The House That Chavez Built

Love him or hate him, Hugo Chávez was a savvy politician — a point that one might see as ironically confirmed by the timing of his death. For the Venezuelan president leaves the scene at the peak of his political career, but just in time to miss what is likely to be a severe economic downturn. This downturn might have permanently blackened his legacy had he remained alive. It is, in any case, entirely of his making.

Politically, Chávez died at a moment of sky-high popularity among his supporters, in part because of his own ability to portray himself, over the last two years, as a true martyr, a man willing to sacrifice his health and his life for his country, his movement, and his people. At the same time he bolstered his reputation abroad through his lavish dispensation of foreign aid and trade. The Chávez administration’s spending on South-to-South aid in proportion to gross national income, for example, is second only to that of Saudi Arabia. Within Latin America, he learned late in his career that he could develop good relations even with countries on the opposite side of the political spectrum (Colombia, Chile, and Mexico) simply by becoming a leading importer of their goods. Learning to contain his criticisms of other Latin American leaders, as he did also late in his career, also helped.

So should his designated successor, Vice President Nicolás Maduro, actually manage to assume the presidency, he will find himself commanding a remarkable store of political capital. Yet Maduro (or whoever else ends up following in Chávez’s wake) will also inherit one of the most dysfunctional economies in the Americas — and just as the bill for the deceased leader’s policies comes due.

By now it’s widely understood that excessive dependence on commodity exports can distort an economy in fundamental ways. One manifestation of this principle is what has come to be known as “Dutch Disease” (named after the problems faced by the Netherlands as it reaped a windfall from North Sea oil in the 1970s). Dutch Disease occurs when a country that is excessively dependent on commodity exports experiences a price boom. The sudden inflow of foreign currency raises the demand for local currency, yielding an uncompetitive exchange rate. This overvalued exchange rate, if unaddressed, can kill the country’s other exports as well as stimulating an avalanche of imports, which can hurt domestic producers.

There is no question that Venezuela under Chávez came to experience one of the worst cases of Dutch Disease in the world. The Chávez government deliberately maintained an overvalued exchange rate during the oil boom that began at the end of 2003. Although there have been periodic devaluations (five in the last nine years), these were never deep enough. Because of this persistent overvaluation, Venezuela’s trading sector became increasingly distorted. Exports of fuels boomed, but by 2008 exports of everything else had collapsed. Meanwhile, imports have flooded the country on an unprecedented scale, to a greater extent than even during the free-trade years of the early 1990s.

All this would have been bad enough on its own. But Chávez’s response to Dutch Disease exacerbated Venezuela’s economic ills. Instead of, for example, squirreling away some of the country’s oil windfall profits in a rainy day fund, as a way of minimizing their impact on the rest of the economy, Chávez chose instead to spend lavishly on his constituents, creating the basis for the broad electoral coalition that kept him in power for so long. To the poor, he gave a vast array of social services, spanning doctors from Cuba, college degrees at newly created universities, free appliances, and even new homes. To the rich, he gave preferential access to exchange rates and hefty government contracts, all of which multiplied the fortunes of many wealthy Venezuelans. This overspending had a clear electoral bent. For the 2012 presidential election, according to the Venezuelan think tank Ecoanalítica, the government spent twice as much than it did for the 2006 presidential election.

This lavish spending wrecked Venezuela’s fiscal health. According to Barclay’s, Venezuela’s fiscal deficit went from 2.8 percent of GDP in 2007 to almost 16 percent in 2012. In addition, public sector debt has ballooned. Even the state-owned oil company, awash with cash, has increased its debt.

All of this stands in stark contrast to other petro-states around the world, who during the same boom period registered either huge fiscal surpluses or small deficits. Even the worst-performing economies of Europe (Greece, Spain, and Iceland) have deficits no higher than 7-8 percent of GDP, which look quite moderate in comparison to Venezuela’s. The resulting situation is so extraordinary, indeed, that we might be better off referring to this set of phenomena as a uniquely Venezuelan syndrome: “Venezuelan Disease.”

Overspending has two predictable effects. The first, a positive one, is to stimulate job creation. Today, Venezuela’s unemployment rate is an impressive 5.9 percent, lower even than that of Germany. The second, more negative, is inflation. In Venezuela, the inflation rate at the end of 2012 surpassed 25 percent, possibly the third-highest in the world (even loftier than that of Zimbabwe and Turkey, to mention just two of the worst inflation-offenders in recent memory). This inflation rate is all the more unusual given the high levels of imports, which tend to put downward pressure on prices.

Venezuelan Disease involves more than just fiscal profligacy. It also involves misguided responses to inflation. Populist governments tend to make their worst mistakes in dealing with inflation. Governments today, unlike in the 1960s, have learned to worry about inflation because it is one of the quickest ways to expand poverty. Inflation acts as a form of consumption tax that falls heavily on low-income, salaried groups, lowering their purchasing power dramatically. Populist governments in particular panic about inflation precisely because it hurts the very same group they want to court — namely, low-income workers. But rather than cutting back on spending and introducing productivity-boosting reforms (in order to increase the number of goods that currency units are chasing), populist governments respond to inflation by imposing microeconomic controls.

They tend to favor three types. Foreign exchange controls try to lower the demand for dollars by restricting access to them. Retail price controls make raising prices illegal. And labor market controls, which aim to protect low-income salaried workers, can range from raising the minimum wage to making it harder for employers to fire employees. Venezuela under Chávez saw all three forms of controls.

The problem is that these controls end up exacerbating the very same problems they are meant to address. For instance, exchange rate controls accentuate rather than alleviate the demand for dollars; those who hold increasingly undervalued bolívars, the Venezuelan currency, become desperate to get rid of them.

Price controls, in turn, precipitate a supply crisis. Producers facing price controls for their products, in a country with galloping inflation, soon discover that their costs exceed their allowable retail prices. At this point, production is no longer profitable. Producers must either discontinue that product (which yields scarcity) or switch to importing (which stimulates the demand for dollars, offsetting the government’s effort).

And labor controls produce more inflation and labor scarcity. By imposing an excessive increase in minimum wages, the government is actually increasing rather than decreasing the inflationary pressures on the private sector. And by creating restrictions on firing labor, the government creates labor scarcity.

This is a vital point. When workers cannot get fired easily based on job performance, they begin to underperform. In Venezuela under Hugo Chávez, the government increasingly restricted the ability of the private sector to fire workers. The latest labor code, for instance, makes it virtually illegal to fire workers for missing work. Venezuela is unusual in that firms need permission from the state to fire workers.  Consequently, absenteeism in the workplace is booming. In February, El Nacional, a Caracas daily, reported from various business chambers that absenteeism is on the rise, currently ranging from 5 to 46 percent depending on sector and firm.

The key point is that the excessively populist approach of relying on controls results in a microeconomic collapse. The entire economy, whether public or private, experiences a productivity crisis. In the Venezuelan public sector, the most embarrassing example is the oil industry, the government’s most important source of cash. The Venezuelan oil industry is in the midst of a schizophrenic episode. On the one hand, levels of proven oil reserves and export prices are at historical highs. But productivity has plummeted. So dismal is the oil sector’s situation that Venezuela now needs to import gasoline, and has a hard time finding creditors for its oil company (again, a remarkable thing for a petro-state).

If oil, the regime’s most important milk cow, is in trouble, the rest of the less vital state-owned enterprise is approaching a state of collapse. Ricardo Obuchi and colleagues at the Institute for Advanced Studies in Administration (IESA) in Caracas have been tracking the performance of state-owned companies, with alarming reports. For instance, cement production, whose sector was nationalized in 2008, is producing scarcity levels of up to 70 percent. Ten states thus far have reported severe electricity blackouts this year.

In the private sector, the most conspicuous sign of microeconomic ailments is consumer goods scarcity. This problem is so acute that the Central Bank even keeps tabs on the issue by publishing a scarcity index. In January 2013, the index indicated the highest level of scarcity in four years, with “critical scarcity” in eight basic food products, such as sugar and sunflower oil, and “serious scarcity” in nine others.

Declining productivity and rising scarcity in consumer goods seem to have taken many chavistas by surprise. But they have nonetheless been quick to name a culprit: the private sector. For them, this productivity slump is a sign that the private sector is conspiring against a popular government. This analysis prompts the government to become more belligerent toward the private sector, which in turn, leads to the worst effect of all: capital flight. According to Barclay’s, Venezuela has experienced capital flight ranging from 15 to 40 percent of exports every year since 2004, also unusual for petro-states which are, if anything, trying to cope with capital inflows.

Nicolás Maduro, Venezuela’s foreign minister under Chávez’s previous term and caretaker of the government during Chávez’s last medical leave, has pursued a similar approach. In January he lambasted the private sector for the economic crisis, denouncing “the hate that they have for the Venezuelan people.” In the few months that Maduro has been in charge, he has increased price controls on 50 items, and threatened firms and “hoarders” with more audits, more sanctions, more jail terms, and more nationalizations.

A reader might ask: Given all these ailments, why doesn’t the Venezuelan government ease up on populism rather than going for a “deepening” of the model, as Maduro has promised? Many factors account for the persistence of the status quo, but it is worth emphasizing both the economic and political factors sustaining the current policies.

The economic factor is the combination of large oil export revenues, which provides the cash, and the prospects of occasional devaluations, which can expand the government’s revenues. With each devaluation, the government has discovered that, when things get rough financially, there is always a chance of respite, with the stroke of a pen. The government can simply decree a change in the value of the bolívar, and fiscal problems ease for a while. For instance, Venezuela’s latest devaluation of 31 percent in February (from 4.30 to 6.30 bolívars to a dollar) is likely to give the government between 3 and 6 percent of GDP in bolívars that it didn’t have before. The devaluation will increase inflation significantly, no doubt, but it will ease (though not solve) the state’s financing needs, and this helps the government stay its course — even while deepening the economy’s weaknesses and hurting the poor over the medium term.

The political factor is even more pernicious. It has to do with who gets the blame. In an economy beset by scarcity, inflation, labor absenteeism, capital flight, and under-investment, many citizens attribute these problems to the private sector, rather than the state. They see the state as the only actor that can bring relief, in the form of welfare and more sanctions on businesses. The worse consequence of Venezuelan Disease is how easily it lends itself to misdiagnosis.

All this confronts the opposition with a difficult predicament. To beat Venezuelan Disease, the opposition faces two challenges: disrupting the economic basis of populist policies (the high oil prices with occasional devaluations), and redirecting blame for mistaken policies to the government, where it belongs. The former challenge is completely beyond the opposition’s capacity to influence, while the latter is extremely hard to shape. The opposition must not only point toward the problems in the country, which is easy, but it must also convince the majority that the problem is the state rather than the private sector. Good luck with that.

And yet, despite this combination of impossible and semi-impossible challenges, the Venezuelan opposition has not done as badly as one would think. Though the opposition suffered a serious defeat of 11 points in the October 7 presidential elections, its candidate, Henrique Capriles, did relatively well. Of the 20 elections that have taken place in Latin America against sitting presidents, only two have been won by the opposition. Among the rest, Capriles has been the largest vote-getter. Electorally speaking, Capriles has been able to mount the most successful opposition force in all of Latin America among politicians running against sitting presidents.

The reason for this relative success was twofold. First, the opposition maintained unity. Second, Capriles was successful in pinning blame for Venezuelan Disease on the government’s policies, though he failed to convince a majority.

The failure to defeat Chávez is still reverberating through the ranks of the opposition today. Up until 2010, the greatest challenge confronting the anti-Chávez forces was the tendency of their followers to abstain. The opposition fought that challenge successfully, managing to increase its share of the vote in absolute terms. Now the biggest task it faces is to contain its internal frustration. This frustration is fueling arguments for a more hard-line, unforgiving, and ideological approach toward the government.

The main risk of a more hard-line opposition approach is, of course, contagion. When one side digs in its heels, the other side will do the same. This is a strategy that could easily backfire for the opposition. In an electorate that is dominated by moderates leaning to the left, a situation of extreme belligerence between the poles will likely benefit the pole that is on the left.

Venezuelans are worrying today about a future without Chávez. But they should worry about the other things that are also missing from their country: price stability, labor productivity, economic diversification, and capital investments. These are the effects of Venezuelan Disease, a perfect example of how too much of a good thing (government overspending and regulation) can produce shortages of many other good things. Hugo Chávez did not get to witness the full effect of Venezuelan Disease. His successor will not be able to escape it.