Venezuela: an economy in dire straits

Rafael Pampillón

18 March 2003

Venezuela’s economy fell to record lows last year. Inflation, high interest rates, capital flight and excessive dependence on its oil are to blame. But that’s not all: a foreign debt crisis could be looming.

Venezuela ended 2002 with a lower income-per-inhabitant figure ($3,250) than 1950 ($3,500). In real terms, the population's average income not only stagnated, but dropped to a level lower than 1950. How is it possible that a Venezuelan can earn less in 2002 than in 1950? Over half a century of wasted development! How has a nation with some of the brightest prospects in the western hemisphere managed to sink so low?

During 2002 the economy showed the worst results in its history. GDP fell 7 percent – the greatest fall since 1989. Two percent negative growth is foreseen for 2003, and per-capita income will slide even further – to $3,000. Inflation will end the year at 40 percent. Those – to date – excellent solvency indicators are starting to feel the effects of the crisis, so much so that analysts wonder if Venezuela may be facing the possibility of a debt crisis.

The main problems confronting Venezuela are social. Unemployment has continued to grow, reaching 11 percent in 2002, deteriorating the social climate to unbearable levels and leading to sharp increases in the so-called submerged economy. The Venezuelan Institute for Economic Research predicted that 70 percent of families could fall below the poverty level by the end of 2002, and that extreme poverty could hit 43 percent of the population.

Venezuela’s economy ended the year with high interest rates, soaring inflation, a recently devalued exchange rate, excessive public spending, dwindling private investment, increased taxes, a negative budgetary balance, exaggerated dependence on oil exports, flight of capital and fiercely protectionist, populist policies. Not a very flattering scenario. Investors are running scared and capital is leaving the country.

What signs are there that Venezuela could suffer a foreign debt crisis? The nation has always been characterized by its closed economy, dependent – practically entirely – on the oil that constitutes its principal revenue source to meet its obligations. It relies on oil as the chief means of generating taxes and luring foreign money. This results in a highly volatile tax intake, something that breeds distrust among credit institutions. Most analysts believe a basic problem with Venezuela’s economy is that it is held hostage to its petroleum reserves. An economy depending so heavily on one single source of revenue is in dangerous waters.

[*D International market *]

The price of a barrel of oil fluctuates according to movements on the international market and, though in the last few years this price has approached $25, it could change rapidly (as soon as the Iraq conflict is resolved). This would cause a hefty fall in the country’s revenues. The picture is further clouded by deteriorating productive investment figures, a low level of non-traditional exports and the significant flight of foreign capital, produced by the poor economic situation and by a climate of stark political tensions that endanger possibilities of inflowing foreign cash.

Venezuela’s poor results - growing unemployment and poverty - place in doubt the viability of the populist economic model of increased public expenditure, without parallel growth in state revenues and import-substitution policies.

Long-term economic growth is obtained through opening up to the exterior, through macroeconomic stability (price stability, budgetary equilibrium and low interest rates) and by trust in institutions. In short, through political stability, respect for property rights and a well-designed, operational legal system. Venezuela has poorly functioning institutions and considerable corruption (according to International Transparency), which have an adverse effect on investment and, therefore, on growth. The World Bank believes evidence exists proving that high levels of corruption are related to poor economic growth and the low per-capita income levels seen in many countries. It has likewise been observed that the influx of foreign investment is also affected by the corruption rate. For that reason, Chile attracts abundant foreign capital, while Ecuador and Venezuela draw very little.

Therefore, the policies Mr. Chavez adopts should aim to foster trust and credibility in institutions, creating a juridical environment that supports, and offers security to companies, so foreign investment can return. Little by little, dependence on petroleum as the main economic motor should be eliminated and countercyclic economic policies adopted to foment inflow of foreign currency and increase saving in periods of growth. Thus, in times of recession, Venezuela could count on resources to stimulate the economy. Finally, it should abandon populist policies that provoke increased public spending and inflationary tensions. Application of these policies should be made in a context of reconciliation and consensus, permitting negotiation of a national pact, based on diversification of the economy and creation of other sources of wealth besides petroleum. Thus, foundations could be laid for true economic development. Only through profound institutional reform and national consensus will Venezuela be able to crawl out of the hole in which it finds itself. It must adopt economic measures necessary to end the progressive impoverishment of its society. Unfortunately, Mr. Chavez’s personality and record do not leave much room for optimism.


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