Recently a well known economist wrote a piece about Latin American economies, noting that “the spectrum of economic policies in the region in the last few years has spanned the entire range from pragmatism to populism…At the very far left corner there is the extreme radical populism of Venezuela’s Chavez.”
An examination of Venezuela’s recent economic performance suggests that the country’s economic policies actually fall into the pragmatic camp, not the populist one.
A look at macroeconomic indicators shows that the economy is performing well. Economic growth has been the fastest in Latin America for each of the past two years. In the first quarter of 2006 growth continued apace, registering 9.3%. Yet in the midst of the economic boom, inflation has been halved. This year, at least one forecaster expects Venezuela to experience its lowest inflation in 18 years though it will still be one of the highest in Latin America. Declining inflation in the midst of an economic boom, while not unprecedented, is atypical and suggests pragmatic economic management.
Factoring in social indicators, Venezuelan economic performance looks even better. Unemployment has been steadily dropping, reaching 10.1% in April 2006. In 2005 the government’s index of social wellbeing reached its highest level in 10 years. Incomes of the poor doubled in the past two years. The poverty rate, which had been increasing for most of the past twenty-five years, has been dropping. In fact, the World Bank recently noted that “Venezuela has achieved substantial improvements in the fight against poverty.”
Critics tend to credit increasing oil prices for the resurgence of the economy and dismiss the government’s economic management. As the petroleum sector accounts for roughly one-third of GDP, around 80% of export earnings, and over half of government operating revenues, there is no denying that Venezuela’s fortunes depend on it. However, a boom in the price of a commodity can be a mixed blessing, which introduces a special set of challenges, called the “Dutch disease” or “resource curse.” Many observers of the Venezuelan economy tend to ignore these challenges.
One potential effect of the “Dutch disease” is a rise in inflation, resulting from a rapid increase in the money supply as the windfall from higher commodities prices is passed into the domestic economy. With Venezuelan inflation dropping and approaching an 18 year low, the economic managers seem to have navigated around that shoal.
An alternative effect of the “Dutch disease” is an overvalued currency, which stimulates an import binge, making domestic producers uncompetitive, leading to a recession in sectors, such as manufacturing, exposed to foreign trade. Although imports have risen significantly in the past two years, the numbers need to be put in perspective. First, the simple fact that imports are growing much faster than the economy is not by itself a cause for alarm. In fact, rapid import growth has been typical for Venezuela during periods of economic expansion, just as rapid declines occur during economic contractions. Second, imports as a percentage of GDP are well within the range recorded during the 1990s, a period of modest economic growth. Third, much of the growth of imports is attributable not to consumables but to capital goods, such as machinery, parts, and equipment used for future production. Moreover, the Venezuelan manufacturing sector is healthy, having grown 9.1% in 2005, which suggests that the economic managers are successfully holding off any onset of the “Dutch disease”.
Critics have charged that the government is wasting the country’s newfound wealth on foreign adventures instead of investing in the economy. It is indisputable that the government is using its wealth for political purposes, such as refinancing Argentina’s IMF debts. On the other hand, refusing to repatriate the windfall is precisely what allows the country to overcome the challenge of the “Dutch disease.” Furthermore, moving assets out of the United States and into other countries can be viewed less as an adventure than as an astute way to hedge against the eventual decline of a severely overvalued dollar.
Some observers claim that Venezuela has only two types of presidents: those with oil revenues and those without. While this has been true historically, several indicators suggest that Venezuela is becoming better prepared to compensate for a cyclical decline in oil prices.
1. The current account balance is solidly positive. Currency reserves reached their highest levels in sixteen years, and one forecast expects them to increase by more than 40% in the next two years.
2. External debt, already low by Latin American standards, has been steadily declining and is now estimated at 30.8% of GDP.
3. The government has made a series of moves to protect export revenues by increasing its share of oil revenues.
These figures suggest that Venezuela has the reserves and borrowing capacity to replace earnings from oil in the event of a cyclical decline, which few are predicting at this point. Furthermore, Venezuela has taken steps to prevent such a collapse by maintaining an active role in OPEC, pursuing a satisfactory price floor. By contrast, some leading opposition figures criticize the government for maximizing price instead of production, a move which could trigger an oil glut and price collapse and damage the economy.
Several domestic economic policies reinforce the pattern of economic pragmatism:
1. The large investment in public infrastructure, resulting in a 40% increase in government construction spending in the first trimester this year, can be seen as much more than a jobs program or short term stimulus. A recent study shows that investment in public infrastructure in Venezuela gives the government a good return on investment as well as being a significant driver of long term growth.
2. Though heavily dependent on oil revenue, the government has improved tax collection from non-oil sources, which resulted in a budget surplus for 2005, despite significant funding of social programs.
3. Increasing investments in public services, such as education and health care, are essential to the development of productive work force and were key recommendations of a 2001 World Bank Report on Venezuela. Although Barrio Adentro and the various missions are framed as populist in nature, they are also critical to long term economic growth.
In conclusion, the Venezuelan government clearly seems to have embraced a pragmatic economic approach. If the discipline continues and the policies succeed over the long term, the government’s strategies may provide an economic model as well as a social one for resource rich economies.
John Hofer has an MBA in Finance and International Business from Columbia University. He is an independent analyst and can be reached at [email protected].