Don’t Blame It On the Oil

Don’t Blame It On the Oil

Venezuela is a formidable petro-state. It has more proven oil reserves than Saudi Arabia, and exports most of the oil that it produces. Between 2004 and mid-2014, when historically high oil prices were the norm, Venezuela enjoyed one of the largest revenue windfalls in the world. Now it is experiencing one of the most severe recessions. All oil-based economies have suffered from the decline in oil prices since June 2014. But Venezuela’s economy has essentially collapsed, ravaged by what we might call RIDDS: recession, inflation, dwindling foreign reserves, debt, and shortages.

According to the government, Venezuela’s woes are the fault of foreign actors and local capitalists. Saudi Arabia’s refusal to cut oil production, the United States’ reckless fracking, rumor-mongering by Wall Street speculators, hoarding of products by Venezuela’s own “parasitic bourgeoisie” — this is all president Nicolás Maduro talks about these days.

Despite Maduro’s claims, Venezuela’s RIDDS is not the result of external shocks, or even the local bourgeoisie’s “economic warfare.” It’s not the result of oil dependence, either. Neither does it have much to do with the economic incompetence of the country’s leaders, conspicuous as that factor may be. Venezuela’s economic woes started long before the current downturn in oil prices and the start of Maduro’s administration. Rather, the blame for Venezuela’s RIDDS must be laid on the nature of the country’s regime, which disincentivized its leaders from competently managing the oil boom, and is now crippling the government’s ability to respond to the downturn.

In the early 2000s, Venezuela’s regime under Hugo Chávez became semi-authoritarian and hyper-populist. Such regimes have four inherent characteristics, all of which affect how they manage their economies. First, the ruling party engages in frequent elections, but constantly breaks the rules to ensure acceptable outcomes. Second, the executive branch erodes or eliminates institutions that can check its power. Third, the ruling party spends in a partisan fashion: it grants huge resources, typically unaccountably, to its followers, while denying them to its enemies. Fourth is the regime’s hostility to the private sector. These features help explain the country’s descent into economic hell.

The electorally competitive aspect of the regime helps explains why, under Chávez, and now Maduro, the Venezuelan state developed a chronic spending problem. Venezuela’s spending was done mostly in secret, but much of it clearly went to generate a consumption boom, with the aim of counteracting the ruling PSUV party´s waning electoral competitiveness. All forms of fiscal stimuli were tried: direct cash transfers to low income groups, subsidized consumer goods, multi-million dollar contracts for local firms, low tariffs, and preferential access to inexpensive dollars. By the end of the Chávez era in 2013, Venezuela’s fiscal deficit reached approximately 15 percent of GDP. This contrasts with the OPEC countries during this period, most of which took advantage of the recovery in oil prices since 2009 to re-accumulate surpluses. Until the price of oil began to decline, Maduro did nothing to cut back.

We know that this spending had political aims because Chávez’s own minister of planning, Jorge Giordani, said as much in a letter he published online after being fired by Maduro in 2014. The government’s objective of “consolidating the revolution” — and more specifically, of winning the October and December 2012 elections — led to “extreme levels” of spending, Giordani wrote.

Comedians had a field day in late April when a women threw a mango at President Maduro’s head, asking him to call her back, which he did. It turned out that the woman wanted a new apartment — and Maduro obliged. The incident became an Internet sensation because it served as a perfect parody of Venezuela’s consumption-oriented populism: hit the government hard with a petition, and you might get lucky enough to win a new house.

Lavish spending wouldn’t have been nearly as bad if it hadn’t been accompanied by the simultaneous destruction of the country’s only milk cow — its oil industry. Venezuela is one of the few petro-states in the world that, despite registering increasing levels of proven oil reserves since the mid-2000s, has experienced decreasing production and rising debt for over a decade. This is the result of two fateful decisions by the government. The first was to deprive the state-owned oil company, PDVSA, of much-needed capital. The second was to replace trained personnel with hordes of “revolutionaries” eager to go along with any of the president’s wishes. The result has been a productivity crisis almost unheard of in the oil world.

In a well-run oil company, one would see the opposite trend: employment would expand only when production was expanding, and always at a slower rate. Such companies do exist — Ecopetrol, in neighboring Colombia, is a good example. Oil production in Colombia increased 92 percent between 2005 and 2015, but employment in Ecopetrol increased by only 50 percent. Meanwhile, in Venezuela, production declined during this period, but PDVSA’s employment expanded by 256 percent.

The connection between PDVSA’s woes and regime features is clear. The erosion of checks and balances granted the president full prerogative to use revenues at will. Populism directed the president to spend oil revenues on consumption (and corruption) rather than on production-enhancing investments, such as rigs. Sectarianism explains why PDVSA was bloated with loyalists rather than technical experts. In Colombia, where checks and balances have been increasing since 2010, and populism has never been a major part of the state’s DNA, oil management has been of an entirely different quality.

The regime’s harmful effects are evident not just in PDVSA, but in the economy as a whole. Venezuela responded to the oil boom by engaging in massive statism. Nobody disputes that some state intervention in the economy is crucial to encourage growth, reduce poverty, protect the environment, and tackle inequality. But Chávez and Maduro have gone far beyond what’s reasonable. Under their directives, the state nationalized, over-regulated, and over-spent like few other contemporary petro-states.

Any basic economics textbook teaches that monetized deficits lead to high inflation, and Venezuela was no exception. The country’s annual inflation rate averaged 27.4 percent per year between 2007 and 2013, at least five times the rate for all of Latin America. Even countries ideologically aligned with Venezuela, such as Nicaragua, or those equally resource-dependent, such as Mexico, or both, such as Bolivia, have significantly lower inflation. Currently, Venezuela’s inflation may be as high as 68 percent — possibly the highest in the world.

Populist governments, like all governments, worry about inflation because it increases poverty. But populist governments are distinct in how they react: with price controls rather than fiscal adjustment. Following this script, Chávez imposed one of the most convoluted systems of price controls in the world, in at least three markets: retail prices on a large number of products, labor markets, and foreign exchange markets.

Controls on foreign exchange have been one of Venezuela’s most self-destructive economic policies. To contain inflation and capital flight, both Chávez and Maduro have relied on a complicated multiple exchange-rate system supplemented by increasing rationing. A serious balance-of-payments crisis forced Maduro to devalue the currency in 2013 and again in 2014, leading to an even less transparent system of three exchange rates, of which two were pegged “official” rates and one was a floating unofficial rate. Multiple exchange rates cause the cost of capital to have different values, and only enterprises with access to preferential rates can remain competitive and survive. The rest disappear — as entire sectors of the economy have. In combination with price controls and nationalizations, these distortions are causing severe shortages of food and consumer goods.

Unfortunately for the government, but not surprising to anyone minimally literate in basic economics, exchange rate controls have stimulated rather than stopped capital flight. As Francisco Rodríguez at Bank of America has argued, economic actors are so eager to acquire dollars that they are paying fortunes in bolívares for dollars, and quickly taking them out of the country. Today’s bolívar is trading at around 285 to a dollar in informal markets, an astronomical distance from the official exchange rates of 6.30 to 197.00 to the dollar. This heightened demand for dollars is one reason that international reserves have been shrinking at an average of $38 million per day, bringing total reserves today to the dangerously-low levels they were at in 2003, right before the oil boom started.

As bad as RIDDS might be, it is only the tip of the iceberg. Venezuela is in the midst of a severe governance crisis. Chavismo is now facing a chronic incapacity to effectively deliver social services. This is a terrible handicap during a recession, because it means that the poor are left with almost no protection. The governance crisis is particularly visible in the health sector, where hospitals are facing scarcity of even basic products such as acetaminophen. In September, the scarcity index for medications was estimated at around 60-70 percent. Diseases long eradicated in Venezuela, such as malaria, dengue fever, and tuberculosis, are making a comeback.

Like previous statist episodes in Latin America, chavista economics has now created a need for exactly what it hates the most: draconian adjustment policies. Each of the options under consideration is enormously costly: Reducing spending would undermine the most important electoral tool available to the government. Selling nationalized firms would generate few revenues because they are in total disrepair and interested buyers are scarce. Selling CITGO would reduce Venezuela’s access the U.S. markets, which continues to be the most reliable source of foreign reserves. Defaulting on foreign debt would make future borrowing too costly. Increasing the price of gasoline at home would hurt low-income groups the most.

Because the government knows that any of these policy options are ideologically embarrassing and politically dangerous, it is choosing stealth adjustment instead. It is gradually devaluing the currency by reducing the number of transactions eligible for the cheapest exchange rate. It is gradually reducing imports by restricting access to foreign exchange. And it is refusing to pay its domestic debts to private corporations, an approach Hausmann and Santos describe as a “domestic default.”

The other response of the government has been to become more autocratic. As the price of oil declines, dependence on the military is increasing. Loyal military figures are being given more cabinet posts, more benefits, and more discretion. One of the perks the military now receives under Maduro is greater latitude to repress dissidents and to engage in illicit market activities, including drug trafficking. Whereas in the 2000s, the regime came to depend for its survival on the so-called bolibourgeoise — business tycoons who have prospered from state contracts and state protections — in the 2010s, the regime now depends on what we might call mili-narcos: state security forces linked to drug trafficking.

When the U.S. government sanctioned several of these mili-narcos in its poorly worded executive order of March 2015, Maduro responded by promoting several of them. Maduro called this an assertion of sovereignty in the face of imperialism. In reality, it was an affirmation of the regime’s reliance on mili-narcos.

The main paradox of hyperpopulism is that it is the quickest route toward its ideological nemesis. RIDDS is hampering governance and forcing the government to pursue harsh austerity. Public support for the government has plummeted, and this decline in support, in turn, is leading to more militarism. Venezuela’s lesson for voters is straightforward. To protect one’s country from savage neoliberalism and militarism, start by never electing radical populists to begin with.

In the photo, people queue outside a state-owned supermarket in Caracas in January 2015.
Photo Credit: FEDERICO PARRA/AFP/Getty Images