When the outbreak of the debt crisis in 1982 halted private international capital flows to most developing countries, it was not easy for Ecuador to cope with the changed international circumstances. Investments were largely in imported machinery as domestic capital goods production was in its infancy. Exports were concentrated in petroleum and several agricultural products and could not be counted on to increase foreign exchange in the short run. The trade balance was improved in the first half of the 1980s by reducing imports. The author examines the behavior of the Ecuadoran economy in a period of scarce foreign exchange. He uses a small, econometrically specified"trade and growth"model of the Ecuadoran economy to illustrate the importance of trade elasticities. He estimates trade elasticities for Ecuador and integrates them into a small simulation model of Ecuador's supply side. He uses a nested constant-elasticity-of-substitution production function to derive factor input demands for two types of imported goods important in Ecuador: imported intermediate goods and imported machinery. Elasticity estimates of imported factor of production are very low. They characterize both types of imports as complements to domestic factors. The author uses the econometrically specified model to examine the connection between imported factors of production and output capacity. He analyzed trade balance responses to a terms-of-trade shock, a devaluation, and an increase in world demand. Low trade elasticities on the import side make the economy vulnerable to external shocks. The low elasticities necessitate large relative price shifts (through devaluation) to improve the trade balance if growth-reducing policies are to be avoided in times of scarce foreign exchange. A deterioration in terms of trade has a pronounced negative impact on the trade balance. To the extent that trade elasticities remain low in the 1990s, events such as a commodity price decline, a renewed credit squeeze, or increased protectionism against Ecuadoran exports - like the recent European Union quotas on banana imports - can translate into renewed domestic supply disturbances. Policies that lead to diversification of exports and higher price responsiveness for both imports and exports would reduce the vulnerability of Ecuador's economy to external shocks.
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