The Venezuelan Economy
Venezuela is an interesting country. It has some of the highest crime in the world, especially in Caracas, as well as a complicated political history that includes the notorious Hugo Chavez’s reign. Perhaps most interestingly, and certainly most troubling, is the country’s economy. Venezuela’s exports are heavily concentrated in oil — and by heavily, I really mean exclusively. More than 95% of its exports have historically been oil. This was great for the country during the oil boom, coincidentally when Chavez was president. Venezuela was actually a relatively wealthy country in the early 2000’s when oil prices were soaring, but because of Chavez’s general incompetence, arbitrary nationalization of key industries, and overarching arrogance to think that he had made Venezuela prosperous, not oil, the country was due to come crashing back down. This started to happen by the end of Chavez’s presidency as poverty levels started rising, murder rates exploded, and inflation went from a general nuisance to a big, big problem.
In order to dive into the inflation problem, let’s first discuss the underlying economics. The notion of a country with such a heavy concentration of the economy in one area (in this case, oil) is rare, but not unprecedented. In fact, the most famous historical example spawned the name for this phenomenon — “Dutch Disease.” In 1959, the discovery of the large Groningen natural gas field in the Netherlands created a tremendous dependence on natural gas exports for the country’s prosperity. It inspired the work of economists W. Max Corden and J. Peter Neary that created the Dutch Disease economic model. In this model, a country has three sectors: a services-based, non-tradable sector (let’s say Sector A), a tradable, booming sector (Sector B, oil in the Venezuela example), and a tradable, lagging sector (Sector C, everything else in Venezuela). When Sector B takes off, it has two immediate effects on the overall economy. First, the boom in Sector B increases the demand for labor in that Sector, and at some point begins to draw from the labor available to Sector C. Second, the boom in Sector B increases the money and spending in the country’s economy, which in turn increases the viability of Sector A. As an example, imagine how spending at restaurants, movie theaters, stores, etc. changes when wealth is introduced to an economy. This increase in spending in Sector A simultaneously increases Sector A’s labor demand (movie theaters, restaurants, stores, etc. being hiring more people and opening more locations). This labor demand also eventually dips into the labor supply available to Sector C. So Sectors A and B are doing great, and Sector C is gutted from a labor-perspective. Sector B and C are tradable goods, and therefore their market price is set by factors beyond the single economy of this country. Sector A is made up of services, which are mostly considered non-tradable goods, and therefore the increased spending in Sector A compared to the slower-growing supply makes “real” prices go up. Because the prices of the tradable goods are staying the same while the prices of the non-tradable goods are increasing, the country’s currency appreciates in value. So, for example, say oil is 1 currency unit per liter and movie tickets used to be 8 currency units per ticket. Now, with the changes discussed above, oil is still around 1 currency unit per liter (because the price is set in the world market), but a movie ticket’s price is now 10 currency units. This means a movie ticket is now worth 10 liters of oil (or the “real” price of a movie ticket is 10 liters of oil), whereas before it was only worth 8 liters. This is a simple example of currency appreciation. The value of the goods in the country has become greater in terms of the goods it can buy from another country. On the other hand, the value of things in the country that foreign currency can buy has gone down. So, all in all, the currency in the country has made foreign goods cheaper for those in the country (imports) and made the country’s goods more expensive to those in foreign countries (exports).
This country is now in an odd spot — the economy is doing well because of Sector B and the value of its currency has appreciated as described above. This creates a third negative effect. Because the the country’s imports have become relatively cheaper and their exports have become relatively expensive, the country will increase the number of goods imported and reduce the number of goods exported, as other countries’ demand for their exports decreases. This further decimates Sector C in the country, as an already reeling sector now faces increased competition from the “cheaper” imported goods that it competes against, as well as less demand for the goods on the international market because of reduced exports. Especially if Sector C is something like manufacturing that requires money to be invested back in to maintain its infrastructure, this is the beginning of the end for the country’s good economic days.
Now this whole economic situation has been predicated upon the discovery of some resource like oil that has made Sector B explode with prosperity. What happens if that resources either runs out, or its value plummets in the world market? Sector B will tank relative to its previous heights, and Sector C has been summarily eviscerated as described above, and can’t carry the economy. Sector A is buoyed by spending, and now that B and C are both down, there is no money to be spent. The economy is devastated, and the prices of goods in terms of other resources or currencies plummets. For example, what $1 USD may have previously bought in this country could maybe be purchased for $0.75 USD. Or worse — $0.15 USD. This is called inflation, or in the case of the $1 USD to $0.15 USD: hyperinflation.
This exact scenario happened in Venezuela. When oil prices tanked by 66% in 2014, Venezuela’s economy crashed. All of its other sectors had been suppressed at the expense of oil, and now the country had nothing to fall back on. Because of this, the value of the bolivar (Venezuela’s currency) came way down relative to other worldwide currencies. President Maduro, the man who had succeeded Hugo Chavez, tried to control the exchange rate rather than letting it fall, fixing the bolivar-USD exchange rate independent of the actual market rate. He also ordered the banks to print more cash. This had the worst possible effect — there was more cash in the market but less economic value to tie it to than ever before. This made the price of goods within Venezuela skyrocket. What used to cost 250 bolivar started to cost 2000. It also created a unique situation at state-run stores (artifacts of Chavez’s socialism) that provide food and other basic supplies. The government currently fixes the exchange rate at 10 bolivar = $1 USD. This allows them to price food at a state-run store at reasonable prices for poor Venezuelans to purchase. However, the actual black-market conversion rate for bolivar to USD is something like 1100 to 1. So if someone finds $1 USD on the street, they can go to the black market and convert it to 1100 bolivar. Then they can buy an item of food for 10 bolivar at the state-run store, and immediately sell it on the black-market for 1100 bolivar. If you scale this strategy, you can make a lot of money. So many Venezuelans have taken to camping outside state-run stores to snap up the food and supplies for the delusional state-sponsored prices, and then resell for 100x as much on the black market.
Another wild aspect of all of this is how the crazy inflation manifests itself. Because the bills have become worth so little, people have to carry around literal bags full of cash to buy anything from a store. Some shopowners have even resorted to weighing cash rather than counting it, because the sums are so large that weighing the bills is a close enough estimation. The equivalent of drawing $5 from an ATM will leave you with 100 bills. Because of this, many ATMs run out of cash every three hours, and there are often only a few working ATMs at a time across Venezuela. Business owners have no idea what to do with the massive amounts of cash they bring in. Some have resorted to just hiding bags of it around their offices and homes, or even burying it in their backyards.
The saddest part of all of this is that it only stands to get worse. President Maduro has announced plans to issue more money in the largest ever denominations of Venezuelan bills starting in January. It all adds up to a pretty bleak situation: supermarkets are empty, power shortages are so common that government offices are only open two days a week, and the entire health care system has collapsed. This all culminates in a lesson to be learned —a country should never depend on one resource for all of its prosperity, because downside is pretty damn severe.
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