Let me try and test your logical thinking today. Look at the world map below depicting oil reserves in the world and tell me which country’s citizens should be the richest in the world?
Did you say, “that black spot in the northern part of South America”? Sorry to inform you that you are wrong. Let’s try one more time. How do you usually measure the amount of money that you have?
Did you say “Easy, I will count it!”. Sorry wrong again! Locals of this country weigh piles of notes on scales as it is too laborious to count them! Now you would wonder that a country, whose citizens have such huge cash piles, must be having a very high life style. Look at the picture below and guess what are this country’s citizens standing in a queue for?
Did you say “Looks similar to a queue outside ATMs post demonetization in India. Probably, since the country’s citizens have such massive amounts of cash lying with them, the Government must have made a crackdown”? Sadly, your answer is again wrong. These people have been standing in a queue since last two days to buy food in a super market.
It is quite perplexing to a common logical mind – How can a country which has the world’s biggest oil reserves be actually so poor that its citizens are on the roads struggling to get their hands on even essentials such as food, water and toilet paper? Which country is this?
The darkest spot on the world map above is Venezuela.
What, where and how is Venezuela…
Venezuela is a country on the northern coast of South America, consisting of a continental land and a large number of small islands and islets in the Caribbean Sea. It has a population of over 33 million with estimated GDP of $373 billion in 2018.
Oil was discovered in 1922 and, today, Venezuela has the world’s largest known oil reserves, more than 17% of total oil reserves in the world. The economy of Venezuela is largely based on the petroleum sector and manufacturing. Revenue from petroleum exports accounts for more than 50% of the country’s GDP and roughly 95% of total exports.
How it all started…
Venezuela was one of the founding members of Organization of Petroleum Exporting Countries (OPEC). Venezuela’s dictator Juan Vicente Gómez entered into agreement with US companies for exploration and marketing. From the 1950s to the early 1980s, the Venezuelan economy, which was buoyed by high oil prices, was one of the strongest and most prosperous in South America. The continuous growth during that period attracted many immigrants.
In the late 1950s Venezuela’s real GDP per capita almost reached that of West Germany. Venezuela was the world’s 4th largest wealthiest nation per capita. In subsequent years, Venezuela built a vast refining and marketing system in the US and Europe.
However, the entire dynamics changed when world oil prices collapsed in the 1980s. The economy contracted, inflation levels rose and since then Venezuela has not been able to come out of its problems.
What went wrong…
Buoyed by a strong oil sector in the 1960s and 1970s, Venezuela’s governments spent fairly large amounts on public programs including health care, education, transport, and food subsidies. Literacy and welfare programs benefited tremendously from these conditions. Because of the oil wealth, Venezuelan workers enjoyed the highest wages in Latin America. However, this situation was reversed when oil prices collapsed during the 1980s. The economy contracted and inflation levels rose, remaining between 6 and 12% from 1982 to 1986 and reaching the peak in 1989 at 84%.
President Hugo Chavez formed Venezuelan government from 1999 to 2013. The highly populist approach of the Government under him discouraged the non-petroleum manufacturing sector. This coupled with other factors such as exodus of capital and reluctance of foreign investors spelled doom for the economy. The housing market in Venezuela shrunk significantly with developers avoiding Venezuela due to the massive number of companies who have had their property expropriated by the government. Further, in order to make basic goods more affordable to the poor, the federal government formed by left introduced price controls – capping the money people pay for such staples as flour, cooking oil and toiletries. This meant that many companies no longer found it profitable to produce these items, driving them out of business. This, combined with a lack of foreign currency to import the staples, led to shortages. As can be seen from the chart presented above, Venezuela has been fighting a losing battle with inflation since the 1980s, in fact much before then.
Venezuela has been ranking at the top in the Global Misery Index since the last couple of years. Due to the shortages faced in the economy for even basis necessities like flour, milk and toilet paper, the Venezuelan Government has been rampantly printing new currency, causing further devaluation of the Bolivar (Venezuela’s currency). Due to the leftist policies followed by the Government, it has become even more difficult to import drugs and other medical devices leading to several avoidable deaths.
There is a pervasive system of corruption and cronyism among the high and mid-level positions in the government. Those in the Government exchange Bolivar for Dollars at the Government exchange rate which is fraction of the rate at which they sell it in the black market. Those in positions of power are accumulating wealth at the cost of the masses.
The economy has contracted by 6.2%, 16.5% and 14% in 2015, 2016 and 2017, respectively. While inflation has spiraled at 122%, 255%, and 1088% during the same period. Venezuela’s currency has lost 99.9% of its dollar value over the past two years.
Lessons for us…
“The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries” – Winston Churchill
This is exactly what happened in Venezuela. The real problem in Venezuela started when a socialist Government was formed under Hugo Chávez in 1999. Chavez’s government became semi-authoritarian and hyper-populist and consolidated its power over the economy in order to gain control of large amounts of resources. In 2000, oil prices soared, offering Chavez funds not seen since Venezuela’s economic collapse in the 1980s. Chavez used such oil funds for populist policies aimed at providing public services to improve economic, cultural, and social conditions. Such policies included redistribution of wealth, land reform, and democratization of economic activity via workplace self-management and creation of worker-owned cooperatives.
However, the economy became highly dependent on funds obtained through high oil prices. The increased political spending led to high inflation and currency controls. Chavez’s government continuously overspent in social spending and did not save enough money for any future economic turmoil.
An unfriendly environment with private businesses and the risk of default prevented the entrance of stronger foreign currencies into Venezuela. Further, Government’s approach to the economy generally involved taking over strategic sectors, with the notion that underinvestment by the private sector could be remedied by state control. Firms were often expropriated on a whim, and state-owned endeavors were launched without careful thought or planning. This led to a bloated bureaucracy, growing corruption, and a long-term decline in key sectors. State-owned enterprises often ended up in the hands of corrupt bureaucrats who made them into their own domains, and then milked them dry.
Do phrases like “protector of poor”, “equal distribution of wealth”, “Will not let private companies enter our region”, and “Will not let foreign sources in to our soil” sound familiar? West Bengal, Communist Party of India? Yes, these would sound familiar as a socialist government anywhere has the same language. However, as can be seen from the Venezuelan example – the masses only share the miseries equally and not prosperity – collapsing health system, severe shortages of food and medicine, skyrocketing infant and maternal mortality, and thousands of preventable deaths.
This article is penned by Anurag Roonwal, Investment Adviser, Moneybee Investment Advisors Private Limited. For more details, please call on +91 22 4030 2052.