The Venezuelan Crisis Correctly Understood

Today, I’m presenting an essay about Venezuela. I’m going to introduce readers into what the actual (political-economical) drivers of the Venezuelan misery in the very recent years are. The reasons for the massive devaluation of the country’s local currency which resulted in puzzling consumer good scarcity.

Introduction & Abstract

We are on the morning of another very important election run in Venezuela. It has been the third crucial vote for the ruling chavista party since Fall 2012 (the re-election of Hugo Chavéz) I am about to follow closely.

The country drags from one to another election and the government at all levels (communal to federal) drain and suck upon the economy’s already fragile state. Politicians (of all parties but especially the weakening but ruling chavista party) use oil-money (the country’s only sizeable source of income) and divert it to re-election purposes. People commonly speak of the country as being in a kind of “freeze” whenever elections come up. When I first travelled the country I understood this statement as to refer to the mind and political arena. But it is much more: Everybody can experience upcoming elections when cotton or paper become scarce because it is used for the election advertisement! Elections literally starve the economy! Something wholly unknown and imaginable to “us” in the “West” I guess.

What we usually find in media both Western, as well as Venezuelan, is to emphasize only one of the following messages and deem it to be the single cause for the rapid state of decay Venezuela finds itself:

  • PdVSA and the Government act as union for the ruling party’s interest. Or: “Venezuela is corrupt”
  • The local currency (the “Bolivar” or BsF) is depreciating rapidly
  • Socialist price controls
  •  “Venezuelans are lazy” or inexistence of meaningful domestic production
  • Widespread scarcity of consumer products

To fully comprehend the whole situation we need to understand what these issues have in common. What are the main driving factors and rationals behind it? Put abstractly the scenario could be called a populist ruling party optimizing their gain, given a very specific economic structure. I want to reformulate the above – puzzling facts – into questions and start to give you the whole picture and not ideological viewpoints:

  1. Why are elections so important in this country at all? Why is the state so economically dominant at all?
  2. Why are PdvSA leaders nearly a personal union with the ruling party? Why is Venezuela so corrupt?
  3. Why is the bolivar depreciating quickly?
  4. Is there something special about imported products?
  5. Why do we see widespread scarcity of (consumer) goods? Why isn’t Venezuelan domestic production kicking in (Keynesian-style)?

1. Two figures which says all about the economic structure:

95% of Venezuelan exports are oil/gas (1). 70% of consumer goods in Venezuela are imported (1, 2)! This means that oil exports cover for the vast majority of consumption of all Venezuelans. It is obvious why the value of the currency is thus so important!

This fact leads to the assumption, that domestic production is low and underdeveloped. Everybody who travels the country can witness this: Even one-time plastic razors are imported, as well as non-sophisticated shoes or even dresses. Venezuela suffers from the Dutch disease.

The conclusion is: If a government wants to distribute wealth in an economy where production is monopolized by PdVSA and consumption goods are imported on top of a weak domestic sector, then the government’s only and simplest option is to redirect PdVSA profits. And this is consistent with what we find: Oil & Gas production and thus exports are done through the nationalized PdVSA. The company is the only substantial cash cow to Chavista policies. That’s why PdVSA is of utmost importance to a government which runs on a “redistribution-via-state”-scheme. If you want to redistribute, you have to get hold of the asset / productive force. Thus in Venezuela we observe an economy where the only crucial economic productive asset is in the hand of the government.

That is the clue as to why elections quickly mean more to the country than in west – it has a whole other economic dimension. Simplified, we can say that the usage of PdVSA profits and hence personal consumption (!) is decided in these elections.

2. The “big rotation” in PdVSA (2003)

2003 basically all of PdVSA middle and top employees were fired and replaced with pro-Chavéz people. This is to be understood as a consequence of the above mentioned importance of PdVSA. Anti-Chavista management would be the weak spot of the government and its redistribution policies. Traditionally big Latin-American oil was easily influenced (or even an extension) by US interests (1). This is what Hugo Chavéz’ anti-imperialist rhetoric relates to and what he himself experienced in 2002/2003 when PdVSA tried to cut him off the cash cow and consequently would have killed the Chavista agenda. Ever since the big rotation, PdVSA has become far more than an oil producing company. In fact, PdVSA is just like another department to the Venezuelan state and elite. A lot of the social programs are run and performed directly through PdVSA and not the state himself! In election time, PdVSA provides funding and a pool of manpower available to the ruling party.

3. Two years of constant election campaigning…

…put pressure on the government (first Chavéz, now Maduro) to “quickly” increase overall prosperity indicators: Unemployment, Inflation, Debt and high consumption levels (income). As economists we know about trade-offs in policy goals, and this is exactly what we see.

Campaigning and ever bigger social programs were put in place to lower unemployment and increase consumption of the poors (traditional Chavista voters). Meanwhile, once the freshly printed BsF (backed by foreign reserves due to oil exports / USD) arrive in the hands of households, they will be immediatly spent. As local currency never was a good option to save even in times of relatively low inflation, those who can would not save in BsF. Thus the new BsF gets spent in some form – either directly on consumer goods or converted into Dollars. This results in pressure on the fixed-exchange rate regime from both sides: Consumer goods (which mostly are imported) and savings motive (converting BsF into Dollar). This again would not automatically mean that the Bolivar needed to devalue: Venezuela is in the very odd situation of running a balance of payments surplus! It exports more than it imports (in Dollar terms). If the government (in this case the Central Bank of Venezuela) were to give Dollars unlimitedly at the official rate of 6.3 to the demanding hands of the private economy, it would actually be sustainable. Venezuela thus is not the typical case of an emerging market economy running on a balance of payments deficit while trying to maintain an overvalued currency. A situation often forgotten.

So why is there an inofficial rate which spiked within two years from 1:10 to above 1:50? It is first and foremost a political issue: Dollars are not given to every demanding BsF-holding hand but allocated according to (in the end) politically motivated schemes through institutions like “CADIVI“. Some BsF holders are left unserved. And from here onwards the typical tale begins: A shadow Dollar market arises and the Government answers with capital controls. Some might argue out of lack of understanding, some say willfully so. However history is more complex, as CADIVI has its root in the same 2002/2003 strike of (the not yet Chavéz-controlled) which led Chavéz to replace nearly half of PdVSA employees.

In the beginning, the allocation of Dollars at the official rate meant profits (arbitrage) for the receiver and thus an additional power tool for the government to discriminate and boost political voices. Before the last two elections (spring this year and today) though, the situation exacerbated and fully went out of control. At the same time, the government cannot pursue a big revaluation, due to risk of face loss or profiteers of the scheme. However it is clear, that a big revaluation or re-design of the allocation scheme must come soon after the elections (couple of months).

Furthermore, the quick and rapid devaluation was unmistakenly fueled by political expectations (not demand for consumer products): Charts of the unofficial rates show how quickly they have moved near the election dates. Insecurity about what the government is doing drives money out of the country. Imagine how many middle-class and above people would have to lose a lot, when opposition won. People hence secure their wealth. It is currently happening in dimensions which aren’t anymore “business as usual just on another level”, but signify a spiraling into death of the economy.

4. A small digression be allowed: Culture

The lead culture in Venezuela (as maybe in the majority of Latin-American countries) is the American Lifestyle. I don’t mean the US constitution or decentralized organization but rather the Telenovela (and Pitbull ;-)) -advertised consumerist lifestyle of big cars, big houses, fancy clothes, many women / a rich white guy, red wine and absence of work. The fact that a lot of middle class families have relatives up north probably accentuates these impressions. America is cool that makes Venezuelan goods always sell below par. For example a weird anecdotal evidence of this cult about imported goods is the preference for low-quality, bad tasting but imported Whisky (counted by years not brand) foreigners will not be able to understand. This is odd as there is ample access to prime rum and or tequila which would be easily valued five times over the whisky in Swiss terms but is deemed as a “drink for poor” in Venezuela. Chavéz intuitively understood, that this cultural bias is a true form of power (something economists are not taught) and tried to fight against as well, re-telling the Venezuelan story trying to establish stronger Venezuelan identity and pride. Maduro, Hugo Chavéz’ successor, takes it on a new level: Censorship software he bought in China one month ago is already working in this election.

Besides the above mentioned it is worth recalling that exports are only worth what they yield in imports. There is no quick model who gives an answer to the Dutch disease. At some point the oil richness must be used to purchase goods abroad. In that sense the above is not meant pejoratively. Some of what we see is just the sovereign decision of households who for the first time get a hold on the oil richness and decide to consume it. Another part though stems from the fact that there are decreasing domestic consumption alternatives or saving possibilities:

5. Scarcity of (consumer) goods is due to three main reasons:

Firstly, whatever the government additionally spends on the campaign and to get economic figures right, crowds out private consumption as both make use of the same source of finance: Oil Dollars. Anecdotal evidence is the problem of getting something very basic like cotton or paper before elections because it is used in campaigns for advertisement / caps / dresses etc. On the productive side, massive intra-organizational mind games with real meaning can be expected to be going on. In election times all important employees / persons anywhere in Venezuela have to position themselves for “after” the elections.
In short: The state sector and the additional pressure in the election campaign are significant to the economy’s workings and fiddles with its structure.

Secondly: Once the facts above put pressure on prices and given the impossibility / unpopularity of swift changes in the currency scheme, the actions of the government are logical: Price controls to lower inflation. And here goes the usual price control tale right out of the economic storybook: Price controls dry the shelves of retailers. Black markets arise which motivate the government to populist measures like store raids etc. etc. Eventually still relatively high inflation and decreasing availability of goods further drive people out of the BsF into USD leading to a spiral.

Furthermore, price controls and scarce availability of USD kills the little domestic industrial (and agricultural) capacity which critically needs imported intermediate goods. The government answer is to blame the producers and tries to import the final goods itself presenting as the solution to the problem. Additionally there is a “no-fire” law, to improve the unemployment figure. Such regulations exist in all areas of the economy, e.g. it is basically prohibited to kick out people who rent homes, etc.

Thus the massive liquidity injection is not a Keynesian wet-dream that fuels corporate profits.Together with retailer raids and recently imposed limits on corporate profits, private entrepreneurship collapses. The heart of economic growth stops beating. Nobody invests.

Thirdly: In the mid-term all of this hurts oil production: PdVSA takes a hit, as it has to sell its collected USD at the official rate to the Central Bank of Venezuela. This drains PdVSA funds for capital expenditure. Structurally, the incentives in place aren’t optimal for oil production: PdVSA has to serve political goals and excessively so, instead of investment in (environmentally friendly) oil exploitation. The massive decay in oil production witnesses this. The times of rising oil prices to compensate for this effect seems to be over now – together with an increasing domestic consumption (fuel is basically free), foreign reserves will slowly but surely come into focus. The “cash cow” used to maintain high level of consumption is being starved to death.

Conclusion:

The idea was to provide the reader with an overview and insights of “how it works what you recently see”. I called it an essay and I agree that it is simplified. However it is up to the human mind to ask for action, now that we recognize the drivers. Before I’m going to present my moderate opinion, I want to conclude by taking into account important aspects not to be left aside. If we did and give out advice light-handedly, we just end in another example of Ricardian fallacy:

  • I refrained from discussing the third important pillar in any Venezuelan analysis, the military (others being Oil and Politics). Another very recent phenomenon then comes into focus: Border-to-border drug trade.
  • PdVSA and a lot of the economic elite is chavista – how far are the willing to go?
  • It is questionable if the opposition could change the situation drastically if it would come to power. One can change politicians quickly but not the economic structure described. Furthermore every ruling party must be accepted by the military (i.e. buy them out). On the other hand any political party cannot massively cut back on support for the poor, or uproar and overthrow is sure. Insofar, any political leader is locked in rigidly – or at least to an important extent – into the existing setup.
  • The ruling party enjoys wide support. Often time we forgot, the chavistas are popular!
  • If we dig into the political support, another topic arises: Political support differs massively in geography and wealth.
  • History shall not be forgotten. Chavéz was the outcome of a Venezuela which was dominated (arguably exploited) by foreign interests for decades. Big parts of the population did never profit from the oil richness. In other words: Venezuela is of huge geopolitical interest. Everybody (not-Venezuelan) was surprised to find Venezuela as one of six high-profile surveillance targets of the US administration. It is clear from the documents that the US worry about the oil coming on the world market and that Chavéz’ idea of making Latin countries independent from US interest would serve as an example to others. On the other hand, China quickly has become Venezuela’s second biggest trade partner after the US. Russia maintains good relationship as well. Together with the heterogeneous geographical support of Chavistas, I see a geopolitical situation reminiscent to some aspects of the in the Syrian conflict. However, so far the truly peace-loving Venezuelans seem not to be capable of easy militarization.
  • Taxation is not a viable option for this government to redistribute because capital restrictions in reality apply only for the (lower) middle class. The rich can always secure wealth abroad in a corrupt society.
  • We neglected the high-criminality and its impact on virtually any aspect of life.

In my view, the abolishment of the Dollar allocation scheme together with some sort of free bolivar or free access to Dollars as well as less domestic regulation (with moderate import tariffs for simple manufactured goods present) could be the true start for steps into the right direction: More consumption as well as a revitalization of PdVSA. These steps are acceptable for the powers to be (chavista elite) and as such in the mid-term wise and profitable. More importantly these steps would produce a monetary situation which eventually allows for entrepreneurship. Only then a true growth process is able to set in.

– JAS

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One thought on “The Venezuelan Crisis Correctly Understood

  1. […] and think in different dimensions unimagined before. E.g. the somewhat surprising question, why Hugo Chavez, whose regime was on the top 6 NSA spylist, may have gotten cancer. (Applebaum’s speculative answer I won’t recite […]

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