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Arguably no other country in Latin America has defined the region’s shift to the political left like Venezuela. Embarking upon a socialist revolution under former President Hugo Chavez in 1999, the country spread its left-wing policies to other nations such as Nicaragua, Peru, and Bolivia. Under Chavez, Venezuela nationalized foreign businesses, bought international allies with subsidized oil, and became a vocal critic of American foreign policy. Unfortunately, poor economic decisions laid the foundation for the country’s current economic mess. President Nicholas Maduro has thus far shown himself ill-equipped to make the hard choices necessary to rescue the economy from inflation and a heavy reliance on imports. Since the failure of the Venezuelan economy would indict the cause of Bolivarian socialism throughout Latin America, it is imperative that extempers continue to follow Venezuela’s economic difficulties.
This topic brief will provide an overview of Venezuela’s economic problems, discuss how Maduro’s government is trying to deal with them, and analyze whether these problems are bound to get worse or better in the remaining months of 2014.
Readers are also encouraged to use the links below and in the related R&D to bolster their files about this topic.
Venezuela’s Economic Problems
Writing about Venezuela’s economic problems has become a staple of Extemp Central. Last year, I wrote that the country faced significant economic challenges in 2014 and that the situation for consumers would only get worse. Unfortunately for Venezuelans, it appears that I was correct. The Economist writes on September 3 that Venezuela suffered a 5% contradiction in its gross domestic product (GDP) in the first half of this year. What is sad about this situation is that Venezuela does not need to be in this position. It sits on the world’s largest oil reserves and other Latin American nations that have turned to the left politically such as Brazil, Chile, and Peru are not experiencing the same degree of economic pain. What makes Venezuela unique from each of those three nations is that the Venezuelan government under Hugo Chavez and Nicholas Maduro has adopted extreme economic positions that work against the basic economic laws of supply and demand. Expropriating foreign property in the name of social justice was politically popular, but has worked to reduce foreign investment over the long-term. For example, The Guardian on September 9 writes that Sidor, a steel firm that the Venezuelan government nationalized in 2008, is suffering from a lack of foreign investment and production has fallen at the plant over the last six years. Although the company has been plagued by strikes for the last few years, the government continues to pay workers and thousands of union officials, which makes very little sense.
Another big problem facing Venezuela is a shortage of imports. Venezuela is heavily reliant on oil exports and The Economist article cited earlier notes that ninety-seven cents of every foreign dollar Venezuela brings in comes from oil. These dollar assets are crucial for the country since it needs dollars to purchase consumer goods. Businesses also need dollars to buy equipment and other assets. However, the oil sector is facing its own problems regarding production. Former Venezuelan Minister of Planning Ricardo Hausmann and Miguel Angel Santos, senior research fellow at Harvard University’s Center for International Development, write in Project Syndicate on September 8 that the state oil and natural gas firm, Petroleum of Venezuela (PDVSA), has seen oil exports decline by 45% since 1997. Production is also falling short due to government mandates that PDVSA work on infrastructure projects for the poor instead of investing in new technology. The Los Angeles Times on September 3 writes that the PDVSA suffers significant debt issues as well. The company is currently carrying $48 billion in debt, which is 250% of the value of the country’s foreign exchange reserves. What makes the situation worse is that Venezuela is witnessing a drop in global oil prices despite significant unrest in the Middle East. Business Week on August 28 writes that Venezuela loses $1 billion in government revenue every time the global price of oil drops by $1. With global oil prices falling, the government does not have as much foreign currency on hand to bring more imports into the country. In fact, as Project Syndicate notes, there is a growing list of creditors that are owed money. Food importers are owed $2.4 billion, the automobile sector cannot get spare parts because it is in default by $3 billion, the country cannot acquire life-saving drugs because it owes $3.5 billion for pharmaceutical products, and some global airlines have refused to keep doing business in Venezuela because of the shortage of dollars (they are owed $3.7 billion).
So how do these import problems produce shortages and higher prices? Well, the first problem is that companies who do manage to acquire products by importing them have to sell them at prices mandated by the government. In a free market goods that are in high demand but in short supply will go for higher prices as a way of discriminating between who can pay and who cannot. This explains why hot button Christmas items steadily rise in price or why certain products on eBay go for more than others. Last year, when some businesses carried high prices for consumer goods, Maduro ordered them to sell the goods at significantly reduced prices or risk losing their business to the government. The Washington Post on August 29 writes that stores are opting not to carry certain products because they cannot make a profit between the cost of importing the goods and what the government wants them to sell the goods for. The result is that consumers do not have access to milk, toilet paper, certain medicines, detergent, or soap. Price controls are also encouraging people to hoard items and carry them into neighboring Colombia, where they can sell them for a higher price and pocket sizable profits. To combat this problem, the BBC reveals on September 11 that Maduro will mandate that stores fingerprint consumers. The article notes that nearly 40% of the products that the Venezuelan government is subsidizing – in other words, making the price of them artificially low by eating some of the cost – are going to other countries. Reuters on August 29 adds to this point by noting that San Cristobal, a city located on the border with Colombia, is seeing the worst shortages in the country. Another step Maduro has taken to stop the smuggling to place 17,000 troops along the Colombian border. The border is shut off to traffic between the hours of 10 p.m. and 5 a.m., but this control measure is expected to end in a couple of weeks.
Shortages of consumer goods are driving inflation through the roof. The BBC on September 10 writes that Venezuela’s inflation rate stands at 63.4%, which is the largest in Latin America. For the entire summer international economists had no idea what the country’s inflation rate was because the Venezuelan Central Bank (BCV) refused to release it. The government has blamed opposition protests in the early part of the year for the inflation, alleging that they undermined business activity, but price controls are likely a larger culprit. The Washington Post article cited earlier notes that the Venezuelan government compounded the country’s inflation problem by printing money that it did not have on hand to make up for government deficits that are currently running in excess of 14% of GDP. Governments printing money is always a remedy for disaster, as it produced inflation in the Weimar Republic in the 1920s and Zimbabwe in the 2000s. However, Venezuela’s government takes pride in subsidizing certain consumer products, especially gasoline, and that forces it to run a sizable deficit if it is not bringing in significant oil revenue. Inflation is a cruel tax on the poor because it erodes their earnings power due to the fact that their money does not go as far as it used to in acquiring goods. For example, a hot dog that suddenly costs $10 instead of $1 would harm someone who make $100 a week at their job. The black market spells out these problems. The Washington Post explains that although the government’s official exchange rate is 6.3 bolivares to the U.S. dollar, that is really only for government workers. Those who need to acquire dollars outside of this have to pay in the neighborhood of sixty-eight bolivares. So basically, the richer and better connected you are in Venezuela, you can acquire dollars more cheaply and easily than someone who is poor. Maduro’s political ideology is wedded to an idea that emphasizes aid to the poor, but ironically his policies are hurting the very people he is trying to help.
Government Policies
Now after reading the first section of this brief imagine that you were in charge of Venezuela. What would you do? Would you appeal to the International Monetary Fund (IMF) for help? Would you try to rein in government spending to stop inflation? Well, if you are Nicholas Maduro, the answer would be none of the above. Maduro has insisted that the policies of the late Hugo Chavez are not responsible for the current mess. Reuters on September 11 writes that he is still blaming the United States and international “speculators” for trying to “ruin Venezuela’s socialist experiment.” As noted above, Maduro has even blamed the political opposition for creating consumer shortages and high inflation, completely divorcing the role price and import controls have had on the country. One reason for the dysfunction might be that a personality cult has formed around Chavez, who died of cancer in March 2013. MercoPress on September 3 notes that Maduro’s United Socialist Party of Venezuela (PSUV) has rewritten the Lord’s Prayer to glorify Chavez. Parts of it read “Our Chavez who art in heaven, the earth, the sea, and we delegates…hallowed be your name….Lead us not into the temptation of capitalism.” By deeming Chavez a holy figure, it is difficult for his older supporters and Maduro to move away from the former president’s policies.
That said, Maduro did make a three hour speech to the country last week announcing a cabinet reshuffle and new measures to deal with the country’s economic problems. Rafael Ramirez, who had served as minister of energy and mines since 2002 and who also controlled the PDVSA and was vice-president of economy and finances, was moved to the foreign ministry. Eulogio del Pino was named as the new head of the PDVSA and Asdrubal Chavez, a cousin of the former president, was named as the new minister of energy and mines. The Christian Science Monitor on September 11 argues that Pino and Chavez are engineers, which might benefit the oil and natural gas sector. Unfortunately, international investors do not think this cabinet shakeup went far enough. One analyst, according to The Christian Science Monitor, said that it constituted a “rotation of used tires.” Other analysts expressed concern because Ramirez appeared to be the sole cabinet member trying to push Maduro toward more free market-friendly reforms. In addition to switching his cabinet, Maduro announced the creation of a BCV fund that would hold money from the country’s Development and Venezuela-China funds. Some are hopeful that the fund will give some transparency to how the government uses oil revenue, which has been pilfered by corrupt politicians in recent years, but others warn that its starting point of $750 million is all that is left of the country’s $119 billion in strategic reserves.
One of the ways that the government could try to immediately tackle inflation is if it seeks to lessen the subsidy given to fuel. The Malaysian Star on September 10 writes that Venezuelan motorists see cheap gasoline as a birthright and they pay less than $1 to fill up their gas tank. For those extempers that currently have a license and drive, you know that those are prices that some Americans would kill for. The reason that gasoline prices are so cheap is because the Venezuelan government spends $12.5 billion to eat the difference between where the price is set and what the market price should be. If the government stopped the subsidy, it would reduce government spending and would have more dollars on hand to buy imports. The problem is that eliminating or even reducing the subsidy would spark a political backlash against Maduro. The last time that a Venezuelan government lessened the subsidy was 1997. Venezuelans also remember the riots that broke out in Caracas in 1989 when the government of Carlos Andres Perez moved to reduce the subsidy. As I wrote in last year’s topic brief on Venezuela’s municipal elections, Perez tried to lessen the subsidy to deal with an International Monetary Fund (IMF) mandate to reduce government spending, but Venezuelans did not take kindly to the move. The so-called Caracazo riots left more than 300 people dead and served as a lesson to future Venezuelan governments not to tamper with the fuel subsidy. Economic conditions may leave Maduro with little choice, though. Before being relocated in the cabinet, Rafael Ramirez was arguing for a reduction in the fuel subsidy, but it is unlikely that Maduro will take immediate action on the proposal. First, it appears that he does not want to do anything to politically antagonize his base and it is unclear that Maduro has the political courage to pursue an unpopular proposal, especially since The Malaysian Star notes that his popularity rating has fallen below 40%. And second, the public does not have the appetite for reform unless Venezuela fixes its role in the Petrocaribe alliance that provides subsidized oil to other Latin American nations. The Business Week article cited earlier in this brief explains that while 70% of Venezuelan voters initially supported a reduction in the fuel subsidy earlier this year, that level of support plunged to 35% when reports of corruption emerged within Maduro’s government and when the subsidized oil shipments to other Latin American countries continued.
The Future of the Venezuelan Economy in 2014
The most immediate challenge that the Venezuelan economy faces is whether it is going to be able to make a debt financing payment next month. USA Today on September 11 writes that Venezuela owes its creditors $4.5 billion. Maduro insists that the country will be able to make the payment and the government’s import controls are, in part, motivated by a desire to retain enough in its foreign currency reserves to meet its debt obligations. Still, extempers should follow Venezuela for the remaining months of 2014 and see if the country can continue to pay its creditors. With oil revenue falling, oil production declining, and a growing awareness among investors that the country is not significantly changing its macroeconomic policies, the country might flirt with a debt default. On the one hand, default would be devastating for the economy because it would force the country to offer higher interest rates to future investors as an enticement for buying the country’s bonds. It might accelerate the lack of foreign investment in the economy as well. However, the Project Syndicate article cited earlier argues that a default might actually work in Venezuela’s favor. It insists that Venezuela could take the path of Greece, who has used its debt problems to realign its obligations to creditors by making them take “haircuts” on their investments. Neighboring Argentina’s debt problems, though, show Maduro that conducting a default can be a tricky business. Due to the risks associated with a default, it is likely Venezuela will not go down that path.
Another interesting area that requires a decision by the Venezuelan government is whether it will continue shipping subsidized oil to its allies. MercoPress on August 30 writes that the country is slowing its oil shipments to other countries in the Petrocaribe alliance. In fact, these shipments fell by 11% in 2013, which was the lowest level of oil exported to friendly nations since 2007. The problems in the Venezuelan oil sector have actually caused Venezuela to get oil from non-domestic sources to meet its agreements. MercoPress says that Venezuela’s struggles might open new markets for the United States, since the U.S. is acquiring greater natural gas deposits through controversial fracking procedures. The risk to Venezuela of ending the Petrocaribe alliance is that it would be a tacit admission to other countries in the region that its leftist policies have failed. The breakdown of the alliance might also reduce some of Venezuela’s regional clout when it is poised, as The Washington Post points out on September 11, to get a non-permanent seat to the United Nations Security Council. Extempers should keep up with the Petrocaribe alliance because if Venezuela continued to reduce oil shipments to members that could signal its willingness to decrease fuel subsidies at home, since Venezuelan voters are unwilling to consider domestic fuel cuts until the country’s foreign partners take one.
Venezuela’s economic authorities have to make sure to publish accurate statistics about the economy to get things headed in the right direction. The Latin American Herald Tribune on September 12 writes that Fitch Ratings is criticizing Venezuela for a lack of clear policies. The result of being unclear about what the government plans to do to handle the economic crisis is that foreign investors are unwilling to deposit their money in the country. The Business Insider on September 2 also explains that businesses in Venezuela are complaining about the lack of government transparency. Revealing the recent inflation figure is a good sign, but the country has not released credible GDP figures and has not released its so-called scarcity index, which tracks the shortage of consumer goods, since March. The situation has become so bad that private organizations, such as the Venezuelan Chamber of Commerce, have taken to collecting their own statistics. Just like Argentina, which has worked to mask its inflation rate, Venezuela risks angering its creditors and making itself an untrustworthy business partner. After all, would you deposit money in a country that refuses to give you accurate information?
What will ultimately fix the Venezuelan economy is a willingness of Maduro’s government to own up to the fact that their policies are not working. Price controls are fueling the black market, shortages, and smuggling; a lack of effective management of PDVSA is reducing the country’s oil output; and the uncertain state of property rights in the country is limiting the ability of the country to diversify its economy. The most likely policy Maduro might pursue by the end of the year is a currency devaluation whereby Venezuela would reduce the value of the bolivare relative to other currencies such as the euro or the U.S. dollar. This would have the effect of reducing the country’s debt burden by making the bolivare worth less, but it would make inflation a bigger problem, at least in the short-term, because it would take more bolivares to purchase a product. It would also erode people’s savings, which could lead to protests against Maduro. Still, if the government’s fiscal picture worsens relative to GDP, a currency devaluation cannot be discounted.