The Illusion of Miracle: Venezuela
“Oil is fantastic and induces fantasies. The announcement that Venezuela was an oil country created the illusion of a miracle; it created, in practice, a culture of miracles.” — Jose Ignacio Cabrujas
Introduction to “The Illusion of Miracle” Series:
Political and economic diversification are two sides of the same coin. A single-party (or worse — single-person) state often leads to poorly developed and poorly diversified economies: Oil states, for example, or opium exporters, or countries overly reliant on remittances. Any Latin American will be familiar with the term ‘caudillo’: A strongman who uses a cult of personality and military support to enshrine themselves with political authority. But many others, from Zimbabwe or Brazil to the Philippines and the United States of America, would be able to recognize their own home-grown versions of a caudillo.
Other countries can teach us about ourselves. In “The Illusion of Miracles,” I’m going to explore the relationship between political oppression and economic regression — and why the promises that caudillos whisper in our ear are often illusionary.
We’re kicking it off with Venezuela, the poster child of these broken promises.
The Resource Curse.
For a long time, Venezuela suffered the indignities of colonization and foreign repression. First, from the 16th century until the 19th century, it was part of the Spanish Empire. Several rebellions and two failed republics later, Simón Bolívar liberated the country from the Spaniards in 1821. The foreign interventionism didn’t end with de-colonization, though.
Territorial disputes with Great Britain in 1895 were the catalyst for US intervention: Venezuela belonged to The New World, and The Old World better step back. Otherwise known as the Monroe Doctrine. At the turn of the 19th century, Cipriano Castro — an iteration of the many military strongmen, or caudillos, who would come to characterize Venezuela’s history — defaulted on the country’s foreign debt payments. This led to naval blockades from many of the great European powers, including Germany, Italy, the Netherlands, and Great Britain.
For most of its history, the nascent South American country was dominated by foreign powers and interests. This tumultuous past has induced, and perhaps rightly so, a sense of paranoia over external meddling that persists to this day. It wasn’t until the ‘discovery’ of oil fields in the early 20th century that Venezuela was able to flex its muscles and assert some level of independence. This explosion of oil exports transformed the country into the wealthiest in South America, unleashing higher standards of living, as well as corruption, diverse levels of immigration, foreign direct investment, and rampant inequality — especially between the indigenous populations and their affluent, European-descended peers.
A history of colonization, combined with a reliance on oil production (including all of the challenges that extraction brought), laid the foundations for the Bolivarian Revolution and the rise of Hugo Chavez. Many of the national policies that Chavez laid out, including land redistribution, government-funded healthcare, free education, and the nationalization of industries — were designed to tackle the glaring inequality that had haunted the country for centuries. Chavez’s policies were expensive, and widely reliant on funding from oil. Macro-economic forces (such as a drop in oil prices and a global recession), coupled with micro-economic conditions (such as a less productive oil sector and a kleptocracy) eventually bankrupted the country’s coffers.
When Nicolás Maduro succeeded Chavez as President in 2013, Venezuela had fallen to 180th place, out of 185, on the World Bank’s Ease of Doing Business ranking; the country formally entered a recession in 2014, with a 3% decline in GDP. Since then, hyperinflation reached 800,000%, and 10% of its population has fled the country.
How, in the span of two decades, did Venezuela go from being the wealthiest country in South America to being one of the poorest in the world?
Let the Drummer Kick.
The discovery of oil in Lake Maracaibo, in 1918, precipitated an incredible economic transformation in the country. A decade earlier, Juan Vicente Gomez, the scion of a powerful landowning family and head of the military, took power in a coup (re: Caudillo). Gomez would preside over the oil-rush, aligning himself with Europe and the United States by providing concessions to foreign companies to develop and drill. It’s important to note that this is a common practice among developing nations, and is essentially the cornerstone of China’s Belts and Roads initiative: Invite foreign companies or countries who have technical expertise to invest in domestic infrastructure, and reap a disproportionate share of the reward.
Caudillo Gomez then plowed revenue from oil exports into domestic infrastructure spending — as well as lining his own pockets, and the pockets of his coterie. Venezuela, under Gomez, saw a rapid centralization of power, including the military, as well as an improvement in health, sanitation, education, and, most importantly, roads. His road network started to connect previously remote parts of the country, such as Tachira.
By 1928, Venezuela was the world’s leading oil exporter. Demand for oil during World War II continued Venezuela’s emphasis on oil production, often at the expense of other sectors and industries. In 1930, agriculture was 22% of the country’s GDP, and 60% of its workforce. In 1988, it was 5.9% of the country’s GDP, and only 13% of its labor force. While it’s understandable for most countries to reallocate resources to different sectors as they move along a development curve, Venezuela has primarily transferred capital and labor from agriculture and other industrial sectors to — almost exclusively — petroleum.
By 1974, oil accounted for 30% of the country’s GDP and 95% of total exports. The bolivar surged in value on the backs of these exports, which made other exports more expensive and therefore less appealing. So why even bother making that? Let’s just stick with oil, and stop farming or making anything else! This is the very definition of the term ‘Dutch Disease’ — when a blessing becomes a curse.
In the previous export tree map, you can see that other industries were underinvested in, and that other exports, such as Venezuela’s historic agricultural staples like cacao, diminished in their proportion.
In particular, Venezuela never developed a strong manufacturing sector and let its agricultural sector diminish. In 1976, in order to better control oil revenue, the Venezuelan government nationalized the oil and petroleum firms, creating a consortium known as the Petróleos de Venezuela, S.A.
Venezuela plowed $56B in oil revenue from the PDVSA into over 300 state owned enterprises, none of which were profitable. There was little oversight over how this oil revenue was spent, particularly under the corrupt presidency of Jaime Lusinchi, from 1984 to 1994. Conservative estimates put the amount of stolen funds at $36B during Lusinchi’s Presidency alone. In 1997, the NGO Pro Calidad de Vida estimated that $100B had been absconded with since 1972. It wasn’t just Venezuela, though. In Latin America, total outstanding debt rose from $29B in 1970 to $329B in 1982.
The Hangover.
The Iranian Revolution in 1979 led to a sudden increase in the price of oil: from $5 per barrel in 1974 to nearly $40. This caused massive inflation — but especially in gas-guzzling Europe and America: People had to spend more to fill up their car, but prices went up for every product that required petroleum in its manufacture. These countries subsequently raised interest rates — the default monetary policy tactic for tackling inflation, as people are incentivized to save instead of spend.
The problem is that, for at least a short period of time, higher production costs and fewer consumers are bad for business. Companies see lower profits, which leads to mass layoffs, which leads to a global recession in 1980. Fewer companies are making things, which means less petroleum is used in manufacturing. Which leads people and things to travel less. Which means less oil is consumed. Lower consumption leads to lower prices. Oil prices more than halve to $15 by 1986.
The 1980s is referred to as The Lost Decade in Latin America.
This is bad news for everyone who borrowed money in the boom years. All that debt’s still collecting interest. It is terrible news for countries who are reliant on oil. Venezuela’s economy was too reliant on oil exports, and lacked industrial diversification. Oil production in Venezuela contracted at an annualized rate of -2.6%. Inflation rose to 84% in 1989, while GDP contracted by 20.4% from 1980 to 1987 (for context: The Great Depression in the US caused a 30% GDP contraction; The Great Recession caused a 4% contraction).
Widespread corruption, inflation, and GDP contraction led to the Caracazo Riots in 1989, and, eventually, to Hugo Chavez’s election in 1998 and the Bolivarian Revolution.
Chauvismo and a Distorted Economy.
Chavez rode a wave of popular discontent with the support of the military and Cuban intelligence community. His rise to power also coincided with a rapid rise in the price of oil, largely on the back of an industrializing China. These gains are illusionary, though, since while GDP increased dramatically, that increase belies a lack in industrial diversity and no discernible increase in operational efficiency. Again, the ‘Dutch Disease.’
Chavez invested oil revenue into four main social programs targeting health, housing, food security, and education. These programs, in the short term, achieved great results. The government funded the construction of clinics throughout the country, which, at their peak, were staffed by 15,000 Cuban doctors. Thousands of low-income housing units were constructed at a subsidy, which led to the construction sector growing from 5% to 16% of GDP. Through Mission Mercal, Chavez established a network of grocery chains that offered subsidized foods at a discount of 25–50%, while petrol was subsidized at $0.06 per gallon — a huge and expensive discount. A nationwide literacy program was launched under Chavez, which targeted vulnerable, marginalized, and indigenous populations, achieving a 95% literacy rate by 2007, behind only Chile, Cuba, Costa Rica, and Uruguay in the region.
While short term gains were impressive, these subsidy programs also posed long-term threats. Importing food for Mission Mercal (due to Venezuela’s poor agricultural sector), subsidies for petrol, and paying foreign salaries for Cuban doctors, were all expensive. Furthermore subsidies distorted the market: The construction sector grew, but artificially, and subsidized grocery chains deter private investment in other, non-subsidized grocery stores. Capital, rather than being deployed to be most effective, was instead deployed to be most popular — a feature similar to the many caudillos who preceded Chavez.
This isn’t inherently bad, and to be certain, for a brief period of time, Chavez’s policies did guarantee a rise in living and educational standards. But these improvements, through generous subsidies, are wholly dependent on the price on a single commodity — oil (and an extremely volatile commodity, at that).
Chavez, and less successfully, Maduro, have used subsidies and job guarantees to increase living standards and shore up political support. Unfortunately, most of these reforms were unsustainable in the long run, and their market distortions are still felt today. Transparency International found that under Chavez and Maduro, the number of State Owned Enterprises (SOEs) has almost doubled since the 80s — from 300 to more than 500.
These SOEs manufacture everything from cellphones to automobiles, and few are profitable: In 2016, 70% were operated at losses totaling $129B. In 2007, early on in Chavez’s career, local auto-makers manufactured 172,218 vehicles; in 2014, only 6,161 cars were made. Under Chavez, PDVSA’s (the state owned oil and gas company) workforce swelled from 20,000 in the early 2000s to 120,000 today, even while output (and thus, efficiency) have fallen dramatically. Even the agricultural sector performs disastrously. Private farms were turned into collectives a few decades ago, which now have triple the employees but much lower levels of output.
The prevalence of subsidies and SOEs have also sapped the ability of the private sector to compete. In 1999, there were 490,000 private companies in the country. In 2018, it had fallen to 280,000.
These market distortions sap the efficiency of the economy. And they are costly — especially when oil prices drop. In June 2008, the price per barrel reached nearly $140. By February 2009, it had fallen to nearly $40. And then again in 2014, it went from $100 to $30 by 2016.
Thought experiment: You make something incredibly precious. You have mortgaged your house, taken out student loans for your kids, and bought a Rolls Royce Phantom VII. Then suddenly that thing you make — Blackberries, MySpace, or oil — is suddenly worth 1/3rd of what it was just a few months earlier. You’re f**ked.
Venezuela’s healthcare system was heavily subsidized by oil revenue. In 2014, 80% of the national health clinics were shuttered, their Cuban staff gone. The government was forced to cancel payments to pharmaceutical and medical companies, whose employees then left. Mission Mercal, the state-run grocery chains, can no longer afford to subsidize food, and their agricultural sector is poorly developed. In 2017 alone, Venezuelans lost, on average, 24 lbs. and the poverty rate is now above 90%.
Even before the current humanitarian crisis under Maduro, there was a massive exodus of middle- and upper-class Venezuelans, including many advanced degree holders: Under Chavez, 1.5 million people emigrated, while a conservative estimate of 1.8 million left under Maduro.
The short term gains of the Bolivarian Revolution have evaporated. The country now ranks near the bottom of the Transparency International’s 2017 Corruption Perception Index, at 169th out of 180.
Autopsy.
The f**k happened? We were verifiably rolling in dough. We had black gold.
The same thing that Saudi Arabia is terrified of happening. An economy predicated on one, and only one, thing.
Venezuela became reliant on that one thing because of a poorly developed political system. Caudillos never invested in the infrastructure of a judicial system, or regulators, or a diverse marketplace. Why would they? When you have a single political class, and a single polity, making all the decisions, they’re going to make short term decisions that benefit themselves. And those short term decisions, in a country plagued by the resource curse, almost always result in quick and easy money. It is rare for politicians, of any stripe, to invest in long-term infrastructure, because bread and circuses shore up public support. But those decisions become even easier and more misguided when there isn’t an opposition to challenge you.
A good foil for Venezuela is Norway. Granted, Norway doesn’t have a tragic history of colonization holding them back. But Norway has oil. A ridiculous amount of it.
Norway ranks 28th as the freest country in the world. Their legal system and respect for property rights are ranked 3rd in the world. They can make long term decisions. And one of those decisions was to create a sovereign wealth fund. It is funded by oil revenue, but diversifies the economy and shelters citizens from oil shocks. Remember those treemaps earlier? Norway looks at those and does everything in their power to not have a treemap like Venezuela’s.
Caudillos, or whatever name you want to call short-sighted populist figures, make easy decisions. But easy decisions are costly in the long run. But populist figures make these decisions because they don’t know if they’ll be around in ten years — and so they make this political calculus: “I will do things that benefit me for the few years I know I’ll be around, rather than make long term investments that my predecessor (likely the person or party that kicked me out) will take credit for.”
We see it all the time, everywhere. Stunted politicians make poor investments. They raid state coffers. The give the people bread and circuses today without building a future for tomorrow.
