Update: The Venezuelan Economy in the Chávez Years
By
Mark Weisbrot and Luis Sandoval
February
2008
Mark
Weisbrot is Co-Director and an Economist and Luis Sandoval is a Research
Assistant at the Center for Economic and Policy Research in Washington, DC.
Executive Summary
Venezuela has experienced very rapid growth since the bottom of
the recession in 2003, and grew by 10.3 percent in 2006 and about 8.4 percent
last year. The most commonly held view of the current economic expansion is
that it is an "oil boom" driven by high oil prices, as in the past,
and is headed for a "bust." The coming collapse is seen either as a
result of oil prices eventually declining, or the government's mismanagement of
economic policy.
There
is much evidence to contradict this conventional wisdom. Venezuela suffered a
severe economic growth collapse in the 1980s and 1990s, with its real GDP
peaking in 1977. In this regard it is similar to the region as a whole, which
since 1980 has suffered its worst long-term growth performance in more than a
century. Hugo Chávez Frías was elected in 1998 and took office in 1999, and the
first four years of his administration were plagued by political instability
that had a large adverse impact on the economy. (See Figure 2). This culminated in a military coup that temporarily
toppled the constitutional government in April 2002, followed by a devastating
oil strike in December 2002-February 2003. The oil strike sent the economy into
a severe recession, during which Venezuela lost 24 percent of GDP.
But in the
second quarter of 2003, the political situation began to stabilize, and it has
continued to stabilize throughout the current economic expansion. The economy
has had continuous rapid growth since the onset of political stability. Real
(inflation-adjusted) GDP has grown by 87.3 percent since the bottom of the
recession in 2003. It is likely that the government's expansionary fiscal and
monetary policies, as well as exchange controls, have contributed to the
current economic upswing. Central government spending increased from 21.4
percent of GDP in 1998 to 30 percent in 2006. Real short-term interest rates
have been negative throughout all or most of the recovery (depending on the
measure—see Figure 4).
The
government's revenue increased even faster than spending during this period,
from 17.4 to 30 percent of GDP over the same period, leaving the central
government with a balanced budget for 2006. The government has planned
conservatively with respect to oil prices: for example, for 2007, the budget
planned for oil at $29 per barrel, compared to an average price of $65.20
dollars per barrel for Venezuelan crude last year. The government has typically
exceeded planned spending as oil prices come in higher than the budgeted price,
so it is possible that spending would be reduced if oil prices decline.
However,
Venezuela has a large cushion of reserves to draw upon before an oil price
decline would begin to squeeze its finances. A decline in oil prices of 20
percent or more could be absorbed from official international reserves, which
at $34.3 billion at the end of last year (2007) are enough to pay off all of
Venezuela's foreign debt. This does not include other government offshore
accounts, which are estimated at as much as $21.5 billion. With its low foreign
debt (11.4 percent of GDP), the government could also tap international credit
markets in the event of an oil price decline. Furthermore, a collapse of oil
prices does not appear to be likely in the foreseeable future. The January 8 short-term
outlook of the US Energy Information Agency projects oil prices (WTI crude) at
$87.21 per barrel for 2008 and $81.67 for 2009, compared to an average price of
$72.3 for 2007. The risks of unanticipated supply shocks – especially in the
volatile Middle East − seem to be mostly on the downside, which would
increase prices.
The Chávez government has greatly increased social spending,
including spending on health care, subsidized food, and education. The most
pronounced difference has been in the area of health care. For example, in 1998
there were 1,628 primary care physicians for a population of 23.4 million.
Today, there are 19,571 for a population of 27 million. The Venezuelan
government has also provided widespread access to subsidized food. By 2006,
there were 15,726 stores throughout the country that offered mainly food items
at subsidized prices (with average savings of 27 percent and 39 percent
compared to market prices in 2005 and 2006, respectively).
The
central government's social spending has increased massively, from 8.2 percent
of GDP in 1998 to 13.6 percent for 2006. See (Table 2). In real (inflation-adjusted) terms, social spending
per person has increased by 170 percent over the period 1998-2006. But this
does not include PDVSA’s social spending, which was 7.3 percent of GDP in 2006.
With this included, social spending reached 20.9 percent of GDP in 2006, at
least 314 percent more than in 1998 (in terms of real social spending per
person).
The
poverty rate has been cut in half from its peak of 55.1 percent in 2003 to 27.5
percent in the first half of 2007, as would be expected in the face of the very
rapid economic growth during these years. (See Table 3). If we compare the pre-Chávez poverty rate (43.9
percent) with the first half of 2007 (27.5 percent) this is a 37 percent drop
in the rate of poverty. However this poverty rate does not take into account
the increased access to health care or education that poor people have
experienced. The situation of the poor has therefore improved significantly
beyond even the substantial poverty reduction that is visible in the official
poverty rate, which measures only cash income. Measured unemployment has also
dropped substantially to 9.3 percent in the first half of 2007, its lowest
level in more than a decade; as compared to 15.3 percent in the first half of
1999 and 19.2 percent in the first half of 2003 (coming out of the recession).
Formal employment has also increased significantly since 1998, from 45.4 to
50.6 percent of the labor force. Perhaps most importantly, employment as a
percentage of the labor force has increased by 6 percentage points since the
first half of 1999, which is quite substantial. (Since 2003, it has increased
by almost 10 percentage points).
The main
challenges facing the economy are in the areas of the exchange rate and
inflation. The Venezuelan currency is substantially overvalued. The government
is reluctant to devalue because this would raise inflation, which is currently
running at 22.5 percent and exceeds their target. Since there are exchange
controls and the government is running a large current account surplus (7
percent of GDP), there is nothing that would force a devaluation in the near
future (as for example, the currency collapses in Argentina, Russia, and Brazil
in the late 1990s). But this poses an intermediate-run problem, since even if
inflation is stabilized and begins to be reduced, current rates of inflation
will continue to appreciate Venezuela's real exchange rate. This makes imports
artificially cheap and non-oil exports too expensive on world markets, hurting
the tradable goods sector and eventually becoming unsustainable. It also makes
it extremely difficult for the economy to diversify away from its dependence on
oil.
Inflation
itself is a problem, now running at 22.5 percent. But it should be emphasized
that double-digit inflation rates in a developing country such as Venezuela are
not comparable to the same phenomenon occurring in the United States or Europe.
Inflation in Venezuela was much higher in the pre-Chávez years, running at 36
percent in 1998 and 100 percent in 1996. It has fallen through most of the
current recovery, from 40 percent annual rate (monthly, year-over-year) at the
peak of the oil strike in February 2003 to 10.4 percent in May 2006, before
climbing again to its present rate (see Figure 3).
Because
of its large current account surplus, large reserves, and low foreign debt, the
government has a number of tools available to stabilize and reduce inflation –
as well as eventually bring the currency into alignment – without sacrificing
the growth of the economy. It appears the government is committed to
maintaining a high rate of growth, in addition to its other goals. Venezuela is
also well-situated to withstand negative external shocks, including a likely
U.S. recession or even a serious global slowdown, a significant drop in the
price of oil, and problems in the international credit and financial system.
Therefore, at present it does not appear that the current economic expansion is
about to end any time in the near future.
Introduction
Like almost everything surrounding Venezuela, discussion of
Venezuela's economy is almost always polarized, with emphasis generally on the
negative. For example, for almost two years, major U.S. media outlets, as well
as more specialized publications[1]
stated that poverty had increased under the administration of President Hugo
Chávez. This was false, but the media did not correct its reporting until the
Center for Economic and Policy Research published a paper on the subject.[2]
This brief overview takes a look at Venezuela's economic
performance over the last eight years, examining the major economic indicators,
fiscal and monetary policy, the foreign sector, social spending and programs,
poverty, and other policy issues. The authors hope that it will contribute to
clarifying some of the important issues surrounding this controversial subject.
Economic
Growth
Many accounts of the Venezuelan economy today dismiss the
country's current rapid economic expansion as an "oil boom" that will
end in a disastrous bust, similar to what happened in the 1970s and early
1980s.[3]
It is therefore worth looking at Venezuela's growth in both current and
historical perspective to see if there is any basis for this commonly held
view.
Latin America as a region has suffered a sharp slowdown in
economic growth since 1980, from which it has yet to recover. For the 26 years
from 1980-2006, per capita GDP has grown only about 15 percent, as compared to
82 percent during just the 20 years from 1960-1980. This is the worst long-term
growth performance for more than a hundred years, although the last few years
have shown a significant improvement.
Venezuela was no exception to this trend, although its decline
from peak GDP in 1977 was sharper than most of the region, and lasted longer.
As can be seen in Figure 1,
real GDP per capita declined by 26 percent from 1977 to 1985. It hit bottom in
2003, 38 percent below its 1977 peak.
Since the first quarter of 2003, the economy has grown by a
remarkable 87.3 percent.[4]
There are several issues that arise when looking at this growth in both current
and historical perspective.
First, it must be noted that there are serious measurement
problems with the data prior to 1984.[5]
Without going into all of the measurement problems, there is a general problem
that in an oil economy, consumption and therefore living standards can rise
with the price of oil even as oil GDP declines in real terms. This is because
the rising price of oil can allow the producing country to buy more internationally, even while the
volume of oil produced (which is what real oil GDP measures) is constant or
declining. In fact, during the 1970s it was precisely the decline in output
from Venezuela and other OPEC nations that caused oil prices to rise. These
relationships can be seen in Figure
1. From 1970 to 1985, real oil output fell by 70 percent, while
consumption and non-oil GDP continued rising until 1977-78. Oil prices spiraled
enormously during this period, increasing by 948 percent from 1970 to 1980.
Oil prices collapsed beginning in 1981, and the Venezuelan economy
went down with them.[6] Is this sort
of unraveling ahead in Venezuela, as many analysts predict? Of course, the
future of oil prices is difficult to project. The January 8 short-term outlook
of the US Energy Information Agency projects oil prices (WTI crude) at $87.21
per barrel for 2008 and $81.67 for 2009, compared to an actual average price of
$72.3 for 2007.[7] The risks of
unanticipated supply shocks seem to be mostly on the downside, which would
increase prices. Most importantly, there is the potential for adverse supply
shocks from the Middle East, due to the general risk of widening war,
terrorism, or rebellion for major world suppliers in the region. However, there
is always the risk of an unexpected downturn in oil prices. If such an
unanticipated reduction in oil prices is temporary, Venezuela would seem well
prepared to withstand it. The government has about $34.3 billion, or about 15
percent of GDP in international reserves. This is much more than is needed to
maintain a safe level of reserves for imports or other needs. As discussed
below, the country also has relatively low levels of public and foreign public
debt, and if necessary could borrow rather than cut government spending or
public investment enough to seriously slow the domestic economy. The government
also budgets conservatively for oil prices that are far below current prices:
for 2007, the government budgeted for oil at $29 per barrel, whereas the
average price of Venezuelan crude oil was $65.20 (see below). The probability
of an economic collapse brought on by falling oil prices therefore appears to
be very small.
It is
also worth noting that the current economic expansion is far greater than the
1973-1977 upturn, when oil prices were also rapidly rising. As noted above,
since the first quarter of 2003, Venezuela's real (inflation-adjusted) GDP has
grown by 87.3 percent; during the 1973-1977 expansion it grew by 31 percent.
This is despite the fact that oil prices actually rose even more, and to a
higher level in real terms, from 1973-1980 than in their present climb from
1998. Although some of the recent expansion is clearly a rebound from the
2002-2003 oil strike/recession, the vast majority of it is not (see Figure 1). Thus the current
economic expansion has seen rapid growth even for an "oil boom," and
even given its recovery from the oil strike and recession. It seems likely that
the government's expansionary fiscal and monetary policies, and perhaps other
policies (e.g. exchange controls since February 2003 which have kept more
capital within the country) may have contributed to the rapid growth of the
present expansion.
Figure 2 shows Venezuela's real
quarterly GDP from 1998-2007 (third quarter).[8]
As can be seen from the graph, the trajectory of the economy appears to be very
heavily influenced by external shocks, especially political instability and
strikes. Chávez's first year (1999), which began with the price of Venezuelan
oil at its lowest point in 22 years, was marked by negative growth. But the
economy began to grow in the first quarter of 2000 and continued through the
third quarter of 2001. The next few months were a period of the most extreme
political instability: in December of 2001 the Venezuelan Chamber of Commerce
(FEDECAMARAS) organized a general business strike against the government. This
political instability, with much capital flight, continued through April 2002,
when the elected government was overthrown in a military coup. The
constitutional government was restored within 48 hours, but stability did not
return, as the opposition continued to seek to topple the government by
extra-legal means. Growth remained negative through the summer and fall of
2002, and then the economy was hit with the opposition-led oil strike of
December 2002-February 2003. This plunged the economy into a severe recession
during which Venezuela lost 24 percent of its GDP. The economy began to recover
in the second quarter of 2003 and has grown very rapidly since then.
While some macro-economic policies may have contributed to the
economy's poor performance for brief periods – for example the government's
temporary pro-cyclical fiscal policy at the beginning of 2002 – it is clear
that not only the price of oil but political instability played a very large
role in Venezuela's business cycles over the past eight years. After the
failure of the oil strike in February 2003 the opposition – especially after an
agreement reached with the government in May 2003 – began to focus primarily on
electoral means of dislodging the government. This culminated in a presidential
recall referendum in August of 2004. Thus, the political situation stabilized
considerably in mid-2003 and has continued to stabilize throughout the current
economic expansion.
The big upswing from the first to second quarter of 2003 was
driven by the recovery of oil production that was cut off during the strike.
But the economy's double-digit growth continued up to the present, with the
result that annual growth was 18.3 percent in 2004, 10.3 percent in 2005, and
10.3 percent in 2006. This growth has been concentrated in the non-oil sector
of the economy, with the oil sector barely growing at all for 2005-2006 (see Table 1).
As can be seen in Table
1, the private sector has grown faster than the public sector over
the last 8 years, and therefore the private sector is a bigger share of the
economy in 2007 than it was before President Chávez took office.[9]
Table 1 also shows the sectoral
growth of Venezuela's economy over the last nine years, through the third
quarter of 2007. The growth has all been during the current economic expansion
– the four years and a half from Q1 2003 to Q3 2007. The fastest growing sector
during this period has been finance and insurance, which grew 273.4 percent
during this period. Other fast-growing sectors included construction (135.1
percent), trade and repair services (148.1 percent), communications (111.6
percent) and transport and storage (103.6 percent). Manufacturing has done
better than the overall economy, with 93.9 percent growth, but this is not
enough growth in this sector to contribute to a process of serious
diversification away from its dependence on oil.[10]
In
subsequent sections, we will look at the trajectory of Venezuela's foreign and
domestic debt, balance of payments, foreign exchange reserves, inflation,
investment, government budget, and other indicators to assess whether there are
any serious economic imbalances that would justify the prevailing view that the
current expansion is headed for some sort of collapse. From what we seen so
far, however, there is at least a prima facie case that this is not
true. Rather it appears that the Venezuelan economy was hit hard by political
instability prior to 2003, but has grown steadily and quite rapidly since
political stability began improving in that year.
Social Spending, Poverty, and
Employment
When
evaluating the economic and social progress under the current government, it is
important to make two comparisons. One is the obvious comparison with the
situation prior to the Chávez administration, at end-1998 or the beginning of
1999. However, another comparison is also important: the period beginning with
the first quarter of 2003, because that is when the government first got
control over the national oil industry (Petróleos de Venezuela, S.A. -- PDVSA).
Oil production at that time
amounted to about half of the government budget and three-quarters of its
export revenue. Without control over these resources – and indeed when they are
controlled by hostile forces seeking to use or even sabotage them in order to
destabilize and/or overthrow the government – as happened in 2002 and 2003, it
is difficult if not impossible for the government to achieve much of anything
in the way of economic or social improvements. In fact, as the oil strike of
December 2002-February 2003 showed, it was impossible to even keep the economy
afloat while PDVSA was controlled by the opposition.
As an analogy, since the United
States has no comparable sector of such importance to the economy or government
revenue, imagine that the U.S. Federal Reserve were controlled by a board of
governors that was determined to use its control over monetary policy and
interest rates to destabilize the economy and government. Such a board could
wreak havoc on the economy simply by raising the Federal Funds rate to the
level where it would induce a recession. In such a situation, it would not
necessarily be fair to hold the executive branch or Congress responsible for
the resultant economic destruction.
Of course, in Venezuela,
looking only at the changes the first quarter of 2003 would also not be
appropriate, because it would measure economic and social change from the
bottom of a deep recession. That is why it is important to look at both
periods.
The
Chávez government has greatly increased social spending, including spending on
health care, subsidized food, and education. The state oil company alone was
responsible for $13.3 billion (7.3 percent of GDP) of social spending in 2006.[11]
The most
pronounced difference has been in the area of health care. In 1998 there were
1,628 primary care physicians for a population of 23.4 million. Today, there
are 19,571 for a population of 27 million. In 1998 there were 417 emergency
rooms, 74 rehab centers and 1,628 primary care centers compared to 721
emergency rooms, 445 rehab centers and 8,621 primary care centers (including
the 6,500 “check-up points,” usually in poor neighborhoods, and that are in the
process of being expanded to more comprehensive primary care centers) today.[12]
Since 2004, 399,662 people have had eye operations that restored their vision.
In 1999, there were 335 HIV patients receiving antiretroviral treatment from
the government, compared to 18,538 in 2006.[13]
The Venezuelan government has also provided widespread access to
subsidized food. By 2006, there were 15,726 stores throughout the country that
offered mainly food items at subsidized prices (with average savings of 27
percent and 39 percent compared to market prices in 2005 and 2006,
respectively).[14] These plus
expanded special programs for the extremely poor (e.g., soup kitchens and food
distribution) benefited an average of 67 percent and 43 percent of the
population in 2005 and 2006 respectively.[15]
These do not include the 1.8 million children that were beneficiaries of a
school food program in 2006, compared with 252,000 children in 1999.[16]
Access to education has also increased substantially. For example,
the number of public schools in the country has increased by 3,620 from 17,122
in the 1999/2000 school year to 20,873 in the 2004/2005 school year. By
comparison, in the period between the 1994/1995 and 1998/1999 school years, the
number of public schools increased by 915.[17]
School enrollment has also increased at all educational levels. For example, in
the period between the 1999/2000 and 2005/2006 school years, gross enrollment
rates for preschool have increased by 25 percent, for primary education by 8.3
percent, for secondary education by 45 percent and for higher education by 44
percent.[18]
Over one million people also participated in adult literacy programs.[19]
The government has also increased its collection of non-oil taxes
on businesses,[20] which had
been avoiding their taxes, as is common in most of Latin America.[21]
Table 2 shows the central
government's social spending from 1998 to 2006. There has been a massive
increase, from 8.2 percent of GDP in 1998 to 13.6 percent for 2006. In real
(inflation-adjusted) terms, social spending per person[22]
has increased by 170 percent over the period 1998-2006. But this does not
include PDVSA’s social spending, which was 7.3 percent of GDP in 2006. With
this included, social spending reached 20.9 percent of GDP in 2006, at least
314 percent more than in 1998 (in real social spending per capita).
The poverty rate has been cut in
half from its peak of 55.1 percent in 2003 to 27.5 percent for the first half
of 2007, as would be expected in the face of the very rapid economic growth
during these years. Table 3
shows the poverty rate since 1997, by household and population. If we
compare the pre-Chávez poverty rate (43.9 percent) with the first half of 2007
(27.5 percent) this is a 37.4 percent drop in the rate of poverty, which is
substantial.[23] However
this poverty rate measures only cash income – it does not take into account the
increased access to health care or education that poor people have experienced.
As we have shown previously, taking the most conservative estimate of just the
value of the health care benefits – what the poor would have spent on health
care in the absence of these new programs – would lower the measured poverty
rate by about 2 percentage points.[24]
Of course, this is a very conservative estimate of the value of just the
increased health care benefits to the poor, since in the absence of these
benefits, most poor people would simply have gone without health care, and
therefore suffer from worse health, lower income, and lower life expectancy. So
the value of these health care services is much greater than the amount that
they would have spent out-of-pocket in the absence of the government programs.[25]
The situation of the poor has therefore improved significantly beyond even the
substantial poverty reduction that is visible in the official poverty rate,
which measures only cash income.
In evaluating government policy with respect to poverty, it is
also worth noting that the sharp spike in the poverty rate at the end of 2001
(39 percent) to its peak of 55.1 percent in the second half of 2003 is
overwhelmingly attributable to the opposition oil strike of 2002-2003. There is
little doubt that poverty would be even lower today if not for the enormous
economic damage caused by this strike. Unemployment has also dropped sharply
during the current economic recovery. As can be seen in Table 4, the unemployment rate has
fallen from 19.2 percent in the first half of 2003 to 9.3 percent in the first
half of 2007,[26] its lowest
level in more than a decade. If we compare to the beginning of the Chávez
administration, unemployment stood at 15.3 percent in the first half of 1999.
By any comparison, the official unemployment rate has dropped sharply. Of
course, an unemployment rate of 9.3 percent in Venezuela, as in developing economies
generally, is not comparable to the same rate in the United States or Europe.
Many of the people counted as employed are very much underemployed. But the
measure is consistent over time, and therefore shows a considerable improvement
in the labor market. This can be seen in other labor market indicators. For
example, employment in the formal sector has increased to 6.17 million (2007
first half), from 4.40 million in the first half of 1998 and 4.53 million in
the first half of 2003. As a percentage of the labor force, formal employment
has increased significantly since 1998, from 45.4 to 50.6 percent (2007).
As can be seen in Table
4, there has been an increase of about 1.8 million jobs in the
private sector and 578 thousand jobs in the public sector since the first half
of 1999. Perhaps most importantly,
employment as a percentage of the labor force has increased by 6
percentage points since the first half of 1999, which is quite substantial.
(Since 2003, it has increased by almost 10 percentage points). Private
employment was also a larger percentage of the labor force (75.0 percent) in
the first half of 2007 as compared to the first half of 1999 (71.6 percent).
However, both of these indicators probably understate the improvement in the
labor market since the number of people who were out of the labor force for
education – as access to education was increasing – rose by more than 3.4
percentage points, relative to the labor force, during this period.
Fiscal and Monetary Policy, Exchange
Rates, Balance of Payments, and the Sustainability of the Current Economic
Expansion
As noted previously, one of the most persistent themes in
reporting on, and discussion of, Venezuela's current economic expansion is that
it is an oil boom headed for collapse. Although some of these statements rely
on a drop in oil prices as the trigger for Venezuela's economic collapse, many
such prognostications offer little in the way of concrete explanation as to
what will bring the current expansion to a halt.[27]
This is quite different from predicting, for example in the United States at
the peak of the 1990's stock market bubble, that stock prices would fall
sharply and that this loss of wealth would cause a recession (as did actually
happen). Or that the housing bubble, which appears to have peaked in July 2006,
would have to burst and that this deflation (through the wealth effect and
credit impacts of falling home prices, a shrinking construction sector, etc.)
will cause a recession. In these cases one can estimate the overvaluation of
asset prices, the size of the expected correction, and the expected impact of
such a correction on the economy.[28]
But given the vagueness of this popular conception of Venezuela's expected
economic troubles, it is not possible to address the argument with this kind of
specificity; however, it is possible to look at the Venezuelan economy and see
if there are any serious economic imbalances that threaten to cut short the
current economic expansion.
Venezuela has budgeted conservatively with respect to the price of
oil, and the prospect of a collapse in oil prices in the foreseeable future
seems unlikely – as described above. Critics also point to the run-up in
government spending as an unsustainable trend. Table 5 shows the government's finances since 1998. As
can be seen, there has indeed been a very large increase in central government
spending, from 21.4 percent of GDP in 1998 to 30 percent in 2006. However,
revenues increased even more, from 17.4 to 30 percent of GDP over the same
period, leaving the central government with a balanced budget for 2006. For
2007, the government has once again budgeted very conservatively for oil at $29
per barrel, 56 percent under the average $65.20 dollars per barrel that
Venezuelan crude sold for last year. For 2008, the government has assumed a
price of $35 per barrel. However, what the government generally does as oil
revenue far exceeds the budgeted price, is to spend beyond budgeted
expenditures. Thus, while a fall in oil prices will not cause a budgetary
crisis, it could lead to reduced government spending from current levels. This
could slow the economy from its present very rapid pace, but it is unlikely to
cause a downturn, because Venezuela has a considerable cushion to deal with a
decline in oil prices.
As can be seen in Table 5 and Table 6, Venezuela has taken
advantage of the current expansion and increased oil revenues to reduce its
public debt, and especially foreign public debt. Total public debt increased
quite substantially through the crisis of 2002-2003, reaching a peak of 47.7
percent of GDP in 2003. But by 2006 it was down to a modest 24.3 percent of
GDP. The government also
transitioned away from foreign financing, leaving the external component of the
foreign debt at just 15.0 percent of GDP. Total interest payments on the public
debt, foreign and domestic, summed to a relatively small 2.1 percent of GDP in
2006.
Thus there is plenty of room to borrow, if necessary, if Venezuela
were to face an unexpected decline in oil revenues. But before having to
borrow, the government could dip into its international reserves. As can be
seen in Table 6 (below),
the government's foreign exchange reserves by the end of 2007 were $34.3
billion, or about 15 percent of GDP. Also, if we add the offshore accounts of
the FONDEN and the National Treasury to the current level of international
reserves, the total is in excess of $50 billion. The government's revenue from
oil in 2006 was $28.9 billion. In the face of an unanticipated decline in oil
prices, the government could therefore draw on reserves and borrowing from
financial markets for some time before any serious budget cuts would be
necessary. For example, if oil revenue were to decline by as much as 30
percent, this could be absorbed from reserves, which would otherwise be
expected to grow over the next year.
Another common feature
of the "oil boom to be followed by bust" analysis of Venezuela's
economy is that government spending is fueling rapidly rising inflation, which
will spin out of control. According to this theory, which also is not well
specified, either the inflation itself would cause a crisis – e.g. become
hyperinflation – or the government would be forced to put the economy into a
sharp contraction in order to avoid or reduce dangerous levels of inflation.
Figure 3 shows
Venezuela's monthly year-over-year inflation rate since 1991. As can be seen in
the graph, inflation declined steadily from May 1998 to January 2002, from a 40
percent to a 12 percent annual rate. It then rose rapidly during Venezuela's
worst political instability, from February 2002 to February 2003. This period
included the military coup of April 2002 and most importantly, the oil strike
of December 2002 to February 2003, which generated major supply shortages and pushed
inflation back up to a 40 percent annual rate. After the strike ended,
inflation declined steadily again for the next three and a half years, despite
the rapid growth during recovery that began in the fourth quarter of 2003. But
since June 2006 there has been another upswing, pushing the year-over-year
inflation rate from 10.4 percent to 22.5 percent (December 2007).
The current uptick in inflation is fueled by a combination of
shortages and the accumulated effects of four and a half years of very rapid
growth. How serious of a problem is this increased inflation, and could it lead
to an economic crisis and/or the end of the current economic expansion? First,
it should be kept in mind that there is no consensus in the macroeconomic
research on inflation as to how high it can go without a negative impact on
growth, with some studies finding a threshold of 20 percent or more – a
threshold that Venezuela is just now passing.[29]
Second, it should be emphasized that double-digit inflation rates in a developing
country such as Venezuela are not comparable to the same phenomenon occurring
in the United States or Europe. Inflation in Venezuela was much higher in the
pre-Chávez years, running at 36 percent in 1998 and 100 percent in 1996.
Although much of the public does not understand this, it is real
(after-inflation) growth in incomes— and employment – that affects people's
living standards, not the rate of inflation per se. This is true so long
as inflation does not spiral to the point where it actually reduces real
growth. So far, it does not appear that inflation in Venezuela is getting out
of control.
Furthermore, since the country is running such a large current
account surplus, and the government is taking in more revenue that it can
spend, it has a number of tools to fight inflation without necessarily
sacrificing economic growth. One has been sterilization, whereby the government
takes excess domestic currency out of circulation by issuing bonds. The recent
sale of $7.5 billion worth of bonds by PDVSA in April, which were snapped up by
a large number of investors,[30]
are an example of the government using bond sales for this purpose. Venezuela's
current account surplus also gives it the leeway to defuse inflation through
imports. This is what happened through most of the current economic recovery,
when inflation was falling despite very rapid growth – excess domestic currency
was converted into dollars and spent on imports. As can be seen in Table 6, imports tripled from
their depressed level of $10.5 billion in 2003 to $32.5 billion, or 17.9
percent of GDP in 2006. But exports, fueled by rising oil prices and the
recovery of oil production from the strike, grew much faster, from $27.2
billion in 2003 to $65.2 billion, or 36 percent of GDP. As a result, the
country has been running a huge current account surplus: it was 15 percent of
GDP for 2006. In the first three quarters of 2007 this surplus has shrunk
considerably, but is still about 7 percent of GDP.
In sum, inflation has been rising over most of last year but it is
not an imminent threat to the current expansion. This is likely to remain the
case so long as Venezuela maintains a large current account surplus.
Nonetheless, the government will need to make sure that inflation does not
begin another upward climb of the sort that has happened over the last year.
Fortunately, given the government's favorable current account, international
reserves and borrowing capacity, it has the ability to bring down inflation
without a sharp slowdown in economic growth.
There have also been reports of shortages of foods such as beef,
sugar, corn oil, milk, chicken and eggs. In most cases these foods can be
purchased in various black markets when they are unavailable in supermarkets
and the Mercal centers. These shortages are generally believed to be at least
partly a result of price controls, the rapid growth of the economy and
consumption, as well as hoarding of some items. While this may become a
political problem if it persists or worsens, it is something that the
government can easily mitigate. Even more so than in the case of inflation, the
government has the ability to ease any shortages through imports, and
presumably would do so if there were a serious threat of economic or political
damage.
The most serious economic imbalance is the exchange rate. The
bolivar is pegged at 2,150 to the dollar; it was fixed at 1,600 in February
2003 when the government implemented foreign exchange controls. If we assume
that the currency was neither overvalued nor undervalued when the exchange
controls were implemented – more likely it was already overvalued – we would
expect a depreciation to about 3,182 as a result of Venezuela's inflation.[31]
Thus the Venezuelan currency is at least 48 percent overvalued relative to the
dollar. It is worth noting that this is not necessarily overvalued to the
extent indicated by the parallel market rate, where the currency has
depreciated rapidly over the last year, to more than 6,000 bolivares per
dollar. Nonetheless the currency is still significantly overvalued. This is
something that will have to be remedied if Venezuela is going to pursue a
long-term development strategy that diversifies the economy away from oil. An
overvalued currency discourages the development of non-oil sectors, especially
manufacturing. It makes imports artificially cheap and the country's exports
more expensive on world markets, thus putting the country's tradable goods at a
serious disadvantage in both international and domestic markets.[32]
This is a serious long-term development problem. There are also distortions and
inefficiencies associated with the system of exchange controls and the parallel
market.
The overvalued fixed exchange rate, combined with present levels
of inflation, also presents a significant intermediate-term problem. Even if
inflation is stabilized and begins to be reduced, so long as it remains at or
near current levels and the nominal exchange rate remains fixed, Venezuela's
currency will become increasingly overvalued. This will increasingly squeeze
domestic production outside of oil and non-tradables, and would eventually
become unsustainable.
Nonetheless, Venezuela's overvalued exchange rate does not present
the kind of immediate threat that e.g., overvalued exchange rates in Argentina,
Mexico, Brazil, or Russia presented in the 1990's, where a sudden and forced
devaluation was imminent. The cost of adjustment in such situations can be
quite significant, as it was in Argentina and Mexico. But the Venezuelan
government has a number of options for bringing the currency to a more
competitive level over time, given its large current account surplus. The
government is understandably reluctant to devalue at present, when it is trying
to stabilize an inflation rate that has risen sharply over the last year. But
it is a problem that must be dealt with sooner or later.
Real interest rates have been negative throughout the recovery as
measured by the 90-day deposit rate, or most of the recovery (as measured by
the lending rate[33]). This is
shown in Figure 4. These
low interest rates, combined with the government's expansionary fiscal policy,
have no doubt contributed to the economy's rapid growth since the fourth
quarter of 2003. It is worth noting that the government's currency controls,
originally enacted in February 2003 as a means of limiting capital flight from
the country, have enabled it to pursue expansionary fiscal and monetary
policies while maintaining a fixed exchange rate. Thus the overall combination
of macroeconomic policy has been successful at promoting rapid growth, although
with an increasingly overvalued real exchange rate.
Finally, another recurring theme is that Venezuela's economic
growth will be cut short from a lack of investment, as investors – both foreign
and domestic – perceive the economy to be an unfavorable investment climate. Table 6 also shows gross
capital formation and gross fixed capital formation since 1998. As can be seen
from the totals, gross fixed capital formation stagnated from 1998-2001 and
collapsed by 57 percent during the worst instability and oil strike of
2002-2003. However, it has grown enormously during the current economic
expansion. It rebounded sharply in 2004, growing by 49.7 percent year-over-year
in real terms. It has continued its rapid growth through the present,
increasing by 38.4 percent in 2005, and 26.6 percent in 2006. For the first
three quarters of 2007, gross capital formation is up 24.6 percent
year-over-year.
These figures do not separate public and private investment. Data
for gross capital formation which does make this separation is available
through 2005. In that year, gross private capital formation represented 14.9
percent of GDP, an increase from 12.7 percent in 2004 and 6.9 percent in 2003,
indicating an increasing share of private investment in the economy during this
period. It is possible however, that private investment has not kept pace with
the growth of public investment after 2005. We do know from Central Bank
balance of payments data that foreign direct investment in Venezuela was
negative for the year 2006, for the first time in eight years of the Chávez
government. This is a significant change, although not that large, as foreign
direct investment in Venezuela was about 1.8 percent of GDP in 2005. But we do
not know yet how much of the growth in total or fixed capital formation of the
last two years has been private versus public.
But even if private investment is lagging, public sector
investment has been badly neglected for decades and there is much potential
there to improve the productivity of the economy – as was most famously
demonstrated by the collapse, and then recent repair of the Viaduct 1 bridge
that was a vital part of the route from the La Guaira airport to Caracas. If
private investment does not keep up with the economy's rapid growth, it is not
clear that this will necessarily slow Venezuela's growth and development.
In 2006, the government nationalized the telecommunications giant
CANTV and some of the country's electricity generation (which was already more
than 80 percent in the hands of the government). It has also taken a majority
stake in its joint ventures with foreign oil companies in the Orinoco basin.
These moves have generally been portrayed as very negative not only for
Venezuela's investment climate but also for its economic future.
However, it is important to keep some perspective on these
changes. The telecommunications sector was nationally owned and then privatized
in the 1990s. Companies were compensated fully for their assets: "I think
this deal is a fair one," AES chief executive Paul Hanrahan said at a news
conference in Caracas adding that negotiations had "respected the rights
of investors."[34]
CANTV has a near-monopoly on land phones and Internet service, and has been
slow to expand access – Venezuela's Internet access remains below average for
the region, with 125 users per 1000 people, as compared to 156 for Latin
America.[35]
(This is particularly bad because Venezuela is far above average in per capita
income for the region).
In the oil sector, the
first round of negotiations were settled for 31 of 33 contracts, with only
France’s Total and Italy’s ENI choosing to leave. Last year, most of the
remaining joint ventures were also renegotiated, but Exxon-Mobil and
ConocoPhillips announced that they had rejected the government's offer and
would pull out. Venezuela is one of the only major oil-producing states in the
developing world that allows foreign investment in oil production – even US
allies such as Mexico and Saudi Arabia, for example, do not. Venezuela's
reserves of heavy crude in the Orinoco region are now estimated to be among the
largest in the world, so foreign companies have strong incentives to stay
involved. They also face increasing competition from state-run companies from countries
such as China, Brazil, India, Russia, and elsewhere.
In sum, the Venezuelan government's moves toward increased state
involvement in the economy have not involved large-scale nationalizations or
state planning, and have been careful not to take on administrative functions
that are beyond its present capacity. As noted above, the government has not
even increased the public sector's share of the economy. The central
government's spending, at 30 percent of GDP, is far below such European
capitalist countries as France (49 percent) or Sweden (52 percent). There is
still plenty of room for both private and public investment.
Conclusion
In sum, the performance
of the Venezuelan economy during the Chávez years does not fit the mold of an
"oil boom headed for a bust." Rather it appears that the economy was
hit hard for the first few years by political instability, and has grown
rapidly since the political situation stabilized in the first quarter of 2003.
High oil prices have certainly contributed to this growth, as has the
government's expansionary fiscal and monetary policy. Containing and reducing
inflation, as well as realigning the domestic currency, appear to be the most
important challenges in the intermediate run; in the long run, diversifying the
economy away from its dependence on oil is also a major challenge.
However, the declining public debt (as a percentage of GDP), the
large current account surplus, and the accumulation of reserves have given the
government considerable insurance against a decline in oil prices. This
favorable macroeconomic situation has also left the government with much
flexibility in dealing with inflation and the related imbalance in the exchange
rate. Since the government is committed to maintaining solid growth, it does
not seem likely that it would sharply curtail economic growth in order to bring
down inflation, as is often done. This is especially true since it has not
exhausted other alternatives. Venezuela is also well-situated to withstand
negative external shocks, including a likely U.S. recession or even a serious
global slowdown, a significant drop in the price of oil, and problems in the
international credit and financial system. Therefore, at present it does not
appear that the current economic expansion is about to end any time in the near
future. The gains in poverty reduction, employment, education and health care
that have occurred in the last few years are likely to continue along with the
expansion.