The Fat Tail called it right on Chavez

On March 5, the Venezuelan government surprised many observers when it nationalized a rice processing plant owned by the U.S. food company Cargill. Following his recent referendum victory, President Hugo Chavez is feeling emboldened, and this nationalization, along with new controls over food production, are part of his plan to give relief to his lower-income supporters. The short-term political logic is compelling. The moves will help Chavez’s core constituents get basic food staples at more affordable prices, but they also risk undermining future production and investment in the agriculture and food processing sectors.

In spite of these obvious risks, these moves are in line with Chavez’s longstanding agenda to increase the role of the state in the economy and to enlarge wealth redistribution. Many did not foresee that Chavez would take on “non-strategic” sectors like food production — after all, the most notable nationalizations tend to be in strategic sectors like energy that generate high revenues that the government can tap into immediately. They reasoned that Venezuela had already nationalized strategic sectors like energy, utilities, telecom, and banking, and it might end there. Plus, the broader trend in recent years has seen governments around the world privatizing rather than nationalizing companies, particularly in consumer and retail sectors.

But it is unlikely that Cargill’s leaders were startled by the developments last week. The reality is that most corporations and investors do not have the luxury of claiming that they could not have known about an expropriation risk. Below is an excerpt from The Fat Tail:The Power of Political Knowledge for Strategic Investing in which Ian Bremmer and I discuss the history and some of the underlying drivers of nationalization that are relevant for contemporary cases such as Venezuela:

Venezuelan President Hugo Chávez has always stirred Latin American resentment against Washington to bolster his popularity. In the name of resistance to “imperialism,” in 2004 he began to demand that U.S. and other foreign oil companies pay higher taxes and royalties to his government. He met little resistance and continued to push for more, using the new profits to tighten his control on domestic political power. Ecuador’s Rafael Correa and Bolivia’s Evo Morales have consciously followed the same model.

In Venezuela, the state oil firm PDVSA once pumped substantially more oil than it does now. A strike in 2002 and 2003 by oil workers, angry over Chávez’s heavy-handed policies, induced the president to fire 10,000 of them — including a large percentage of the company’s most experienced and talented engineers. The company has not recovered. Venezuela’s problem is not limited to oil. In 2002, Chávez ordered that land be redistributed to squatters and the unemployed, who would then grow the food that would feed Venezuela. But the haphazard way in which the program has been implemented has damaged Venezuela’s economy. The country is now more dependent on food imports than before, because farmers, fearful that their land could be seized at any moment, have been unwilling to plant crops they may not be allowed to harvest.

Since the late 1980s, academics and policymakers have increasingly assumed that the risk of expropriations was waning. With the end of the Cold War there has been a general trend towards government protection and promotion of ownership and investment rights. The privatization of previously nationalized property became a core component of the process of economic liberalization in the states of the former Communist bloc and Latin America, and even in developed states like France and Britain.

Yet, the risk of expropriations refuses to die. Witness the surge in state expropriations of privately owned assets that make headlines around the world these days. The Russian parliament passes a law that limits foreign investment in “strategic sectors” of the Russian economy and expropriates existing investment. Venezuela squeezes foreign oil companies, takes land, and nationalizes electrical and telecommunications firms. Ecuador seizes the assets of Occidental Petroleum, the country’s largest foreign investor. Zimbabwe’s Robert Mugabe orders the large-scale expropriation of white-owned farms.

In fact, we are not witnessing a clear “convergence” process in which economic liberalization and privatization become the order of the day. If anything, the global foreign investment environment is becoming more varied and complex.

Governments expropriate for many reasons. And “expropriation” can take a variety of forms, from the creation of predatory tax regulations to the nationalization of an entire economy. The causes can be varied and complex, and understanding this allows both companies and foreign governments to better plan for handling this type of risk. Overall, the forces that induce governments to expropriate generally include some combination of international politics, economics, ideology, domestic politics, and nationalism. In Venezuela all of these factors have come into play.

Ideology has historically been a key driver of expropriations. This was the case not only for Communist states (Cuba, the Soviet Union, etc.) but for a number of socialist or statist-minded developing countries like India, Sri Lanka, and Mexico — and, in the 1940s and 1950s, for developed countries like Britain and France. With the end of the Cold War and the retreat of Communism, ideology has significantly diminished as a driver of nationalizations, though it remains a factor in places like Venezuela, where the Chávez government’s stated goal is to create a socialist society. Fortunately, expropriations driven by ideology are relatively predictable, because those who build political movements on demands for the nationalization or expropriation of private property are usually not shy about broadcasting their intentions.

Some assume that governments expropriate investments for the “public good,” to restore the national wealth to the nation’s people. Political motivations for expropriation are often far more selfish — there is usually a basic domestic political economy game in play. Expropriated property can be used to build popular support and political capital, to placate interest groups and constituencies, or simply to enrich public officials. This is at least part of the story in Venezuela.

In difficult economic times, expropriation (usually surrounded by nationalist or ideological rhetoric) can provide a government with a quick infusion of cash. Not surprisingly, some analysts point out that there is a relationship between lack of economic growth and expropriations. Governments may expropriate firms as a response to economic problems, which they may blame on foreign firms. In the current global environment, expect to hear this justification for nationalization more frequently.

Excerpt reprinted with permission from The Fat Tail: The Power of Political Knowledge for Strategic Investing published by Oxford University Press.  Copyright © 2009 by Oxford University Press, Inc.