The Venezuelan Economic Crisis and Oil

Venezuelan economic woes that affect the general population will continue to worsen, even if oil prices rise again.

venezuelan-economic-oilVenezuela has been mentioned in the last few months repeatedly because of the precarious state of its economy.

It entered recession as of last year after GDP growth during the first three quarters contracted by more than two percentage points in each term. The Venezuelan inflation rate for 2014 was the world’s highest, 63.6 percent as reported by President Maduro (The Venezuelan Central Bank, the institution in charge of releasing data on macroeconomic indicators, stopped publishing inflation and other economic data after the third quarter).

The reason given by the Venezuelan president, as described in the link above, is that the United States is waging an “oil-war” aimed at Russia and OPEC members. This is of course an absurd analysis considering two important points.

First, the United States is not the only country over-supplying the crude oil market. Saudi Arabia, a key OPEC member, has refused to lower production quotas of the oil cartel because they have chosen to retain international market. Also, Russia is increasing production in pursuit of the same strategy. Venezuela cannot follow suit because brain drain in the national oil industry restricts the possibilities of increasing crude oil production in the capital-intensive industry.

Second, and most important, the price of crude oil plummeted in the fourth quarter of 2014, but the Venezuelan economy has contracted throughout the year. Hence, falling oil prices are an intervening variable of the current Venezuelan economic woes, not a causal one. This is because the international price of oil for the first three quarters of 2014 was traded at an average of 100 USD per barrel, which was the same average of roughly the last three years.

Hence, since there was no negative correlation between last year’s oil prices and economic performance (because oil prices were high when the economy was contracting in 2014), then there is no logical causal link between them. I would argue that the cause of the ongoing Venezuelan economic crisis is also the reason why the country was perceived in 2014 as the worst managed economy of the world: the retention of foreign exchange controls for over a decade.

In 2003 the government of the late President Chavez applied mechanisms of foreign exchange controls (allegedly to prevent capital flight) that have not only remained in place until today, but have been made less flexible with time. This has resulted in an artificially overvalued currency that encourages importing products from abroad instead of producing them at home (what in economics is referred to as the “Dutch disease”).

Also, resulting from the currency’s overvaluation is that it encourages a black-currency market and the smuggling of Venezuelan products to neighboring Colombia. This is especially true of gasoline, as it is sold in Venezuela at a couple of cents (USD) per gallon, as it is subsidized almost entirely in Venezuela, and then sold at international prices in Colombia. This results in an astronomic four-figure profit margin for smugglers. The government has repeatedly sated that it is tackling issues such as smuggling and economic woes.

However, press releases do not translate into action because the people in charge of combating those issues (the military–especially border guards–and high ranking government officials that control the flow of foreign exchange) are the ones benefited due to the fact that they appropriate most of the rent from smuggling and the black market. Therefore, the key to permit an economic recovery in Venezuela is not that oil prices rise again, is that its management improves.

The good management of the Venezuelan economy starts by a comprehensive structural adjustment that at its core sees the lifting of foreign exchange control, as it is the main factor distorting the domestic economy. However, this will not occur until the current Venezuelan governmental elites, both civilian and military, accept to restructure the economy, which will diminish or destroy their rent-seeking endeavors.

Hence, only if the current elites see their rent-seeking mechanisms evaporate before the enactment of an economic structural change will they agree to it. Nonetheless, it is difficult to assess what sequence of events, if any, will lead to this. It could take the full bust of the economy through hyperinflation, or widespread never-seen-before public riots, or international pressure from foreign governments and financial institutions, or some combination of the above.

What is certain is that under the current policy scheme the economic woes that affect the general population will continue to worsen, even if oil prices rise again.

Daniel S. Leon is a PhD candidate at the University of Leipzig, Germany.