Francisco Rodriguez – Venezuela: A Deepening Political and Economic Quagmire?

hi good morning everybody thanks very much Susan it I’d like to thank all of you for being here our and particularly of course central hemispheric policy for giving us this opportunity to think about the Venezuelan economy society and are the perspectives and are in quagmire that are the countries and currently I’m I want to devote my time to are talking about the economy which is what I specialize in what I devote my time to are trying to understand what’s going on with the Venezuelan economy were circling are and what uh what we can expect out of current government policies and also to consider that as compared to what are the government should be doing um and I think that if we look at the Venezuelan economy right now and it’s very clear that it’s a mess right it’s very clear that you have inflation that’s skyrocketing you have inflation going at 60-plus percent but probably that inflation is underestimated because there’s price controls in a set of reporting problems so so we’re talking probably talking about an underlying inflation which is already considerably higher and is accelerating we have an obvious situation of scarcity at levels which has never before seen in Venezuela and actually in a type of phenomena that’s relatively rare in any economy somewhat worm innocent of what was happening in the countries in the Soviet bloc are in the 1980s we have an economy that’s contracting that’s going to contract probably by around four percent is going to have contracted by around four percent in in when we get the final numbers for 2014 and maybe depending on what policies are undertaken this year maybe at a similar rate also that that could also be underestimated by some of the data problems so it’s very clear that there are a lot of things going wrong here and and of course when you look at that then the inclination the main reaction as well then that means that we have to change everything because that means that the whole economic policy the whole economic model is wrong and I wouldn’t contest that I think that there are a lot of elements of and I think substantively there are significant costs that the nation has paid out of the economic model are that has been adopted during the past 15 years but I think it’s important to try to distinguish between the different components of that economic model and to try to understand which of them are the ones that are causing the big problems right now because that’s the only way in which we can understand well where is that we’re going to start in terms of the solution so it’s a problem the exchange rate is the problem are the nationalizations is the problem property right is the problem lack of judicial stability and rule of law and changes in the loss well I mean all of these and you might say the problem is all of those and that’s a very tempting answer which could be right at some level but doesn’t really help address the question of how you solve the problem which where do you start which of those things do you do first where is it that you’re going to concentrate your efforts and this is a question that is relevant equally relevant for the current administration as well for as for any future administration that might have to face with these problems and let’s let’s for a moment put us in the in the perspective of a new government let’s suppose that there were uh and I’m just going to give it a bit of a of teeth in terms of a scenario let’s suppose that the government loses the parliamentary elections you have a recall referendum president motors were called you have new elections and and and and a new president comes to power well that would probably be precedent that would have a relatively restricted in that scenario if it happens according to the current constitutional rules that you have a pretty restricted time-space right because this is going to be a presidency that’s going to last for two and a half years might have a Congress the Congress with them but then there’s a set of judicial institutions horse and there are problems I’m just about in every single other institution outside of the legislative and the executive which were at least not be initially friendly to that new administration so so it really has to pick its fights and and the question that I want to ask is economically what fight do we want to pick do we want to go there and say okay we have to open up the oil industry we have to completely change the oil industry regime we have to start privatizing firms or we say well we have to solve the exchange rate problem we have to be valuable have to raise gasoline prices where do you spend

your limited a political capital are your limited ability to function as a government and and my point is that that is as relevant question for this administration is the for any future administrations and I think that you spend your limited capital at this moment in solving the relative price problem and what I call the relative price problem is something which is I think quite easy to conceptualize Venezuela is the Venezuelan government survives on its dollars you can conceive it Venezuela as one big oil well and sometimes less comes out of that oil well sometimes more and when there’s more that’s coming out then you sell that oil you change it for other things and that’s what in Christ’s event is one economy and all of the Venezuelan economy subsist on the imported goods that come out of those oil sales if tomorrow that or well dried up I think that next day when I would go would basically go into the Stone Age and that’s all it doesn’t produce anything that it’s not oil in the sense that everything that it produces is a way it’s essentially a way of converting the dollars that come from oil into our goods and two other goods and services uh but but it turns out that that’s state that our government which relies on those oil revenues it’s basically turning around and saying oh I’m going to give this I’m going to sell these dollars really cheap and it does that in several ways one of them is that it says okay the exchange rate is 6.3 and it sells dollars for six point three cents sorry for six months we bought lavars which are less six point three cents and then people can and whoever gets one of those actually can do two things with that I could do what the government wants them to do which is to use those dollars in order to bring in goods but then you’re going to have an inspector that’s going to be looking at the store which you’re selling I’m trying to ensure that you’re selling them at a maximum return nominal the profit rate of thirty percent or you can sell them in the black market for an instantaneously thousand percent oh you do the math that’s what happens it there’s no incentive for those dollars to become goods and that feeds into a scarcity problem so you have a scarcity problem which is essentially caused by price controls and this is something very basic that that is that the root of the way in which economists look at scarcity problems and it’s one of the of the three useful things that have learned study economics is that when when you see price controls create scarcity and you don’t have scarcity without price controls you might have expensive goods without price controls if you don’t have enough resources to import then the prices will go up but but but when you have the level of scarcity that or you have right now in Venezuela the only explanation for this is price control is and the explanation is there I we see it it’s it’s evident the government is selling dollars at a ridiculously low rate and you might say well but who gets those dollars at 6.3 I don’t get them well the the fact is that precisely because the government is selling them to achieve then they’re Russian and then the government comes up with some rationing mechanisms to allocate those dollars are too to some people and those rational mechanisms involving but those rationing mechanisms are also involved just waiting in line because the what what people are doing when they’re lining up is essentially lining up to buy the goods the imported goods that the government is trying to maintain at artificially low prices which reflect the price of that the artificial price that is trying to maintain for foreign exchange so what’s the end result of this Venezuela and we people who are at least sufficiently all this myself in this room I have lived through a Venezuela at twenty dollars a barrel at 15 at eight dollars a barrel and there were medicines there was toilet paper people were driving around or cars or shopping malls were being built reverse economic activity at eight dollars a barrel so how come are now are forty dollars at our old but no it’s not a 40 at a hundred dollars a barrel we had over the problem is scarcity of toilet paper well it’s because at that moment a roll of toilet paper in Venezuela artificial prices was worth three cents of a dollar in the same roll of toilet paper in Colombia sells for 56 cents of a dollar so you’re creating this massive massive incentives or capital flight you’re basically telling everybody look if you can get a dollar from the government take it out as soon as possible but the last thing that you want to do is put it in goods in the market on so this this is a mess it’s actually a mess that’s not difficult to solve because the underlying problem is this attempt to maintain dollars cheap

how does this come about and why is it that we have this now and you see there’s a narrative which which is very appealing which is well this is the moment of the collapse you know this is the day of reckoning for chavismo they’ve been doing so much harm to the economy over the past 15 years that finally there they were coming to terms with it um and and I do not dispute and I I subscribe to the view that the policies that have been adopted during the past 15 years have had substantial costs in terms of productivity but I think that that has been reflected in the fact that Venezuela had a very low birth weight compared to other Latin American countries during the context of an oil boom then saw had a per capita PPP adjusted growth rate of one percent from between 1998 and 2012 that’s the lowest of any major Latin American country but but if you look at the model so much talk about the model if you look at the at the model and terms of nationalizing stated nationalizing the private sector strong intervention in the price setting mechanism exchange controls all of that was something that existed in 2012 up to 2012 and the economy wasn’t collapsing in 2012 and the economy didn’t it was it was surviving it was muddling through it could have been doing better I was doing well enough for 44 to satisfy the the being able to stay in power with uh with some type of electronic on our institutions constrained and an express this commonality has said in some of his research the are present Chavez paid a cost because of this model in terms of popularity approvals and votes are and you had leaders like ever Morales like Korea were getting reelected with much higher margins than Chavez precisely because javis was not able to deliver economically as much as those countries did in the midst of their boom but we still had oil at a hundred dollars a barrel up until six months ago eight months ago and and the country was already in a mess and essentially what happened here had to do with combination of two things one of them is the an idea that started gaining force in the last days of Chavez which was the idea that the government should get very involved in price setting the approval of the law of just prices and costs are in initially in 2011 and then it’s kind of more wholesale launching in 2012 um and and and it’s hard to to understand what it whether this change is something that really came out of Travis of thinking or he was just Paul ticking running up into the election but the fact is that he wasn’t around to explain that to everybody and and the people who were left actually believe that that’s what they needed to do that they needed to strongly intervene in the price setting mechanism much more than what they had done before and you mix that with our word I would say can be called the rookie mistake which is a president maduro before being actually formally present but while being in charge broke rule number one of Venezuelan politics which is you don’t devalue before an election and if actually he devalued on februari eighth of 2013 roughly two months before the election and that’s very costly we know that that evaluations are costly politically much more so if they if they come together with with what took place in Venezuela at that time which is a loss of control and a loss of coherence in the economics cabinet were even that devaluation was not coherent because they closed down seated me which was a mechanism for currency allocation it didn’t replace it for anything else and the black market rate started going up and then when this all started falling into into the following site called the black market rate goes up that fuels inflation are and then the government has to raise salaries and its costs go up but the government says I’m not any value because devaluation is going to feel more inflation so it has less revenue so what does it do it has to print money if it prints money then prices go up more the black market rate goes up more the exchange rate in real terms becomes more appreciated the government has to print more money but then after that initial rookie mistake then the government I said well no no we’re not gonna do you anymore we’re not going to make that mistake again um so they started doing something which had not happened before in Venezuela which is trying to maintain a not the nominal exchange rate fixed when it’s clear that

it’s become completely out of line with anything that has to do with reality and and there is where you get into this relative price problem so what you what you’ve done to the economies that you taken any economy were sixty percent are of resource allocation happens to the private sector and you basically left that private sector without prices and you created these incentives then to try to escape these price controls which lead to capital flight and you created huge rents from the price controls which lead people to devote all of their efforts capturing those friends I’m not just talking about and of the military that might control the border with Colombia and my control am I take advantage of those friends I’m talking about the fact that there are studies showing that two-thirds of the people who are standing in lines right now are there to try to to buy the products to resell them even the very poor actually find that it makes a lot more sense for them to buy the five kilos of arena plan and consume two of them and resell the other three because that way they are an important part of their income so so you’re so so effectively we have a situation in which you have a lot of resources that are not being used and I want to put that at the emphasis again on this capital flight because I’ve tried to estimate very conservatively the capital flight figure in Venezuela and the most conservative estimates are gave you 20 billion dollars I think it could be well more but let’s stay with that number um yeah well what that means is that Venezuela I could effectively by going to a more sensible exchange are the great regime and in fact by doing what I think it should do which is to lift exchange controls right now I been so I could actually have those 20 billion dollars that are going to capital flight now become 20 billion dollars of goods in store shelves and that is the basis for an expansionary adjustment that’s the reason why the adjustment the exchange rate adjustment does not need to be politically costly because it can be associated with an increase in the supply of goods and and this is something that happens in many countries that happens are when you’ve had a runaway inflation and R & R the setting of very strict price controls which governments do but usually when prices get completely out of control as in hyperinflation so what’s interesting about this government is that it did it before prices went the full spiral towards hyperinflation but in that sense in terms of the combination of very poor resource allocation a lot of capital flight controls therefore the potential for an expansion adjustment it’s very similar similar to Brazil in 94 it’s very similar to believe you before the hyperinflation so there at the end of the hyperinflation is very similar to a country that wasn’t going through hyperinflation at the moment which is Poland actually which is interesting because Poland had done the same thing that Venezuela has done over the past two years poland went through that crisis and as a result of that it did a quantity adjustment and it generated so many distortions that by liberalizing prices and by liberalizing foreign currency flows they were able to get an economic expansion on out of it um so III and in fact a lot of the same discussion that we have nowadays in in in Venezuela was the discussion that you had in Poland when Jeffrey Sachs doesn’t read about this Jeffrey Sachs has this wonderful book Poland’s jump to a market economy when Jeffrey Sachs went to Poland everybody was telling him no you can’t do that and you can’t let reliance prices and the government cannot resist it again overthrow the are they got anything through that and in fact I when they did that prices a good started appearing almost immediately on store shelves and it was and it’s one of the reasons why this was the smoothest transition so I just want to close by saying that uh I think that any uh whenever we think about adjustments in Venezuela if we we live under the fear of the shower of the 1989 adjustment everybody thinks that if you raise prices of gasoline then people are gonna be rioting this is one one of the one of the coincidences between the governor and the opposition said they both agree with that that you can’t wear a scallion prices because it has a huge political cost and the only difference right now is who’s gonna do it my daughter doesn’t want to do it but he wants to stay in power the opposition wants him out of power but they’re hoping that he’ll do it before they argue in the power so they don’t have to do it and and and and you see I think that the 1989 adjustment was actually quite quite a peculiar it was different because you had not had you were an economy that was living through a boom it was kind of similar to what would have happened if my order had tried to do this in 2013 at the beginning of 2013 but it had not gone through a quantity adjustment type that we have it did not have an economy that was totally distorted by rent-seeking of the type that that we have now I think that the 1989 riots a political scientists

sociologists have looked at this carefully coincide that this was a very idiosyncratic event that had a lot to do with I with the issue of transport prices in the city of weariness and what ed are and how I and with failed negotiations over the setting of public transportation prices and and the fact that the public transport workers violated the agreement with the government and then well there’s a whole story associated with that but but but but the lesson that I think that we should learn about 1989 it’s not that you can’t raise gasoline prices that’s the wrong lesson to learn i think the lesson that you should learn from 1989 is a lesson that’s contained in another fabulous and short books and if you want to read two books to understand what has to be done in Venezuela I think that you should read Paul and strum to a market economy by Jeffrey Sachs I think that you should read paper tigers and minotaurs by Moses 19 and the fact is that uh the things that you think are going to happen when you do an adjustment things that you fear the people who you think are going to resist who are going to block it this idea that we’re gonna have a social explosion if we raise equity prices those all of those things that you’re expecting there are the ones that don’t happen and the things that you have to deal with are the ones that don’t expect what to do for example with all of the people who are standing and lying right now who don’t have jobs I’m going to finish with this well I think that we actually need a a worker retraining program for them because we actually need to incorporate them productively into the economy that type of issues is the ones that can make an adjustment more difficult than the ones that we fear now great thank you very much and it was wonderful sort of opening presentation and thank you for setting the scene and for giving us your analysis the situation