Michael Eriksson's Blog

A Swede in Germany

A few thoughts on the crisis in Venezuela (and the importance of incentives)

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With Venezuela hitting the spot-light again, I decided to read up a little, specifically with the Wikipedia pages on the economy of Venezuela and on the Venezuelan economic collapse of 2016, and at least skimming several other articles, e.g on the Economic policy of the Hugo Chávez administration and Economic policy of the Nicolás Maduro administration.

These are two simultaneously very disturbing and very enlightening reads, especially when combined with e.g. the experiences gathered in the Soviet Union or, more recently, in Mugabe’s Zimbabwe. Extreme government control, lack of respect for private ownership and the rights of the individual, the lack of incentives to create growth, …, appears to lead to economic disaster everywhere it is tried. (As, of course, predicted by many more free-market minded economists for a very long time.) If we want economic growth, it is central to give people a reason to try to build something for themselves or their families, to make their own lives better, to give those who want to work or start business easy opportunity to do so, etc.; at the same time, it is valuable to have a connection between benefit and cost, to avoid waste and poor resource use. The ideas of Ayn Rand are often naively optimistic or simplistic, but the core principles are the right one—and while human nature causes capitalism and free markets to fail to some degree, its effect on strongly socialist, communist, “central planning” societies is far greater. A sad twist is that poverty often breeds an (understandable) wish for e.g. greater redistribution between “haves” and “have nots”, greater government control, etc.—but that these very measures salt the earth and reduce economic growth. (At least when taken beyond some point. See also an excursion below.)

The starting observation is that Venezuela is one of the poorest countries on earth, and currently likely has the worst developing economy—when it should be a very rich country. Indeed, in the mid twentieth century, it was… Why? Because Venezuela is one of the world’s most oil-rich countries, and oil, now as then, is an immense source of richness. (As can readily be seen by some oil-rich Arab countries; or by how Norway went from trailing Sweden to outclassing it in wealth, after beginning to exploit its North-Sea oil.) Today, “poverty” is too weak a word for the problem: Venezuela is suffering the equivalent of a severe heart-attack—and cannot afford a physician…

To detail what went wrong from then till now would require far deeper studies, but much of it can simply be grouped under the heading “unsound politics”, largely of an extreme Leftist character. Partially overlapping, partially not, we have problems like corruption, crime, and violence. A cardinal error is the over-reliance on oil, making the country vulnerable to economic crisis when the oil price falls—and to over-spending when it rises. A strong, functioning economy would benefit considerably from oil, but oil would not be its only leg: Other industries and areas of business, be it cars, electronics, software, various services, …, would be additional sources of wealth and dampen the fluctuations caused by oil.

To look at some more specific issues from the Wikipedia articles*:

*With the obvious reservation that I do not personally vouch for their correctness—and that I do not bring a great prior expertise on Venezuela. The contents do match my previous, more shallow, impressions both during the Chávez era and the last few years very well, however. Further, with the reservation that this is a very incomplete listing with few details; those interested really should read the original articles.

  1. Social programs* like the Bolivarian Missions have reduced incentives for the people to work and caused a massive cost burden, the harder to carry when oil prices were unfavorable.** At least one included land expropriations, disrupting existing production and giving land-owners great incentives to seek their fortunes elsewhere. Others have aimed at e.g. creating more cooperatives in lieu of regular businesses—despite the disputable or outright poor results such have had when attempted elsewhere (largely, in my opinion, due to poor incentives).

    *Apparently instituted more to gain political support among the poor than to actually improve their lives. Their effectiveness at the ostensible goals appears to have been limited. My take would have been far more positive, had the success rate been greater.

    **I stress that I do not rule out that there have been positive effects to counter-balance the negative; especially since Venezuela, even then, had people who actually were poor—not the “poor” people of today’s Germany or Sweden. However, this post is specifically about the development of the economy. Apart from those programs focusing on teaching, there is mostly negative or neutral effects to be found or expected.

  2. Property expropriations of various kinds (cf. also above) that give owners, including foreign companies and investors, incentives to leave.
  3. Price controls that reduce the incentives to produce and import (or increase the incentives to export) contributing to shortages and creating black markets. In the case of gas, effectively sold by the government, this also implied a missed income opportunity compared to selling the gas far more profitably abroad and finding other arrangements for the domestic situation. (This especially since the low gas price almost certainly led to wasteful use.)

    Of course, the help for the population is dubious: What good are lower prices when there is nothing to buy? What about the opportunity cost of standing in line, Soviet style, wasting time that could have gone towards earning money (usable to pay for more expensive goods)?

  4. Trying to keep the exchange rate to the U.S. dollar at an unrealistic level, reducing the country’s competitiveness, incurring additional costs, (again) creating black markets, … I also strongly suspect that this, contrary to intentions, has strongly contributed to the degree of inflation: Firstly, this type of dual rates could make the people lose faith in the currency and consider it worthless, rather than worth less. Secondly, it becomes a second choice for currency, seeing how much easier everything goes if one has a few dollars. That a price spiral (in the native Bolivares) then occurs is not the least surprising—and an actually usable currency with a single exchange rate would be preferable, even if this one exchange rate is far less favorable than the government prefers.
  5. Allowing* oil output to fall: This reduced the oil income even at times of high prices and made the fall in prices the more hurtful.

    *The word should be seen with some caution. This was likely a hard-to-prevent side-effect of other policies, and it might not have been in the power of e.g. Chávez to prevent. However, a government take-over certainly did not help…

Of course, these and other factors often interact negatively in vicious circles, e.g. in that poor living conditions and prospects make the best and the brightest leave the country, thereby reducing productivity and the attractiveness of Venezuela as a place of business, thereby worsening living conditions and prospects further. Or consider how poverty leads to more crime, which leads to less incentives to work and to run businesses, which leads to more poverty. There are also very often direct and indirect negative side-effects (in addition to the above), especially through the immense inflation of recent years—as well as, if to a lesser degree, the “merely” very high inflation of the decades preceding them.

What can be done to save the country? Barring a miraculous rise of oil prices followed by a complete turn-around in economic and other policy, I see little hope. The least bad resolution that is realistic might be a complete collapse and a fresh start—to build something new from the ashes, even if it means that the road is that much longer. Superficially reasonable analogies might be found in the German Weimar Republic or possibly the German or Japanese post-WWII economies—all instances of rapid recuperation from a disastrous situation. However, these situations differed in many regards, including that there was a strong tradition of successful industry and a great number of bright and educated people in the country, that the problems were largely caused by external events (own culpability notwithstanding), and that the state of the rest of the world made it far easier to become internationally competitive again. In the latter two cases, considerable external support have to be added.

Excursion on GINI and similar:
I deliberately do not include issues like “income inequality” or a high GINI* value, even though these can be common Leftist complaints. These are not normally problems per se; and might even, within limits, be positive. The real issue is something very different: Lack of social mobility, where our parents’ fortune or lack of fortune do more to determine our fortunes than do our own efforts. When the poor-but-bright-or-industrious can end up being wealthy, they are far more likely to have hope and to realize those hopes; and larger parts of society will strive to build something. On the other hand, when they have little chance of making themselves a good life, why should they bother?** (Be it because there is too little social mobility or because even a middle-class life is not very good, as has usually been the case in e.g. most Leftist dictatorships.) Similarly, I do not put that much stock in complaints about imperialism, foreign ownership, and other ever-recurring examples of Leftist scape-goats: Even if the actual profits were to leave the country, there are still positive effects in terms of local employees earning money, infrastructure improvements, foreigners spending money locally, … All other factors equal, local ownership is better for the locals; however, the factors seldom are equal—and experiences point to it being better to have foreign owners running a well-managed and profitable operation than, like in Venezuela, having locals running a disastrously mismanaged one.

*Another reason to consider GINI complete bullshit is that it is too simplistic a measure, not taking absolute wealth levels into account, potentially giving the same value for very different income distributions, and, above all, not considering why a certain situation has arisen (e.g. politics, demographics, high or low social mobility).

**In a twist, countries like Sweden and Germany can suffer from the reverse problem with the same effect—if someone can have a materially great life without putting in an effort, then why bother with the effort?

Excursion on approaches to raising living standards:
Venezuela well exemplifies an ever-recurring difference between the approaches of the Left and and large parts of the non-Left—the former focuses on changing the division of the pie, even at the risk of making the pie smaller; the latter at making the pie larger, even at the risk of increasing the difference in pie slices. In most cases, even the poor seem to fair better with the second approach…

Written by michaeleriksson

January 11, 2018 at 12:35 am

One Response

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  1. […] empirical evidence on this issue, as with China (discussed in the linked to article), the Venezuela of the last few decades, the old East vs. the old West Germany, etc.* Indeed, Germany’s likely […]


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