfason, 2001: 850). Though, despite the widespread acceptance of the existence and the economic effects that the curse has in resource rich countries, the causal mechanisms of this phenomenon have not been categorically recognized. Much of the literature on economic explanations did not take into account the role of government (Rosser, 2006: 14). To some extent, this has been considered a setback, as from a policy perspective, while it is important to know if a curse exists, it is perhaps more important to know the mechanisms by which it casts its spell (Sala- i- Martin, & Subramanian, 2003: 5). Therefore, another strand of the literature has taken a political approach to explain the mechanisms under which the curse affects countries well endowed with natural resources. 2.2 Political Explanations Another group of scholars has focused on the political dimension in order to assess whether resource endowments are indeed a curse for developing countries or not. Hence, Anderson s (1998) study dismisses economic explanations and instead focuses on the policy dimension as a reason behind the poor performance of resource- abundant countries. He suggests that an explanation for the relatively slow growth of natural resource- rich countries does not lie within the declining terms of trade, or differences in spillover effects across

17 Petroleum in Ecuador: The Management of Natural Resource Wealth 17 different sectors. He believes that explanations of the problem lie within countries distortionary policy regimes (20). Moreover, according to Ross (1999), the different political explanations for the curse fall into three major categories. Firstly, cognitive explanations- - studies within this category maintain that under periods of resource booms, authorities at the governmental level tend to develop a shortsightedness that is translated into negative policies for the country (298). Abundant natural resources may lead authorities to lose track of the need for sound economic policies and good institutional setting (Sachs & Warner, 1999). Secondly, societal explanations these studies contend that exports of the resource sector is likely to allocate power in the hands of influential classes or interest groups that benefit from policies that impede sustained growth. State- centered explanations, studies within the third category, hold that under periods of resource booms, state institutions tend to be weakened (Ross, 1999: 298). According to views of a rentier state, when the majority of a government s revenues come from resource rents, the authorities are not compelled to levy taxes from the general population and become less accountable to society (Losman, 2010: 429). Indeed, Alayli (2005) contends that in light of ample rents, resource- rich governments deliberately reduce or eliminate taxes, in this manner the public tends to demand less accountability from authorities (4). Furthermore, Shambayati argues that there is almost no social pressure from dissenting groups to call their governments for an improvement in economic policies. Since taxes are very low and welfare programs tend to be considerable, opposition is discouraged to mobilize around economic issues (Shambayati, 1994: 309). Taking a more institutional approach, Chaudhry (1994) contends that rentier states have extractive institutions that preclude the establishment of sound development policies. This occurs when resource rents are substantial, as there is a strong incentive to capture control over the process of redistributing the rents. This in turn generates incentives to deteriorate the institutional setting that regulates the use of public funds (Alayli, 2005: 4). Yet, although rents tend to distort the institutional system, its effects, however depend on the level of

18 Petroleum in Ecuador: The Management of Natural Resource Wealth 18 entrepreneurship a country has. For Baland and Francois by creating better goods and services and an increase in income, entrepreneurial activity may destroy the negative effects of rents. A high level of entrepreneurship may reduce the level of rent- seeking behavior. This in turn, accounts for an explanation for divergent patterns of economic growth in resource abundant countries (Baland & Francois, 2000: 540). Along this line, Robinson et al (2005) present a political model on which they argue that political incentives are relevant to understanding whether a resource curse will occur or not. To develop their model, they focused on periods of booms of publicly owned resources, such as oil among other minerals. They consider that resource booms increase the inefficient distribution of resources (3). They also consider these lootable resources because these resources are considered to be particularly important for rentier states as they hold a significant chunk of government revenue (Losman, 2010: 428). Therefore, for Robinson et.al, policy mistakes can in fact be seen as rational political strategies undertaken by politicians as a response to incentives produced by resource rents. More specifically, they argue that a resource curse is unlikely to occur in countries with a good institutional setting that constraint politicians ability to use clientelism for their political interests (2005: 28). Furthermore, their study established four main political aspects of the curse. First, they show that political elites tend to overextract resources in light of their personal interests. In other words, the path of resource extraction is determined by government s possibility to remain in power. Second, consistent with the first result, Robinson et.al contends that the extraction path is more efficient under permanent resource booms. Governments undergoing permanent periods of bonanza are more likely to procure resources on the long run, hence following a socially efficient path of extraction. Nevertheless, the third aspect maintains that under permanent booms misallocation of resources will be exacerbated. Finally, their study holds that institutions critically determine the extent to which political incentives during booming periods will be translated into policy changes. In the presence of robust institutions, which promote accountability and state competence, the allocation of public resources will be

19 Petroleum in Ecuador: The Management of Natural Resource Wealth 19 improved. A good institutional setting can mitigate the adverse political incentives that resource booms create (Robinson et.al, 2005: 5). Melhum et al. (2006) confirms this argument with similar results. Their study concludes that divergence in development outcomes is determined by the institutional arrangement a country has. Therefore, countries that have good quality institutions are not affected by the resource curse. To develop their argument, they make the distinction between producer- friendly institutions and grabber- friendly institutions (16). The former are the institutions in which rent seeking and the production of the resource are complementary activities. Whereas the latter are the institutions where production of the primary resource and rent seeking are competing activities. Grabber friendly institutions are likely to be adverse effects on economic growth as the elites gain from specialization in unproductive activities, malfunctioning of bureaucracy, and proliferation of corruption (Ross, 2014: 11). Sala- i- Martin and Subramanian (2003) elaborate further on the deleterious effects of natural resource abundance on economic growth through the impact that particularly minerals and oil have on institutional quality. Looking at the Nigerian experience, their study argues that poor outcomes in terms of sustained economic performance are the result of misuse of funds and corruption (23). Moreover, Schuldt and Acosta (2006) add that the abundance of natural resources, fed by the revenue flows from exports generates a mentality of consumerism. This ideology encrusts further in society due to the excessive availability of funds from external borrowing. Financial aid promotes more consumerism and a waste of resources, hence aggravating the problem. As a result, the institutional setting is also negatively altered since resources are mismanaged (77). Boschini et al. s study on a group of African countries, argues that certain types of natural resources, for instance minerals, are more likely to cause problems such as rent- seeking and corruption. Hence, they contend that it is the interaction between the type of resources and the type of institutions that determines the effects of natural resources. This interaction is referred as appropriability of a resource. Their study concludes that with a robust institutional setting, resources rather than becoming a curse can become an asset (Boschini et al. s, 2007:

20 Petroleum in Ecuador: The Management of Natural Resource Wealth ). Drawing on political explanations of the curse, Bakwena et al. study confirms the role that the quality of institutions play in turning natural resources into an opportunity for economic growth rather than a curse. Though, their study also draws conclusions about the system of governance that is more capable when it comes to abating the resource curse. According to them, a democratic governance system is better than a non- democratic system in turning natural resources into economic prosperity (Bakwena et al, 2011: 21). Governance is the factor that determines whether the effects of a curse materialize or not (Iimi, 2007: 692). In another vein, Ross argues that higher levels of flows from one type of resource petroleum tend to make authoritarian regimes more durable (2014: 2). Governments of these primary- exporting economies not only have important resources to execute public spending, but are also in the capacity to deploy measures directed at the broad population. In this manner, they ensure a governance base that enables authorities to introduce reforms and respective changes in accordance to rentier practices. In other words, this legitimation of authoritarian regimes is possible in the first place because of substantial richness of natural resources that alters the economic, political, institutional, and social structure of the country (Acosta, 2009: 11). Other intellectuals elaborate on the interaction between the natural resource abundance and human capital accumulation. Various researchers consider the crowding out effect of natural resource dependence on human capital as key for understanding the resource curse (Shao, Yang, 2014: 633). Natural resource revenues tend to weaken governments ability to solve social issues and provide public social goods. According to Alayli, as government s do not develop the ability to raise their revenues from other activities besides resource rents, there is a tendency for the state bureaucracy to be ineffective in performing its task to the benefit of the society at large (2005: 4). Moreover, Gylfason (2001) argues that countries with natural resource wealth tend to erroneously underrate the necessity of sound economic policies and human capital formation (850). By placing natural resources as their most important asset, authorities from these countries become overconfident and overlook the development of stocks of human capital.

21 Petroleum in Ecuador: The Management of Natural Resource Wealth 21 Therefore, Gylfason calls for more expenditure on education, as it will enhance human capital accumulation, transcendental for developmental outcomes. Kurtz and Brooks (2011) hypothesize about the effects that human capital accumulation and globalization can have with regards to developmental outcomes. Their study finds that in the absence of large stocks of human capital, the paradigm is very likely to occur. Moreover, they suggest that the effects of globalization are dependent on human capital endowments (763). In other words, in oil- rich countries where human capital accumulation is high, the effects of globalization tend to result in an increase in economic growth. Despite strong evidence that abundance of natural wealth indeed affects the development path of several resource- rich nations across the globe, another trend of literature contrasts this conventional wisdom. By touching upon exceptional cases such as Botswana, Indonesia, and Norway among others, prominent researchers question the existence of the paradigm. For instance, Holden (2013) analyses the Norwegian experience with the policies for the management of the nation s petroleum wealth. The case study reveals that Norway has reaped the benefits from sound policy by implementing the 10 principles under the oil commandment 5. In this manner, the country has been able to increase the investment of oil revenues. Concurrently, it has been able to save a substantial share of those revenues through a pension fund. Also, Norway s fiscal rule, if followed, ensures that the revenues from petroleum wealth will last forever in order not to preclude future generations spending (875). Similarly, Rosser s study on Indonesia concludes that the country s rapid economic growth is not a mere result of political elites implementing sound economic policies. Rather, it 5 The 10 oil commandments adopted by the parliament include: 1) National supervision and control over the operations; 2) Oil discoveries must be exploited in a way which makes Norway independent of others for its supplies of crude oil; 3) New industry will be developed on the basis of petroleum; 4) The development of an oil industry must take necessary account of existing industrial activities and the protection of nature and environment; 5) Flaring exploitable gas on the NCS must not be accepted; 6) Petroleum from the NCS must as a general rule be landed in Norway ; 7) The state must become involved at all appropriate levels and contribute to a coordination of Norwegian interests on Norway s petroleum industry ; 8)A state oil company will be established which can look after the government s commercial interests ; 9) A pattern of activities must be selected north of the 62 nd parallel which reflects the special socio- political conditions prevailing in that part of the country; 10) Large Norwegian petroleum discoveries could present new tasks for Norway s foreign policy (see appendix A of Holden, 2013: 876).

22 Petroleum in Ecuador: The Management of Natural Resource Wealth 22 is a more nuanced experience in which external factors set the conditions for Indonesia s rapid growth. Therefore, according to Rosser, the main implication for resource abundant countries is that to attain good economic performance, besides a shift in the structures of power which promote capitalist practices, there is also the need for the right external economic and political external conditions that provide opportunities for growth to occur (2007: 54). Other similar prominent studies draw on success experiences of development despite the curse. Acemoglu and Robinson (2003) study, for instance, analyses Botswana s experience with diamonds and concludes that the country s institutional setting is the fundamental factor for the country s development (113). In the same fashion, Iimi (2007) highlights Botswana s institutional quality as the determinant of its rapid growth (681). There is not yet sufficient systematic knowledge about under what circumstances certain policies will work favorably. There is the prevailing need for policy advice based on a solid theoretical framework that draws on actual experiences (Ross, 2014: 18) Therefore, a satisfactory framework for explaining dissimilar paths of economic prosperity across countries should take into account as a determining factor, the interaction between institutions and the abundance of resources (Robinson et.al, 2005: 7). Thus, political explanations of the curse, in particular an institutional approach, serve as a departing point to develop the subsequent theoretical framework of this thesis.

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24 Petroleum in Ecuador: The Management of Natural Resource Wealth Theoretical Framework & Research Design The sections of this chapter provide the theoretical framework, followed by the corresponding research design. 3.1 Institutions As noted, to elaborate our theoretical framework, the main focus will be placed on the political explanations of the resource curse. More specifically, we will touch upon the quality of institutions. Therefore, the purpose of this section is twofold. Firstly, it will enable us to establish a proper framework for determining the quality of political and economic institutions 6. Secondly, it will help illustrate the dynamics between these political and economic institutions, in an attempt to unravel the reasons behind poor development outcomes and the recurrence of a resource curse 7. To do this we will draw mainly on Acemoglu & Robinson (2012), Acemoglu & Robinson (2006), and Acemoglu et al. (2004). Institutions will be defined as the rules of the game in a society or, as North more formally puts it, they are a set of constraints that shape human interaction; accordingly, they form the basis of social, economic, or political exchange (North, 1990: 3). The institutionalist standpoint argues that institutions are determinants of a country s failure or success to attain economic prosperity (North, 1991; Rodrik, 2003; Acemoglu & Robinson, 2012). Hence, the central issue of economic history and of economic development is to account for the evolution of political and economic institutions that create an environment that induces productivity (North, 1991: 98). Economic institutions are fundamental for economic development as they determine the incentives and the constraints under which economic actors interact in a society (Acemoglu et al., 2004: 2). 6 Examples of political institutions include: regime type (democracy, dictatorship or autocracy), and the extent of constraints on political elites and politicians (Acemoglu & Robinson, 2004: 4). Throughout the analysis, political institutions will be considered through the regime type. That is, when referring to political institutions, we will be discussing on the three regime types analyzed: The military regime of the 1970s (dictatorship), The neoliberal period 1980s- 2000s (democracy), and the Socialist regime of 21 st century (democracy). When referring to economic institutions, we will be discussing on the State Petroleum Company. 7 According to Acemoglu & Robinson, countries differ in their economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people (2012: 73).

25 Petroleum in Ecuador: The Management of Natural Resource Wealth 25 On the other hand, political institutions determine the distribution of power and resources in a society; these institutions are the rules that determine incentives in politics. They determine who has power in a society and to what extent this power can be exerted. More precisely, political institutions determine the constraints on the use of de facto and de jure political power 8 ; they also determine who holds de jure power (Acemoglu et al., 2004: 10). De facto political power depends on the economic resources a group/elite has, which determines the group s capacity to use or misuse existing political institutions (Acemoglu et al., 2004: 4) Consequently, those who exercise this power are able to set up economic institutions of their preference 9 (Acemoglu & Robinson, 2012: 80). Thus, based on the distinctive features of both economic and political institutions, they need to be separated into two categories: inclusive and extractive institutions (Acemoglu & Robinson, 2012). On the one hand, inclusive economic institutions pertain to the type of institutions that promote productivity growth, economic activity, and economic growth. This type of institutions guarantees opportunities not only for economic and political elites but also to the broad population of society. Inclusive economic institutions provide a playing field in which people can exchange and contract. Furthermore, they distribute power and wealth in such a manner that it becomes very difficult for other groups to destabilize the foundations of inclusive institutions (Acemoglu & Robinson, 2012: 74-79). They tend to persist when there are limited rents that elite can extract, since those rents would lead to economic institutions that make expropriation possible (Acemoglu et al. 2004: 10). In other words, once they are already set in motion, it is difficult to turn its structure around. In turn, inclusive political institutions tend to displace economic institutions that put entry barriers, repress the proper functioning of the market, and expropriate the resources of society (Acemoglu & Robinson, 2012: 81). 8 De facto political power is the ability of social groups to solve their collective action problem, lobby or bribe politicians, capture control over political parties, and use other means of repression Acemoglu & Robinson, 2006: 56). On the other hand, de jure political power pertains to the power that is originated from the political institutions of the country (Acemoglu et al. 2004: 4). 9 When the distribution of power is narrow and unrestrained, the political institutions are considered absolutist. Conversely, when the power is distributed broadly and subject to constraints, political institutions are considered pluralistic (Acemoglu & Robinson, 2012: 80).

26 Petroleum in Ecuador: The Management of Natural Resource Wealth 26 On the other hand, political extractive institutions are considered to lead to negative development outcomes. This type of institutions vests power, that is almost unrestrained in the hands, of a narrow elite 10. In turn, this elite group arranges a dominant apparatus that reaps the benefits from extracting resources at the expense of the rest of the population. Therefore, extractive institutions tend to exacerbate social tensions due to excessive concentration of power and wealth in the hands of the very few (Robinson, 2013: 2). Extractive economic institutions, in effect, accompany extractive political institutions. Essentially, extractive economic institutions depend on the extractive political institutions for their continued existence (Acemoglu & Robinson, 2012: 81). The synergistic dynamic between extractive political and economic institutions allow the elites who possess political power to set up economic institutions with few constraints or dissenting forces; it also enables elites to arrange future political institutions and their evolution. In turn, extractive economic institutions enrich 11 elites, and with elites wealth and power, the consolidation of their political dominance is facilitated (Acemoglu & Robinson, 2012: 81). This implies a persistence of both extractive political and economic institutions. Two sources of persistence stand out: first, the size of the elite de facto political power, which enable it to push for a favorable arrangement of political and economic institutions. Second, political institutions are long lasting, and a very substantial change in the distribution of power is required to change political institutions (Acemoglu et al. 2004: 6). However, it is worth noting that though slowly and with difficulties, political institutions do change. Countries transition from dictatorship to democracy and change their constitutions to adapt the constraints on power holders (Acemoglu et al., 2004: 5). Changes in political institutions, have effects over the distribution of de jure political power (Acemoglu & Robinson, 2006: 56). Nevertheless, the political advantage created by a democracy for the citizens may 10 The narrower the elite is, the more cohesive it is and the more likely it will be able to set up the institutions its members favor (Acemoglu, 2006: 2). 11 Acemoglu & Robinson (2012) refer to these phenomena as vicious cycles and virtuous cycles. The former being the case highlighted above, whereas the latter being the case where inclusive political institutions lead to the formation of inclusive economic institutions that encourage prosperity and prevent efforts from elites to undermine institutions (see ch.11 & 12).

27 Petroleum in Ecuador: The Management of Natural Resource Wealth 27 lead to a greater domination of politics by the elite (Acemoglu & Robinson, 2006: 4). The reason for this is that democracy creates a future cost for the elite. Hence the elite will take actions in order to increase their de facto power and in this manner avoid this future cost. Furthermore, the political elites and the oligarchy are involved in the same democratic system 12. That is, the interaction between the two forces generates the recurrent existence of elites with oligarchic traits 13 (Perez, 2013: 26). In every country however the divergent historical events and social structures translate in differences in the nature of the elites in power and the features of the extractive institutions in place. Even in a society structured by economic extractive institutions, economic growth can be achieved in two manners. First, it can occur when the elite can allocate resources to highly productive sectors of the economy that they control. Secondly, it can occur when extractive political institutions allow the establishment of to some extent inclusive institutions (Acemoglu & Robinson, 2012: 91). However, due to the unfavorable conditions that extractive institutions inflict on the economy, this type of growth will likely occur solely in the short term. Long- term sustainable growth will only be achieved through inclusive institutions that create the necessary incentives to invest in physical and human capital accumulation- - necessary factors for prosperity (Acemoglu et al., 2004: 31). Consequently, without the proper set of institutions in place, independently of endowment factors, a society is very unlikely to experience substantial development in terms of economic and human development (Rodrik, 2003: 33). Therefore, in the context of this research, inclusive political institutions will be defined as institutions that are effectively centralized and sufficiently pluralistic 14 (Acemoglu & 12 The difference between political elites and the oligarchy is that in the former there is a tacit compromise on the ideological interests of those who assume public office sponsored by a political party. While in the latter, its commitment is based and strengthened in the condition of its social class rather than in its ideology (Perez, 2013: 26) 13 The oligarchy can settle in a society because its production model is controlled under the local autonomy that is territorially fits this economic group and whose industry is linked to the most advanced countries of the world. And what the state does, is to keep the availability of resources for those who manipulate them. In this manner, in South America the oligarchy has been key to recognize the economic power that is composed by: foreign companies, the state, and private capital (Rosero, 2013: 29-30). 14 Pluralism in the context of this theoretical framework will be regarded as a component of democracy under which diversity or plurality of opinions exists and where the interests of different groups of society are taken into account within the political system (see, Konrad- Adenauer- Stiftung, 2009: 17). It also refers to power that is

28 Petroleum in Ecuador: The Management of Natural Resource Wealth 28 Robinson, 2012: 81). By centralization we mean the state has sufficient power its role as enforcer of law and order and encourage and regulate economic activity. Lack of political centralization reflects not only lack of law and order but also a system where many actors have sufficient power to disrupt the functioning of the system 15 (Acemoglu & Robinson, 2012: 80, 87). By pluralistic we mean a power that is not vested in a single individual that is power that is vested in a broad coalition or a plurality of groups in society (Acemoglu & Robinson, 2012: 94). When either of these two conditions falls short, political institutions will be considered as extractive. Therefore, qualitatively, with these criteria we will look at the political system (regime type), its principal actors (political elites and oligarchy), and the policy management of the oil sector. Also, when available, quantitative data will be used from the worldwide governance indicators in order to support the qualitative insights 16 ; we will look at voice and accountability, political stability, government effectiveness, and control of corruption 17. Moreover, inclusive economic institutions will be defined as those institutions that provide secure property rights and relatively equal access to economic resources to a broad cross- section of the population 18. Ultimately, in societies where only a small segment of the not vested in a single individual or a narrow group that is power is vested in a broad coalition or a plurality of groups of society (Acemoglu & Robinson, 2012: 80). 15 The foremost barrier to political centralization is fear from change since any power holder group trying to centralize power in the state, will be also centralizing power in its own hands (Acemoglu & Robinson, 2012: 87). Notably, political centralization is crucial for growth under extractive political institutions (Acemoglu & Robinson, 2012: 94). Notably, centralization is only possible when a group has more power than others to build a state. 16 The worldwide governance indicators (WGI) are a dataset that summarizes the views on the quality of governance. The WGI reports six aggregate indicators that include: voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption (see 17 The conceptualization of the WGI goes as follows: Voice and accountability: captures perceptions of the extent to which a country s citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and free media Political stability: measures perceptions of the likelihood of political instability Government Effectiveness: captures perceptions of the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government s commitment to such policies Control of Corruption: captures perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as capture of the state by elites and private interests (WGI, 2015) see (