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How to Run an Economy (Into the Ground)

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Image: AFP/YP
A version of this article also appeared in the South China Morning Post's Young Post on Thursday, April 21. http://yp.scmp.com/news/features/article/103282/how-hugo-chavezs-chavismo-ran-venezuela%E2%80%99s-economy-ground

The precipitous fall in global oil prices wreaked havoc on many oil producing countries. The crash put immense fiscal strain on the Gulf states and countries like Russia, which rely heavily on oil exports as a source of foreign currency. Yet, arguably no economy has been hurt quite as badly as Venezuela’s. 

Venezuela has the world’s largest proven oil reserves; the commodity comprises 95% of the country’s export revenue and 50% of GDP. But whereas Middle Eastern nations with sizable oil reserves converted the valued resource into riches, Venezuela never saw such prosperity. 

Years of economic mismanagement meant that the country’s economy was teetering at the best of times. Inflation ran into the double digits even when oil prices were at highs of over USD 100 per barrel.  

Now, with oil prices over 60% off their peak, the country’s economy is in dire straits. Inflation hit 100% in 2015, is expected to reach 700% in 2016, and may reach 2,000% by 2017. Venezuelans regularly face shortages of basic goods in supermarkets as well as unreliable utility supplies. Unemployment and poverty rates are rising. With oil revenues plummeting, the government is struggling to meet its obligations. 

How does a country so rich in natural resources find itself in such a predicament? A lack of diversification beyond the oil industry was part of the problem. Beyond just that, Hugo Chavez and his successor Nicolas Maduro are guilty of implementing deeply flawed economic policy.

During his time in office, Chavez enacted a series of populist measures commonly known as Chavismo. His marquee policies of price controls, wide-ranging subsidies, and general opposition to the market economy had a severely detrimental effect. 

Ostensibly to protect consumers from rising prices, Chavez imposed a series of price controls. These stipulated, for example, the maximum price for which one could sell a loaf of bread or a bar of soap. What Chavez failed to appreciate is that suppliers would be unwilling to put goods on shelves if they did not receive a profit. The result: shortages of everything from teabags to toilet paper. 

The cruel irony of price controls is that they cause the greatest harm to the very people they seek to help. It does not matter how cheap cooking oil is if no one can buy cooking oil. Price controls undermine the core benefit of free markets: that any two parties have the freedom to trade at a mutually agreeable price. 

Chavez, and now Maduro, have perpetuated ridiculously wasteful subsidies. Petrol subsidies have been scaled back, but a liter of fuel still costs less than a liter of water. Part of reason the government never built up sizable foreign reserves is because a large portion of oil revenue simply went to subsidizing oil consumption in the country. 

The government also insists on maintaining an official exchange rate which massively overvalues the Venezuelan bolivar. The government’s exchange rate is 10 bolivars to a US dollar. On the black market, however, the bolivar trades at over 1,000 to an American dollar. As a result, few are willing to trade their US dollars for Venezuelan bolivars—many, fearing the currency will decline further, are doing the opposite—so the country faces a grave shortage of foreign exchange. 

The fall in oil prices did not break the back of the Venezuelan economy. Oil revenues were merely a fig leaf partially covering the deep economic malaise in the country.

Putting Venezuela back on track will require liberal, free-market policies and the discontinuation of wasteful subsidies. To attract much needed dollars, the government must abandon its delusion that it can maintain the bolivar’s official exchange rate. The currency must be “floated”—allowed to trade at the market rate. Additionally, price controls, which have been responsible for the crippling shortages, must be abolished without delay. 

The immediate consequence of these measures will be heightened inflation as prices adjust upward. Importantly, however, shortages of essential goods will quickly disappear, and a competitive market will soon push prices down. Although the bolivar will at first depreciate further, the result will be to attract US dollars into the economy and ultimately strengthen the currency. Less tangibly, Venezuela will experience renewed international and domestic confidence, laying the groundwork for future development. The era of Chavez has passed. So too must the era of Chavismo. 

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