The effect of dollarization on the policy space of policymakers : how is dollarization affecting the policy space of local policymakers in officially dollarized and semi-officially dollarized nations?

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The effect of dollarization on the policy

space of policymakers

How is dollarization affecting the policy space of local policymakers in

officially dollarized and semi-officially dollarized nations?

Tim Beckers (10554971)

The changing global economic order: rising powers and growing risks

Master thesis Political Science

Specialisation in Political Economy

Supervisor: Jasper Blom

Second Reader: Sebastian Krapohl

22399 words

21-06-2019

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Acknowledgements

Before I will start my master’s thesis, I would like to write a few thank words to the people who helped me make this possible. First, I would like to thank my colleagues, Michelle Turney, Kelvin Chua

and Abel Ghacham, for putting much time and effort in helping me to get my interviews. I also would like to thank Long Vibunrith for the interview I had with him, providing me valuable information for

my thesis. I also want to thank my friends for supporting me during my master’s and during this thesis, they were always there to support me during the good and the bad times. Finally, I would like

to thank my mother. Throughout my bachelor’s and master’s degree she has always supported me, and has read and corrected many of my papers, including this thesis, over the years. I would like to thank her for all the hours she spent on correcting my weird sentences and grammar mistakes, as well as supporting me everywhere she could. Without her, I am not sure that I would have been able

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1. Introduction

There are few things that are as globally distinguishable as U.S. dollar banknotes. Since commodities like oil, gold, and agricultural products are mostly traded in U.S. dollars (which attributes to the fact that nearly 70% of the world’s trade is commerced in U.S. dollars), it should come as no surprise that the U.S. dollar is not only recognisable around the world but also used and accepted for day-to-day transactions in many countries. Therefore, due to the dollar being the most important currency in international trade, many countries have no other choice than to trade in U.S. dollars in order to stay connected to the global economy (Norrloff 2014, Mccauley, et all 2015). This can prove challenging for nations, especially ones with strong fluctuations in exchange rates between their domestic currencies and the U.S. dollar. Yet for the United States, having the most predominant currency in the world’s economy has generated enormous amounts of power that reaches beyond its borders throughout all parts of the world (Norrloff 2014, Mccauley, et all 2015).

While the U.S. dollar plays a very dominant role in the world economy, some domestic markets trade nationally in U.S. dollars by using the U.S. dollar as a source of payment or as a store of value and therefore replacing the domestic currency. This replacement of a domestic currency by a foreign currency in an economy is called currency substitution (Corrado 2008: 70). In these countries, a foreign currency (often the U.S. dollar) takes over some of the functions of the domestic currency. Nevertheless, there are different levels or stages in which a foreign currency can replace a domestic currency, countries’ economies can be described as dollarized once the U.S. dollar has become a vital facet of their function. Having one’s own currency has always been one of the hallmarks of nationhood (Hymans 2010; Raento et al 2004; Unwin and Hewitt 2001). Through things like currency and stamps, countries can portray to domestic and international audiences their values, ideals, ideologies, and aspirations as a state (Hammett 2014: 901). However, throughout history, many countries have given up this hallmark, their individual currencies, in order to create currency unions (Alesina and Barro 2001: 381). Examples of this are the CFA-franc in West and Central Africa, the Eastern Caribbean Currency Union, and more recently the euro within the European Union.

In some cases, countries decide not to form currency unions but rather to substitute their domestic currency with a foreign one altogether. This happened, for example, when Liechtenstein adopted the Swiss franc or when Luxembourg adopted the Belgian franc. Within the last twenty years, we still see this phenomenon in countries like Ecuador and El Salvador which have completely adopted the U.S. dollar as their national currency (Beckerman and Solimano 2002: 1). This is something that the literature describes as official dollarization (Mack 2000: 353). However, not all countries completely give up their national currencies. For example, Cambodia extensively uses the U.S. dollar within its

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domestic economy. U.S. dollars are accepted virtually everywhere and are even dispensed through ATM machines throughout the country, though they still maintain the Cambodian riel as their national currency. This is described in the literature as semi-official dollarization, (Mack 2000: 353).

Dollarization can be problematic to a country’s sovereignty. Within sovereign states, national governments can implement laws and regulations within their own borders without the interference of another actor (Krasner 1999). In literature, there is a clear relationship between dollarization and a country’s monetary sovereignty. In this thesis, the scope of the sovereignty of this monetary policy will consist of the right to create money; the right to conduct monetary and exchange rate policies; the right to decide upon the appropriate amount of current and capital account convertibility; and the organisation of financial regulation and supervision (Zimmerman 2014: 1). The tension that exists between dollarization and a country’s sovereignty arises from the lack of policy space national policymakers have due to dollarization (Cohen 2003; Minda 2005; Salvatore, et all 2003; Mack 2000). According to Jácome and Lönnber (2010) central banks in dollarized nations become powerless (no policy space), since they no longer have the proper tools or policy space to implement monetary policies.

In this thesis, I will argue that dollarized nations still hold some policy space, however, the availability of these tools varies per type of dollarization. In the literature, there is a clear distinction between three types of dollarization: unofficial dollarization, semi-official dollarization, and official dollarization (Mack 2000, Meyer 2000 and Ra 2008). Whilst in all three types dollarization is affecting the ability to make independent monetary policies (the policies in these countries, which I will call policy space), remained unclear to what extent. In this paper, I will analyse four different monetary policy mechanisms (the seigniorage mechanism, the monetary policy mechanism, the foreign trade policy mechanism, and the income distribution mechanism) and how they are affecting the policy space of policymakers in dollarized countries.

To generate a better understanding of how the different types of dollarization affect the policy space of local policymakers, I will perform a case study of an officially dollarized nation (Ecuador) and a semi-officially dollarized nation (Cambodia). It is not my aim to prove that there is a difference between the two - since semi-officially dollarized nations innately have more policy space than officially dollarized nations - but to explain how these four mechanisms work through distinguishing how the effects of these four mechanisms differ from one another in both cases. In the end, I intend on contributing to the dollarization debate through my analysis between the policy space of semi-officially dollarized and semi-officially dollarized nations while aiming to answer the following research question: How does the implementation of dollarization affect policy space of policymakers in

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What stands out in the literature is how in many dollarized countries there is a constant debate over how to cope with dollarization. This is also the case in Cambodia and Ecuador where dollarization is heavily debated, and this is another critical reason why I have chosen these two countries. In Cambodia, for example, there is an ongoing debate as to whether the government should reduce dollarization within the domestic economy in favour of the Cambodian riel (Sothear 2016, Connor 2017, Kimsay 2018 and Kang 2005). Whilst in Ecuador, the debate is focussed on whether the Ecuadorian government should re-issue its own currency and therefore reverse the dollarization of 2000 (Berríos 2006 and Jameson 2003). Through my analysis and study of the different types of dollarization, I will contribute and add to national debates such as these by not only describing how dollarization is affecting these nations - for better or worse - but by additionally identifying what mechanisms national policymakers still have at their disposal once operating within these dollarized-frameworks. Only through better comprehension of how dollarization directly affects nations can one begin to see how much a dollarized nation is still able to control or regain control of their policy space. By way of this, it should become clear as to whether de-dollarizing would be the most beneficial choice nations such as these could make.

In order to answer this question, I will take the following steps. First, I will elaborate on dollarization, explaining what it is and what the debate concerning its impact is. Secondly, I will conceptualise dollarization and ‘policy space’, and then I will describe how these countries became dollarized by providing a background story about both Cambodia and Ecuador. Following this historical overview, I will analyse the current situation in both countries. Finally, in the conclusion, I will describe how these four mechanisms, if any, differ, are creating the difference in the amount of policy space in officially dollarized and semi-officially dollarized nations. I will do this by performing a comparative case study in which I will outline a total of four different mechanisms that stand out most predominantly amongst the literature and my analysis: the seigniorage mechanism, the monetary policy mechanism, the foreign trade policy mechanism, and the income distribution mechanism. Throughout my paper I will attempt to synthesize the following sub-questions in order to guide my thought:

• In what way does semi-dollarization affect Cambodia?

• How do the four mechanisms influence the policy space of policymakers in Cambodia? • In what way does official dollarization affect Ecuador?

• How do the four mechanisms influence the policy space of policymakers in Ecuador? • What is the difference in the effect of the four policy mechanisms in officially dollarized nations

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By answering these questions, I aim to describe the effects of the four mechanisms on the policy space of policymakers in dollarized nations. Finally, I will conclude that all four mechanisms explain the differences in the amounts of policy space between policymakers in semi-officially dollarized nations and officially dollarized nations. Three of the mechanism (the seigniorage mechanism, the monetary policy mechanism, and the foreign trade policy mechanism) explain why policymakers in semi-officially dollarized nations have more policy space than in officially dollarized nations. The fourth mechanism (the income distribution mechanism) actually shows that policymakers in officially dollarized nations have more policy space, than policymakers in semi-officially dollarized nations due to this mechanism. However, I will conclude that, when combining the effects of all four mechanisms together they clearly show and explain why policymakers in semi-officially dollarized nations still have more policy space than policymakers in officially dollarized nations.

2. Theoretical framework

2.1. Understanding dollarization

In the heart of dollarization lies a political economic debate, since it is a political choice whether a country’s economy is dollarized or not (Frieden 2001: 2-4). Discussion about dollarization usually concerns the internal debate between having a fixed exchange rate for anti-inflationary credibility, and the countervailing value of a flexible exchange rate to allow monetary policy to respond to exogenous shocks (Frieden 2001: 308). When reading Frieden (2001), it becomes clear that the Mundell-Flemming trilemma lays in the centre of this debate. This trilemma tells us that a country can only accomplish two of the following three things: financial integration, exchange rate stability and monetary autonomy (Aizenman 2010: 2). Dollarization revolves around this trilemma and making this decision is not only an economic choice, but also a political one. When studying dollarization, one should understand the political and economic trade-offs and their weighing in the political process (Frieden 2001: 2-4). In the end, a government decides whether to go through with dollarization or to keep its own currency. When choosing dollarization, countries choose for financial integration and exchange rate stability but must give up their monetary policy. In this paper, I will analyse how much of this monetary policy countries must give up. Therefore, I will argue that dollarization is a political choice of a national government. This chapter will be structured as follows. First, I will explain briefly the history of exchange rate policies and conceptualise what dollarization is. Then I will argue that there are three different types of dollarization: unofficial dollarization, semi-official dollarization and official dollarization and explain how these types differ from each other. Finally, I will explain why dollarization occurs, and explain what the main causes are. This will give this paper the guidance on what

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dollarization is and how it will be conceptualised throughout this paper.

The question of whether to dollarize or not, starts with the question of what kind of exchange rate regime to follow and what is best suited for a specific country. This has long been debated between economists, politicians, and policymakers (Salvatore at all 2003: 3). In 1945, this discussion led to the introduction of the Bretton-Woods system, in which most free-market floating currencies were pegged to each other. However, in 1973, this system collapsed and countries had no other choice than to use a (somewhat) free-floating system. In 1979, most Western-European countries decided to introduce the European Exchange Rate Mechanism (ERM), which meant going back to a fixed exchange rate regime (Iannizzotto 2001: 511). At the same time, there was an extensive debate about what to do with the exchange rates of the countries outside of Europe. In the 1980s, the IMF decided that other countries would be best served by fixed, or at least strongly managed, exchange rate policies. This was opted to reduce instability and generate a more stable world economy (Salvatore, et all 2003: 3). Opponents of this opted for fully flexible exchange rates, which would be more beneficial, since fluctuations in exchange rates could function as a buffer against exogenous shocks such as foreign inflation (Salvatore, et all 2003: 3).

Once again, the trilemma plays an important role in this. When lifting the trilemma to the world’s economy, countries can only have two of the following things: a pegged exchange rate, capital mobility, and monetary independence (Bleaney, et all 2013: 878). There is a debate on which combination is best for most countries. On the one side, there is the argument that pegged exchange rates are a recipe for a crisis (Salvatore, et all 2003: 3). There is such high capital mobility in the current financial system, that pegs are difficult to manage. Therefore, most countries have adopted a more free-floating exchange rate policy over the years. On the other hand, certain areas have decided to fully eliminate all exchange rate risks by adopting the same currency; the most extreme example is the introduction of the euro in 2002, therefore setting monetary policies for a number of countries instead of a single country (Bleaney, et all 2013: 878-879). Dollarization is an example of eliminating exchange rate risks by adopting one’s other currency (Shi and Xu 2010). What makes dollarization so interesting is, that a country adopts another countries currency, therefore giving up their freedom to make its own policies (Cohen 2003; Minda 2005; Salvatore, et all 2003; Mack 2000). Dollarization creates a different tension between monetary policy and policymakers, than in places where more countries decide to introduce a new currency (like the euro), since policymakers in a place like the eurozone have the mandate to create monetary policies that are best in line with the interests of the eurozone as a whole (Blot et all 2014). In a dollarized nation this is not the case. For example, Ecuador is officially dollarized and therefore it must follow the monetary policy of the Federal Reserve. The Federal Reserve has no mandate to keep Ecuador’s best interests in mind (Zarazaga 2001). Therefore, these

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countries must give up much more of their monetary freedom than a country in the eurozone. The decision whether to dollarize lies in the trilemma just discussed and it is a political-economic debate. When we zoom in on dollarization, I first need to make clear what dollarization is. I will follow the conceptualisation of Mack (2000: 353): Dollarization occurs when residents of a country extensively use foreign currency, usually the U.S. dollar, alongside or instead of the domestic currency. This is a rather broad definition, because using a foreign currency comes in many shapes and sizes. The most important distinguishing factor is, that it can happen officially, when a country’s government and central bank accept dollarization and actively support it, by providing all necessary services. Or unofficially, when there is no official legal consent about the use of a foreign currency within a country’s borders (Mack 2000: 353). In this thesis, three different types of dollarization will be distinguished:

Unofficial dollarization: Unofficial dollarization occurs when people hold a large amount of their wealth in foreign assets, in a currency, which is not the domestic currency (Mack 2000: 353). Unofficial dollarization covers both legal and illegal forms of dollarization. In some countries, it is not a problem to hold bank accounts or savings in foreign currencies, while in other countries this is strictly regulated. Also, some countries allow their currency to be freely traded in the market, while others have strong limitations. These limitations can be implemented in a country’s financial system but can also imply that citizens are not allowed to convert cash freely in their home countries. Some of the largest economies in the world still have these kinds of restrictions. India and South Africa, for example, have very strict currency regulations, and their citizens can only legally obtain cash foreign currencies when they are able to prove that they are traveling abroad (Reserve Bank of India: 2019).

Unofficial dollarization can include holding any of the following (Mack 2000: 354): • Foreign bonds and other non-monetary assets, generally held abroad; • Foreign-currency deposits abroad;

• Foreign-currency deposits in the domestic banking system; • Foreign notes (paper money) in wallets and under mattresses.

Unofficial dollarization typically occurs in stages that correspond to the textbook functions of money as a store of value, means of payment, and unit of account (Mack 2000: 354). Šonje (2002: 3) argues that unofficial dollarization reflects citizens perceptions of the stability of the domestic monetary regime, the credibility of monetary policies and the perceived stability of the domestic banking system.

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Economists describe three stages of this unofficial dollarization, which explains how it is occurring. The first stage is asset substitution. Asset substitution occurs when people convert their assets into something that they trust more. In this case, it means that people convert their domestic currencies into foreign currencies in order to protect themselves from losing wealth. Losing their wealth can be caused by high inflation, or large exchange rate fluctuations (Feige: 2003). Countries that have some form of unofficial dollarization are countries like Argentina, Brazil, Nigeria, but also countries like Russia (Duff, et all 2005: 2).

The second stage of unofficial dollarization is currency substitution. This occurs when the public holds large amounts of foreign currencies within their bank accounts (if permitted) or in banknotes and actively uses these foreign currency assets within the domestic economy (Whited 2004, Feige and Dean 2004). This means that people can use foreign currency to pay for their daily expenses, instead of the domestic currency. However, the foreign currency is

not legal tender within the country’s borders. In the third and final stage, people think that the

foreign currency and prices of goods are determined by the exchange rate between the two currencies (Mack 2000: 354). Countries in this category are countries like Guatemala. Unofficial dollarization is hard to measure, because it is difficult to know how much foreign currency reserves people hold in their bank accounts or in cash. Therefore, it is hard to completely grasp the effect of dollarization in these types of economies. In the latest study, I found that the Federal Reserve estimates that about 60% of all U.S. cash and 75% of all 100 U.S. dollar bills are abroad. This means that there is about 0,9 trillion of U.S. dollars cash circulating in other nations (Judson 2017: 8).

Semi-official dollarization: Semi-official dollarization is characterised by the mix of the use of domestic and foreign currencies (Mack 2000: 355, Meyer 2000). In these types of economies, a foreign currency plays a large role and is accepted in many cases in daily transactions. Semi-official dollarization has much overlap with unSemi-official dollarization. What differentiates it from unofficial dollarization is, that the foreign currency is legal tender. These countries actively support a bi-monetary system, which is officially implemented.

However, they have not fully adopted a foreign currency; the domestic currency still plays an important role and is not completely pushed away by a foreign currency. We see many cases of this in South America and the Caribbean, mostly due to the importance of American tourism to these countries. Unlike officially dollarized countries, semi-officially dollarized countries maintain their own currencies and have a central bank that manages and controls a domestic currency. Countries in this category are, for example, Aruba, Haiti, Barbados, Cambodia, which all use the U.S. dollar. However, also other currencies can ‘dollarize’ nations.

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Examples of this are Bhutan (Indian rupee), Brunei (Singapore dollar) or Lesotho (South African rand) (Mack 2000: 356). These countries still have their own currencies; in many cases they are pegged to a foreign currency. Therefore, there is no fluctuation in exchange rates, which makes it easy for anyone to accept both currencies. In Barbados, for example, the rate between the US dollar and the Barbadian dollar (BBD) is 1 USD : 2 BBD, making transactions in both currencies easy for anyone.

Official dollarized countries: The last category of dollarization is the officially dollarized countries (Mack 2000, Bogetic 2000). These countries have completely adopted the use of a foreign currency within their own economy. This means that a foreign currency is used as the sole legal tender. Not only does the public actively use a foreign currency in their day to day transactions, but the government itself uses foreign currency to pay its people and its debts. Countries have the option to choose for one currency, but some even choose to adopt several currencies, like Zimbabwe (Buigut 2015). Countries that are officially dollarized, are countries like Panama, East-Timor, Nauru and Ecuador. We also find them in Europe: Liechtenstein, Andorra and Montenegro are all officially dollarized countries, even though they use a different currency, in this case, the euro.

Whilst I already briefly explained how dollarization occurs in its different forms, I will shortly explain the main reasons why nations dollarize. Historically, dollarization of a country’s economy has been a response to economic instability and high inflation (Berg and Borensztein 2000: 3). Especially in times of hyperinflation, the public turns to the use of alternative, stronger currencies to the extent of what is possible. Elaborating on this, Honig (2009) argues that dollarization occurs when citizens of a country no longer have faith in policies created by its governing institutions (Honig 2009: 198). Dollarization originates from a strong distrust in domestic currency and the monetary policies that are created in order to keep exchange rates stable and that promote long term currency stability (Honig 2009: 198). When this trust is lacking, the likeliness of people looking for alternatives to keep their savings and their wealth safe is much higher, which can create a strong demand for foreign currencies which are expected to hold their value better over time. As mentioned earlier, dollarization is a political choice; the type of dollarization these countries face is determined by national political actors. Some countries decide to accept dollarization by formally adopting and supporting it, resulting in semi-official dollarization or official dollarization, depending on a country’s choice. Other countries chose not to embrace dollarization, therefore facing unofficial dollarization (Frieden 2001: 2-4).

Dollarization predominantly takes place in developing countries, since these countries usually face more political and economic instability. Furthermore, developed nations usually have long-standing records of keeping their currencies somewhat stable (Honig 2009: 199). The performance of

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semi-official and unofficial dollarized economies has been highly variable but largely unimpressive (Mack 2000: 356). One of the main reasons is, that their domestic currencies still plays an important role in the domestic economy. These local currencies are often unstable and hamper economic growth by causing high inflation amongst other problems (Mack 2000: 356). Officially dollarized nations, however, usually outperform developing nations that still hold their own currency (Schuler 1996). In the end, the most important reason why countries dollarize, is the need to reduce risk and the lack of trust that citizens have in the country’s own currency and monetary policy. Citizens convert their local currencies into ‘hard’ currencies, because they do not trust their domestic currencies enough as they are afraid that their value will decline. Therefore, they seek the solution in other currencies. This can lead to the point in which a foreign currency plays an active role in the day to day payments by the public. When this happens, one can slowly expect an economy to further dollarize. The type of dollarization that will be created, depends on local policymakers. When they actively support dollarization, countries will become semi-officially or officially dollarized nations; when they are unsupportive, this will lead to unofficial dollarization.

I am aware that there is an important part missing in the literature review: the part in which I explain the 4 mechanisms which I will discuss. However, I have decided to incorporate their conceptualisation within my analysis in order to have a better flowing argument. Therefore, I will now continue with the necessary background on dollarization in Cambodia and Ecuador, in order to get a better understanding of the causes that lead to dollarization in both nations.

2.2. Understanding policy space

Whenever a government tries to make changes in its policies or strategies, in order to stimulate economic development or trade, institutional change is almost always required (UNCTAD 2014: VII). Markets inherently have a certain framework of rules, norms, and restraints in order to function effectively, and because of how deeply markets are embedded in society legally, socially, and culturally, they are sustained and monitored by their respective political forces (UNCTAD 2014: VII). How and to what extent these frameworks are developed and revised, in order to better comply with a society’s needs, depends on the society in which the framework exists. Political forces make decisions on how the implementation of certain rules contribute to things like economic growth or prosperity in welfare, adjusting the framework to their collective liking and desired outcome; however, since nowadays national economies are intertwined into a much larger constellation of international economies, international markets - exactly like domestic markets - require their own framework of rules, norms, and restraints in order to function effectively (UNCTAD 2014: VII). Therefore, this limits how much a national government can adjust their own framework today once operating within an international network of economies. This is especially true since most countries are members of large

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international organisations such as the IMF, WTO, and the World Bank, for example, all of which have their own framework by which their members must adhere to.

Rodrik (2004) wrote extensively about how policy space and international organisations work together. Because of these two different frameworks (a domestic and an international framework), there is tension between the two (Rodrik 2004: 35). National governments who wish to implement new policies that are not in line with international policies; countries may want to implement certain tariffs on a product, in order to stimulate the domestic economy. Therefore, countries need to make the decision how much of their independence they are willing to trade for the access to the global economy and the support in economic development and growth that this potentially gives (UNCTAD 2014: VII). This can be prohibited by an institution like the WTO. Because of this, countries only have a limited ‘space’ in which they can make new policies and adjust their framework. This is the policy space governments have. According to Rodrik (2004), this can be problematic. Since these countries are forced to implement certain policies that are not in line with their own best interests. Rodrik (2004) argues that developing nations should be allowed more policy space in order to fulfil their own wishes. In order to define this policy space, I will use two definitions in order to see the overlap between the two. The first one is of the UNCTAD (2014), an institute of the United Nations. The other is from Kentikelenis, Stubbs and King (2016). Kentikelenis, et all (2016) define policy space as follows (I have underlined the most important aspects of their definition): We understand policy space as a

government’s ability to select the policy instruments via which they address their economic problems, free from coercive conditionalities (Kentikelenis, et all 2016: 547). The UNCTAD (2014) defines policy

space as: this refers to the freedom and ability of governments to identify and pursue the most

appropriate mix of economic and social policies to achieve equitable and sustainable development in their own national contexts, but as constituent parts of an interdependent global economy. It can be defined as the combination of de jure policy sovereignty, which is the formal authority of policymakers over their national policy goals and instruments, and de facto national policy control, which involves the ability of national policymakers to set priorities, influence specific targets and weigh possible trade-offs (UNCTAD 2014: VII). When reading these two definitions, there is a clear overlap between the two.

They both mention the importance for a country to have the instruments through which it can make policies that are best in line with the domestic needs. Also, they both highlight the importance of the sovereignty of policymakers, and how they should be able to do so without external interference. However, the definition of the UNCTAD (2014) further elaborates on this, by adding the fact that this is restrained by the fact that countries are not independent entities in the world economy; they are bound to an international framework. I believe that this is a point that cannot be ignored in this case, since countries are so interdependent in the global economy. Much of the debate concerning policy

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space, revolves around the tension between economic development and the ability of countries to implement national policies in international cooperation, as describe by Rodrik (2004). In order to successfully cooperate, standards are set by institutions like the IMF, World Bank but also the European Union. The debate is mostly focussed on the relationship between economic integration in the world economy and the implementation of national policies. For countries to be able to cooperate and trade together, they will have to find a way of synchronisation of policies, which will allow them to streamline trading and effectively participate in the world economy. McKinnon and Cooper (1968: 1450) wrote the following about this tension: The central problem of international cooperation - and

of this book - is how to keep the manifold benefits of extensive international economic intercourse free of crippling restrictions while at the same time preserving a maximum degree of freedom for each nation to pursue its legitimate economic objectives.

This mostly concerns developing nations, which have less of a voice in the international economic order. The UNCTAD argues that this can be a problem: What is needed therefore is a globally

coordinated strategy of expansion led by state expenditures, with intervention that guarantees some policy space to allow all countries the opportunity of benefiting from the expansion of their domestic and external markets (UNCTAD 2017: 19). Furthermore, they argue that one of the main reasons the

level of policy space is limited to developing nations, is due to dollarization (UNCTAD 2017: 15). Dollarization reduces a country’s ability to control its own policies since it will have to comply with policies that are created in the countries who have the sovereignty over this currency. This makes clear that dollarization leads to a reduction of policy space, in this thesis I will explain how this works. In summary: When looking at policy space and the earlier definitions, I believe the definition of the UNCTAD (2014) makes it clear where the problem lies. As mentioned in the part of dollarization, countries are losing their de jure policy sovereignty. In the end, this means that they will have to give up their de facto national policy control. This is where the problem lies which Rodrik (2014) also discussed. Countries must give up their policy space and they have no other option than to comply with policies, created by and created for, other nations. These countries’ institutions have the mandate to create policies that are best in line with their own interest. Therefore, they are not free to make policies free from coercive conditionalities as mentioned by Kentikelenis, et all 2016. Dollarization plays a crucial part in this, since dollarization creates all kinds of coercive conditionalities which dollarized nations must comply with, since dollarization requires national policymakers to follow various policies set in different nations, which may not be in the best interest of this nation. However due to dollarization, they have no other choice than to follow these policies. This area of tension is crucial in this paper and I will describe how this works on the hand of my four mechanisms.

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3. Methodology

3.1. Overall approach

The main goal of my paper is to understand how the different ‘dollarization policy mechanisms’ affect the policy in dollarized nations. I will do this based on four different variables, or mechanisms, as I will call them. After studying the literature on dollarization and its relationship with policy space, the four most important policy mechanisms that I have found are: the seigniorage mechanism, the monetary policy mechanism, the foreign trade mechanism, and the income distribution mechanism (Mack 2000, Kang 2005, Menon 2008, UNCTAD 2014, Kentikelenis, et all 2016, various IMF article IV reports). In my analysis, I want to make clear how the mechanisms (X) affect the policy space of policymakers in semi-officially dollarized and semi-officially dollarized nations (Y). I will do by conducting a case study, in which I will be analysing two cases (N=2): one of a semi-officially dollarized nation (Cambodia) and one of an officially dollarized nation (Ecuador). I have decided not to incorporate an unofficially dollarized nation in my analysis, since these countries do not support dollarization. Therefore, understanding the impact of dollarization will be much more speculative. The level of dollarization is rather unknown in these countries, since it is hard to understand the level of dollarization. In the semi-officially and officially dollarized nations, policymakers are actively dealing with dollarization, therefore, the effects of dollarization are clearer. For this reason, I will focus on the differences between semi-officially and officially dollarized nations in this thesis.

I have decided to focus on two diverse cases, since I will study four different variables (mechanisms) (Gerring 2001). The first is a semi-officially dollarized nation (Cambodia) and the other an officially dollarized nation (Ecuador), according to Gerring (2001) this will give me a clear overview of the differences (Gerring 2001: 88). Gerring (2001) argues that we need to know similarities, which are sometimes even very different, in order to understand what we are talking about. Therefore, in order to get a proper understanding of ‘how things work’ a descriptive comparative research design will suit this research best. I will study both cases separately and describe how the mechanisms affect the policy space of national policymakers. After that, I will describe what the differences in the effects of the mechanisms are, in order to create a better understanding of how these mechanisms affect the policy space of national policymakers in the two types of dollarization and how they differentiate from each other.

As discussed earlier, my analysis will consist of the same parts in both case studies. First, I will get to the background of dollarization in both nations. With this background, I aim to give a better understanding of why these countries are dollarized and how it is affecting them. I will discuss the causes of dollarization (history), the current status of dollarization (present) and their current strategy on dollarization (future). After that, I will get to the four mechanisms which I call: the seigniorage

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mechanism, the monetary policy mechanism, the foreign trade mechanism and the income distribution mechanism. I will also incorporate literature, explaining these mechanisms as part of my analysis, in order to create a more fluent story. Finally, I will compare the effects of the mechanisms on the policy space of national policymakers, in order to make clear what the differences in effects of these mechanisms are, therefore explaining why semi-officially dollarized nations still have more policy space than officially dollarized nations.

The base of my analysis will be the article IV reports of the IMF since 2010. The Global Financial Crisis ended in 2009, therefore I think the period between 2010-2019 is best suitable for this case study, in order to eliminate the effects that the crisis may had on the relationship between dollarization and policy space. I will study these documents and I will analyse what they say about dollarization and my four mechanisms throughout the years. This way, I hope to see patterns and to create a complete overview of the current status of dollarization and the effect of my four mechanisms, on the policy space of national policymakers. To my regret, Ecuador has decided not to publish all their article IV reports over the past ten years, I was only able to find the reports of 2015, 2016 and 2019. Thankfully, much of the data in these reports also include the data of previous years. While this will give a gap in my total analysis, I still believe this is the best way to do my analysis. The IMF writes their article IV reports systematically in the same way for every country, therefore this gives me a good opportunity to see the differences between the two nations, and forms of dollarization. Furthermore, I will use different documents that are created either by the IMF, national governments (to understand their point of view) or the World Bank (mostly for primary data on economic indicators like GDP growth and inflation) which specifically get into my topic. Therefore, I will create a more in-depth understanding of the effects of my four mechanisms on the policy space of national policymakers.

In order to generate a deeper understanding of ‘what is going on’, I aimed to do two in- depth interviews with policymakers in both countries. Arranging these interviews from Amsterdam was extremely challenging and sadly, I have not been able interview somebody in Ecuador. I have tried to arrange these interviews through my current job at Travelex, the world’s largest non-bank banknotes dealer, which, I know, has close ties in both Ecuador and Cambodia.

I contacted Michelle Turney, head of the New Markets department. This department is responsible for entering new markets for Travelex, and to spot new business opportunities throughout the world. I know that this department keeps ties in both Ecuador and Cambodia. She brought me in contact with Kelvin Chua, who works for the New Markets department in Asia and Abel Ghacham, who works in North and South America. Both were a great help to me. Abel Ghacham and I e-mailed dozens of times, and soon he had a contact for me. He brought me into contact with someone who works for the Dirección Nacional de Seguridad Financiera in Ecuador and he was personally involved with the

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implementation of dollarization back in 2000. Through him, I hoped to get a better understanding of the effect of my four mechanisms in Ecuador, however, after many e-mails and phone calls from Abel Ghacham I remained unable to get to speak to him.

Kelvin Chua put a similar effort into contacting somebody in Cambodia, which at first did not seem to pay off. It was rather difficult getting replies in Cambodia at all. However, thanks to his persistence, I was able to arrange an interview with Long Vibunrith, who currently works for the National Bank of Cambodia as a reserve manager. While he is not directly involved with day to day monetary policymaking, in his current function dollarization still plays an important role. Furthermore, as a member of different work groups throughout his career, he has gained much insight on dollarization over the years. His insights were a great contribution to my analysis, they helped me to understand how these mechanisms are affecting the National Bank of Cambodia’s policy space. Together with the earlier discussed report, this will be the data of my analysis.

3.2. Validity and reliability

The biggest problem with the internal validity is, that I only had one interview in Cambodia: the interviewee could have some sort of bias, through which I will not be receiving enough independent data. In order to eliminate this, I will start my analysis with the article IV documents and the other documents and literature that I found. After that, I will see what the overlap is between the interview and the data/literature I had already found. This way I hope to eliminate any bias and to check the information I have gathered by using multiple sources. Another weak point is, that I was not able to interview someone in Ecuador, therefore I was not able to get the insights of somebody who is active on the ground in Ecuador. However, there is enough information in the documents that I found to perform my analysis and generate a clear understanding of how the mechanisms influence the policy space of domestic policymakers.

The external validity also has some concerns, since this mostly focusses on how well I can generalise my conclusions. I will focus on two countries and compare the, with each other. It is therefore possible that conclusions based on these two cases are not representable for other cases. In order to eliminate this as much as possible, I will extensively study existing research done on dollarization, in order to get a complete understanding of what could possibly be expected to be found. Therefore, being able to recognise whether my findings are case specific or can be found in other cases of dollarization. Replicability and reliability also play an important role in the external validity. To guarantee the replicability and reliability, I will make it fully transparent; interviews will be transcribed and all used governmental pieces/sources are public, so anyone will be able to fully track my research and replicate it in order to have the same findings.

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3.3. Case selection

My total research population are all countries in the world that have experienced some form of dollarization. This scope is rather large, since many countries have experienced some form of dollarization over time. Dollarization occurs on every continent, in various shapes and forms. As mentioned before, I will not include unofficially dollarized nations in my analysis, since the influence of dollarization is less clear to determine. In most unofficially dollarized nations, dollars are used as a store of value, and therefore do not play a large role in the day to day economy (Mack 200: 353). Furthermore, national policymakers actively support dollarization, therefore the effect on the mechanisms on the policy space of national policymakers is much more difficult to analyse. I have decided to focus on the semi-officially dollarized nations and officially dollarized nations.

I have decided to select two diverse cases. According to Gerring (2008: 7-8), diverse cases can be used to examine what the effects are of a range of variables. These variables will be my four mechanisms and I will study the differences in effect of these mechanisms between the policy space of national policymakers. The next step is that I must make sure that my cases are comparable, and that no external factor is influencing the mechanisms. I have come up with the following four criteria in order to select my cases:

1. The countries need to be dollarized by the same currency.

In order to eliminate the effect of different monetary policies, by the countries which currencies have been adopted, I need to make sure the dollarized economies are dollarized by the same currency, since different currencies could have different effects, therefore excluding this variable.

2. The countries should have similar population and GDP.

To have the clearest explanation of how these mechanisms differentiate from each other I aim to eliminate as many variables between these countries as possible. Therefore, I have decided to choose countries which are comparable in population and GDP.

3. There needs to be a ‘before and after situation’.

By having a before and after situation, I am better able to see the effects of dollarization. Without this, it becomes less if the variable (dollarization) is the cause of changes.

4. There needs to be enough literature.

In order to properly analyse, I need enough data, that enables me to analyse the literature. With these three criteria, I have picked Cambodia out of the total of semi-officially dollarized nations, and Ecuador out of the total of officially dollarized nations. I wanted that the countries that I picked used the same currency. I have decided to pick the U.S. dollar as the currency I wanted to use in my analysis, since this currency is the most frequently used currency, that countries use in dollarization.

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Therefore, I will argue that, by using the U.S. dollar as my currency of choice, the generalisation of my findings will be the most reliable. By picking the U.S. dollar, semi-officially dollarized countries like Bhutan (Indian rupee), Bosnia (euro), and Tajikistan (Russian ruble) were excluded. Officially dollarized nations that were excluded because of this, were countries like Montenegro (euro), Kiribati (Australian dollar) and Zimbabwe (that uses many different currencies).

The officially dollarized nations which remained were Ecuador, El Salvador, Marshall Island, Micronesia, Palau, Panama and East-Timor (Jácome and Lönnberg 2010: 5). I have excluded all the small island states, since there is very little literature about them, and most of them are very dependent on the aid of the United States. Most of them hardly have any functioning government or central bank, therefore studying the policy space in these countries would not make a strong contribution to my research. I have also excluded small (island) nations out of the population of semi-dollarized nations like the Bahamas and Bermuda. This left me with Cambodia, Laos and Liberia in the population of the semi-officially dollarized nation.

In the next step, I have excluded Panama and East-Timor since these countries never had their own currency, therefore there is no ‘before and after’. Therefore, the true effects of my mechanisms are more difficult to measure. The transition from a non-dollarized economy to a dollarized economy will be valuable to my analysis. Furthermore, I have excluded Liberia, since its population and GDP is not comparable to the countries which are left. From the semi-dollarized nations, Cambodia is the most interesting for research to me, since dollarization is the current situation. Since I knew Travelex had strong connections there, getting an interview there was most likely, which will be valuable to my research. Furthermore, in Cambodia is in active debate, which I will describe later, whether dollarization is good for them. Therefore, I can contribute to this debate (Sothear 2016, Connor 2017, Kimsay 2018 and Kang 2005). Ecuador is most compatible with Cambodia in terms of population and GDP out of the remaining officially dollarized nations. Both countries are classified as developing nations by the IMF (2018-1) and are therefore in similar stages of development. Besides that, there is also a strong debate on dollarization in Ecuador on which I can contribute. Therefore, I argue that these countries are most interesting and suitable to analyse and base my findings on.

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4. Analysis

4.1. Analysing the effects of dollarization on policy space

In the previous chapters, I have conceptualised and described the debate concerning dollarization and policy space and I discussed my methodology. In the following chapter, I will analyse the effects of the four mechanisms to dollarization in Cambodia (semi-officially dollarized) and Ecuador (officially dollarized). The analysis will consist of two case studies, which will be described in the same way. First, I will start by giving the background story on dollarization, describing the causes (history), current situation (present) and current strategy (future) of dollarization in these nations. This will give a better understanding of why these countries dollarized, how it is currently affecting them, and how they are dealing with dollarization. Then I will describe the four mechanisms and how they are affecting the policy space of national policymakers. After that, I will finish with my conclusion in which I will do the comparison and discuss my overall findings.

4.2. Background information on dollarization in Cambodia

Cambodia is a country in South-East Asia and has a population of 16 million people and a GDP of an estimated 22 billion USD (World Bank 2018-1). The export of Cambodia mainly exists of clothing and shoes, which accounts for four-fifths of all export. Products like rice and bicycles are also important export products of Cambodia. The most important export partners of Cambodia are mostly Western countries like the countries of the European Union and the United States, but also Asian countries like China and Japan. As for import, Cambodia heavily relies on its Asian neighbours, with China (40%) and Singapore (25%) as its most countries of origin.

0 5 10 15 20 25 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 G D P in US D B ill io n Year

Source: World Bank (2018-1)

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Cambodia has seen strong economic development over the past two decades, with double-digit growth on a yearly basis (See Graph 1), with GDP per capita nearly doubling in the previous decade alone (IMF 2018-2: 17). Consumer price inflation has fallen from an average of 56% between 1990-1998 to around 3% in the last 10 years (World Bank 2018-1). Government revenue collections have been exceeding expectations every year, the budget deficit has been brought back to a manageable level and poverty in Cambodia is declining (IMF 2018-2: 9). Overall, the Cambodian economy has seen some strong growth figures recently.

4.2.1. History and causes of dollarization in Cambodia

While Cambodia has seen strong growth in recent years, this has not always been the case. During the Khmer Rouge regime (1975-1979) of Pol Pot, Cambodia and its economy have been severely damaged, and these scars are still visible (Kang 2005; Prasso 2011; Braiton 2011). During the Khmer Rouge regime, all private commercial activities were illegal. Basic things, like private property, means of exchange and store of value, were prohibited and punishable by death (Prasso 2011). During this period, the national currency (the Cambodian riel), and therefore most savings, were made valueless. There was no monetary system under the Khmer Rouge regime. Therefore, the country was without money (Braiton 2011: 6). Cambodians tried to find a way to save their wealth by investing in substitute form of a store of value and means of exchange. This created a strong demand for foreign currencies, especially the U.S. dollar, but also currencies like the Thai bath or Vietnamese dong were popular. They not only invested in foreign currency commodities, like gold or even rice, were also used (Braiton 2011: 6).

The Khmer Rouge regime fell in 1979 and in 1980, the Cambodian riel was re-introduced. However, this was far from a success: Cambodians distrusted their currency, since they had seen how it could be eliminated overnight. The Cambodian riel lost value quickly and inflation skyrocketed (Zamaróczy and Sa 2002: 2). All of this led to Cambodians no longer trusting their own currency. Cambodians decided to keep using foreign currencies, especially the U.S. dollar. This is a typical case of currency substitution, in which distrust in one currency creates a demand for another, foreign currency. In the 1990s, this distrust was further stimulated by an underdeveloped monetary system, political and economic instability and weak legal and institutional structures (Menon 1998).

This lack of trust in the Cambodian riel and in the Cambodian institutions where therefore the direct cause for dollarization, however, this is not the only cause of dollarization in Cambodia. Throughout all IMF (2010-2019) article IV reports, it becomes clear that economic and political stability has found their way back to Cambodia. The Cambodian economy is growing at an impressive rate and is one of the fastest growing economies in the world (World Bank 2015). Furthermore, there have been

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strong improvements, due to effective reforms in the fiscal and monetary system (IMF 2010-2018). Finally, trust in the political institutions has been improving over the years (Menon 2008: 230 and Braiton 2011: 1). Political stability and the creating of new, stronger institutions have created the ability for Cambodia to stabilise and generate economic growth over the past decades (Braiton 2011: 11). What is interesting, however, is that dollarization has not declined, but has increased over the same period. Therefore, Cambodia shows a different trend than its neighbouring countries like Laos and Vietnam, which have seen similar political and economic developments. In these countries, dollarization has declined and the use of national currencies has steadily increased (Menon 2008: 232 and Braiton 2011: 3).

This means that there are new reasons why Cambodia is dollarizing. Firstly, due to the increase of trust in the Cambodian economy and institutions, Cambodians are retrieving their funds from other countries (Menon 2008: 231). Due to their experiences with the Khmer Rouge Regime, Cambodians used to deposit their savings at foreign banks in places like Hong Kong and Singapore, but in recent years it is widely known that these funds are finding their way back into Cambodia (Menon 2008: 231). When analysing the foreign currency deposits in the IMF article IV (2011-2018) reports it becomes clear that these are still rising (See graph 2).

Since these foreign deposits are already in foreign currencies, this means that they have not been converted into Cambodian riel. This is possible, because the whole banking system is still focused on the U.S. dollar. Therefore, this new inflow of currency contributes to the increase of dollarization in Cambodia. While the ratio of Cambodian riel deposits has slowly increased over time, they still contribute a very small part of all currency deposits (National Bank of Cambodia 2018: 16). The National Bank of Cambodia (2018: 16), argues that this increase of Cambodian riel deposits and the

$0 $10 $20 $30 $40 $50 $60 $70 $80 $90 2011 2012 2013 2014 2015 2016 2017 2018 2019 V al ue o f depo si ts in US D bi lli o n Year

Source IMF 2013: 25 and IMF 2018-2: 33

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increasing demand for the Cambodian riel is a sign of renewed trust in the currency and Cambodia’s institutions, yet it increased the level of dollarization.

Secondly, Cambodia joined the WTO in 2004: this created a large inflow of foreign currencies, since this generated a large increase of foreign trade. Historically, Cambodia and its economy have been closed off from the rest of the world, especially during the Khmer Rouge Regime. The article IV IMF reports of (2010: 22) and (2019: 5) show that since joining the WTO Cambodia’s exports have increased from 2,9 USD billion in 2005 to an estimated 14,2 USD billion in 2019. This means exports have almost five folded in 15 years. With an estimated total GDP of 26,3 USD billion in 2019 this means that almost 54% of the Cambodian economy exists of these exports. Global trade is mostly conducted in U.S. dollars. This means that this new foreign trade generated a large inflow of foreign currency in the Cambodian economy, which were not converted into Cambodian riel. The same goes for the increase of foreign aid, which reached Cambodia after it opened its borders. These funds also flowed into the country and were denominated in foreign currencies. Therefore, further increasing the level of dollarization (Braiton 2011: 6).

Lastly, another important income stream for Cambodia is the emerging tourism sector. Cambodia is increasingly popular amongst tourists and they also bring along foreign currencies on their trips and pay with them throughout Cambodia. The tourism sector has grown from 1,2 USD billion in 2010 to an estimated 4,7 USD billion in 2019 (IMF 2010: 23; IMF 2019: 30). Since the U.S. dollar is accepted nearly everywhere in Cambodia, tourists tend not to convert their currencies and opt to use U.S. dollars. This generated another income stream of foreign currency in Cambodia. All of this illustrates that the success of the openness of the Cambodian economy and the growth of the tourist sector are therefore direct the cause of the further dollarization of the Cambodian economy.

4.2.2. Current situation and future strategy of dollarization in Cambodia

Now that it is clear what the causes of dollarization are in Cambodia, I will discuss the current situation of dollarization in Cambodia and how policymakers are dealing with dollarization. Through this, I want to describe how influential dollarization is in Cambodia and describe the societal debate. With the current situation, I will study the period since 2010 since I will also base the analysis of my four mechanisms on the same timeframe (as mentioned in my methodology).

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(Source: IMF 2018-2: 24)

What is important to understand is that, according to the latest IMF article IV rapport (2018-X: 24), the level of dollarization is still very high (See graph 3). In this graph, we can see the level of financial dollarization in Cambodia, since it shows us the amount of foreign currency deposits as a percentage of total deposits. The level of financial dollarization is around the 95% mark throughout this period. As mentioned earlier, this increase of dollarization is rather unique, since the Cambodian economy has stabilised in the same period and economic growth has really increased in these years. Usually, this is a recipe for a decrease of dollarization, which can be seen in neighbouring countries like Vietnam and Laos (Braiton 2011: 1).

In addition to measuring financial dollarization (as is done in Graph 3), another indicator that illustrates the real impact of dollarization, is the use of U.S. dollar cash in the domestic economy of Cambodia. U.S. dollars are widely available and extensively used throughout the domestic Cambodian economy (National Bank of Cambodia 2016). Cambodians use cash U.S. dollars as a store of value, but also in day to day transactions. Prices are often quoted in U.S. dollars and they are dispensed through ATM machines nationwide. Therefore, the U.S. dollar substitutes some of the functions of the Cambodian riel.

It is hard to give an exact number of the amount of cash U.S. dollars in Cambodia, because Cambodia has such a large informal economy, and the National Bank of Cambodia does not control the inflow of U.S. dollars in the Cambodian economy (National Bank of Cambodia 2016). It is extremely

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hard to determine how many cash U.S. dollars are circulating in Cambodia. What is clear, however, is that the amount of cash U.S. dollars in Cambodia is very large, contributing strongly to the level of dollarization (Léon Chef 1997; De Zamaroczy and Sa 2002; Dabadie and Im 2007; National Bank of Cambodia 2016). Overall, dollarization and the use of cash U.S. dollars within the domestic currencies, make clear that the level of dollarization is high (National Bank of Cambodia 2018: 12). However, what are the consequences of this?

Up to now, dollarization has not been an obstacle in Cambodia’s economic development, since economic growth rates have been robust and the financial sector has rapidly developed (IMF articles 2011-2018; National Bank of Cambodia 2018: 12). Due to dollarization, the economy of Cambodia has integrated into the world’s economy, resulting in the economic growth that can be seen over that past decade. Together with a liberalisation of Cambodia’s economic policies, this integration into the world’s economy, stimulated by strong direct foreign investment, has led to this sustainable growth (IMF 2018-X: 72).

However, Cambodia is openly struggling with how to deal with dollarization. When analysing how Cambodia is currently dealing with dollarization, it is clear how high this topic is on the agenda of Cambodian policymakers. The government of Cambodia has released two extensive documents (Financial Sector Development Strategy 2011–2020, and National Strategic Development Plan

2014-2018) in which it describes its long-term strategic plans for dollarization. In both documents, the

debate on what to do with dollarization is described frequently. I have picked one quote who summarizes the debate the most extensively, in my opinion. In the Financial Sector Development Strategy 2011-2020 the Cambodian government states the following about dollarization: There are

benefits to dollarization, such as limited exchange rate movements that promote growth in foreign investment and provide a stable environment for the implementation of prudent fiscal policy. However, the loss of seigniorage and constraints on the wider use of market-based instruments in implementing monetary policy, such as open market operations and foreign currency interventions, raise serious concerns over how well a crisis would be handled, should one occur. This is exacerbated by the limited ability of the NBC to act as the lender of last resort and to provide emergency support to the financial system in the event of a systemic problem. More important than this, the lack of close coordination among ministries (particularly the Ministry of Economy and Finance [MEF]), as well as lack of a clear framework to use in resolving a crisis, are critical gaps that need to be addressed. The fiscal position of the government and adequate “headroom” are crucial for the government to be able to lend support in the event of a crisis (Government of Cambodia 2011: 7-8).

The government argues there are clear advantages of dollarization. According to the Cambodian government, dollarization has created stability and a deeper integration in the world’s

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economy. On the other hand, it also states that the loss of seigniorage and the constraints in making effective policies are a big concern (two of the mechanisms I will describe); dollarization has negative effects on the Cambodian economy and the policy space of policymakers (this will be discussed in the analysis). Finally, the government argues that dollarization reduces their ability to mitigate risks due to the high internal exposure to a major foreign currency (National Bank of Cambodia 2018: 12).

There has been a debate on whether the benefits of dollarization outweigh the costs (Menon 2008, Braiton 2011; National Bank of Cambodia 2018). Eventually, the government of Cambodia, in cooperation with the IMF, has taken the following position on dollarization: The government of Cambodia has committed itself to focus on dollarization, however, it also decided to stimulate de-dollarization slowly. A drastic change in the current policies around the use of U.S. dollars is seen as too big of a risk, since this could lead to distrust and unrest of the Cambodians and foreign investors in the Cambodian economy. It could also lead to rising interest, inflation and higher exchange rates, which would all have a negative impact on the Cambodian economy (IMF 2018: 13). This was also confirmed in my interview (Vibunrith 2019). In the interview he describes the current strategy as follows: We try not to use any administrative measures nor force people to use the Cambodian riel. We

just want to make it more attractive for investors to do business in Cambodian riel, instead of the U.S. dollar. That is better than forcing investors to use the Cambodian riel. We want to be market friendly, investor friendly, as we start implementing our de-dollarization strategy. De-dollarization should

therefore be pursued, but no at the cost of creating economic instability.

4.3. Background information on dollarization in Ecuador

Ecuador is a country in South America and has a population of about 16,6 million people and a GDP of about 105 billion USD (World Bank 2018-2). Its export consists mostly of crude oil, other important export products are bananas and shrimp. Almost one-third of its export go to the United States, while other important export partners are scattered all over the world with Vietnam, Chile, and Russia completing the top four of the most important trading partners.

The effect of dollarization on the policy space of policymakers : how is dollarization affecting the policy space of local policymakers in officially dollarized and semi-officially dollarized nations?