David R. Henderson  

Ricardo Hausmann on the Venezuelan Tragedy

First as tragedy, then as farc... Define "efficient"...

The Financial Times has an excellent interview with economist Ricardo Hausmann on the Chavez and Maduro-created tragedy that is Venezuela. HT2 Timothy Taylor, aka, the Conversable Economist.

The whole thing is worth reading. With help from a good interviewer, Cardiff Garcia, Hausmann, an economics professor at Harvard's Kennedy School, gives a good narrative about the changes in economic policy that took Venezuela from being one of the economic jewels of South America to being arguably, if the numbers are adjusted for reality, one of the poorest countries in South America. Short summary of economic policy: price controls, profligate government spending, and expropriations with the attendant disrespect for property rights. Short summary of political strategy: Chavez overthrows Venezuela's constraints on presidential power and he and his successor jail political opponents and critics.

Now some highlights.

The trouble started way before Chavez

So it was a magnet. It was wealthy, prosperous. It used massively its resources to invest in infrastructure. When democracy came along it prioritised education, health, public housing. And it was a fairly prosperous place. University education was free. Not only primary and secondary but university education was free. There was very cheap access to electricity, water and so on. So it was a fairly prosperous place. When in 1973, 74 the price of oil went up, then the country had these grandiose plans. Very much State centric at the time. State owned enterprises in steel, aluminium, ship-building and all sorts of other things that ended up in very bad failures, and the 1980s was a very, very difficult period in Venezuela.

Chavez's consolidation of power
Well, in the first couple of years he was focused on changing the constitution in order to create a much more powerful Presidency, with a much longer period and with a possibility of re-election, with a single chamber in the legislative branch instead of two, so as to make it more pliant. And with the ability to scrap all the judicial system and start from scratch.
So he concentrated his first couple of years in consolidating political power. He did not change the economics much. He left the same Finance Minister that [previous President Rafael] Caldera had, Maritza Izaguirre, and there was no discernible change in policies.
Then in the year 2000, with the new constitution, he got re-elected and there he started to move a little bit more on the economic front, and in one day he asked the more-pliant-now National Assembly to grant him the power to pass laws through Presidential Decree.
And on one day he passed 48 laws through a Decree. No-one had read the laws. Nobody had discussed the laws. That led to a massive protest movement, and that massive protest movement ended up unseating him for something like 48 hours, and then his popularity had actually collapsed and things were not looking well for him.

Government spending on "social" programs and their intellectual origin
And there he [Chavez] started to use oil money to massively expand social programmes. These social programmes were mostly designed by Cuba, in Cuba, with significant Cuban advice. And he started to spend a lot of the increasing oil money in that.

Price controls, exchange controls, and import controls--and Chavez's motive
So they used exchange controls, price controls, import controls as a way of keeping control on the private sector -- as a way of making the private sector pliant and dependent on bureaucratic decisions of the State. And there I think Sebastian Edwards' model of saying: Okay, what we are going to do now is we are going to expand spending, this is not going to generate inflation because we're going to have price controls, and this is not going to generate a balance of payments crisis because we have import controls... But that, mixed with the fact that they could borrow internationally, and they borrowed internationally in massive amounts. In incredibly massive amounts.

The collapse of the oil industry that reads like a precis of a chapter in Atlas Shrugged
Let me just give you a sense of the magnitude of the mismanagement of the oil industry. In 1998, the year before Chávez got elected, or the year in which in December of that year Chávez got elected and he took power in February 1999. In 1998, Venezuela produced 3.7 million barrels of oil [per day]. Today it's producing about two. If Venezuela had maintained its market share in the world oil industry -- which it could have because it had infinite reserves, it had the largest reserves in the world -- it would be producing two million barrels more than it is currently producing. With the same market share. So the collapse is immense relative to history, and it's immense relative to this opportunity cost of where it should have gone had it just kept its market share the way it was.
That collapse of the oil industry happened in two steps. First, all the know-how of that industry, centuries of man-years of experience was lost in the firing of these people. They were not only fired but persecuted, so most of them left the country. Many of them left the country. And they caused, for example, an oil boom in Colombia [where many of them moved to]. Colombia went from producing 200,000 barrels of oil [per day] to a million barrels of oil thanks to the fact that Venezuelans knew how to extract much more oil from the fields that Colombia was already exploiting.
So there was a massive loss of human capital. They also wanted to create a politically conscious oil company, so they started to put an enormous amount of social programmes and other things on the books of PDVSA, the oil company. And as a consequence they starved the company from investment and they ran the company in an amazingly corrupt way, and this is really not just talk about corruption but evidence of corruption in massive ways. There were these foreign oil companies... These foreign oil companies have been complaining to the government that they want to wrest control of the procurement of oil projects because they know that this procurement is being done at multiples of what things should cost. There's people that have been found in the US owning hundreds of millions of Dollars of money that has been laundered out of PDVSA and so on.

Chavez's wave of nationalizations
Exchange controls and price controls were put in 2004. Chávez won re-election in 2006. And in early 2007 he announced that he was now going to move towards socialism, and he started with a spree of nationalisations. In those days the price of oil was very high, so he could afford to just buy everything that moved or that he fancied.
So for example he nationalised the telephone company that was owned by Verizon. He nationalised the three cement companies that were owned by the Mexicans, Cemex, Holcim and Lafarge. He nationalised one of the largest banks, which was owned at the time by Banco Santander. He nationalised the supermarket chain. He nationalised 3.7 million hectares of land.
So he went on an expropriation spree. At the beginning, when he had money, he would pay for things, and then if these were things owned by people he didn't like, he would just expropriate and not pay for them. So he changed the contracts of the oil companies in a way that essentially extracted part of the expected cash flows out of them, and many of them accepted but a few of them, Exxon, Conoco Phillips and so on sued. And these suits are now being adjudicated by the International Court for the Settlement of Investment Disputes, and these investment disputes in Washington now add up to $16 billion of claims. Of expropriations that he didn't pay for. And these are only the foreigners.
He expropriated the service companies that provided services to the oil company, because they started to protest that they were not being paid so instead of paying he just expropriated them.

Another chapter out of Atlas Shrugged
So he took over significant chunks of the Venezuelan economy, and the typical thing is that the moment they took over a company, they ran it to the ground. Production collapsed. They nationalised the steel company. The steel company at the time of nationalisation was producing 4.5 million tons of steel with 5,000 workers. It now has 22,000 workers but it's producing something like 200,000 tons of steel. So they ran those companies to the ground. Aluminium is almost not done any more, when Venezuela was producing about a million tons of aluminium back when...
So essentially they expropriated the economy and collapsed it on the public sector. And in the private sector they created all these constraints and this enormous uncertainty over property rights because everybody else was being expropriated and you never knew when it would be your turn. Owens-Illinois was a company making bottles. They were expropriated. Why bottles? Another company making detergents was expropriated. Why detergents?
So everybody else would not know when would his turn come up.

The effect of the Venezuelan government's interventions on living standards
So as a consequence, incomes per capita have collapsed to a degree that it is hard to transmit and understand, and that collapse in private incomes is accompanied by a collapse in public services like healthcare for example. They are just beyond belief. People have been writing pieces that I'm sure are going to win a Pulitzer Prize, because it's just astonishing how life expectancy rates, how the prevalence of diseases that had been eradicated... Venezuela was the first country to eradicate malaria back in 1961. Even before the US did. And malaria is back big time. Measles is back big time. There are no drugs for HIV. There are no drugs for hypertension. There are no machines to do dialysis. There are no cancer drugs.
So there's been an incredible collapse in health standards. And as you know, Caracas is the highest murder city of the world. It beats Central American countries which come second and third as the most violent city in the world. So that is what's happened to the collapse in living standards.

The awful role of lenders, including Goldman Sachs
So you think of capital markets as being angels for good in the world. But when capital markets have to deal with a government that is willing to compromise future cash flows for any cash up front, and it's not using the resources to create any good things for the future, then you're giving money to an authoritarian regime to mismanage in the short run and you are condemning the future of the country with obligations that they will not be able to afford to pay. So that's why I call them hunger bonds.
A very clear example that prompted this was Goldman Sachs lending the government $850 million at an interest rate of 50%. No-one has a project that pays 50%. So the government has $850 million now, then they have to pay an amount going forward that they will not have the resources to pay it with. Because they're not using the money in any investment programme that will be able to pay for that debt. That debt is just to prop up the current regime, and in my mind that makes that debt odious. It's a debt of the regime, it's not a debt that should bind the people of a country, because the regime does not represent the people and the regime cannot commit the future of the country. The people's future.

Trump's sanctions, surprise, surprise, haven't made things better
Cardiff Garcia: Any potential restructuring now is further complicated by the US sanctions enacted since that initial interview was taped. The sanctions which have made it very hard, maybe impossible, for US investors to enter into any new exchange of bonds that would happen as part of a restructuring.

The government's attacks on Hausmann and a close relative
Then obviously the government has attacked me for writing op-eds, or they accuse me of these fancy conspiracy theories of all kinds. But the truth is they haven't been able to grab me but they have been able to put my brother-in-law in jail for being a journalist. So that in itself was also a very traumatic experience for the whole family. So I would say this repression, this oppression, this destruction of dreams has been a very disrupting element of my life these last few years.
. . .
No, he's under house arrest. After spending seven months in very, very inhumane conditions.

My one little criticism is that it would have been nice for Cardiff to draw Hausmann out on something that virtually every economist knows, but some readers do not: there is no mystery in why shelves in supermarkets are empty: price controls cause shortages and extreme price controls cause extreme shortages.

Comments and Sharing

COMMENTS (11 to date)
BZ writes:

Thanks for these highlights Dr. Henderson.

Hazel Meade writes:

Why would Goldman Sachs lend them almost a billion dollars at a 50% interest rate?

Can someone explain the rationale behind that?

Scott Sumner writes:

Great post. My cousin's wife is a highly skilled worker in Houston's oil industry. She came here from Venezuela. Their loss is our gain.

David R Henderson writes:

@Hazel Meade,
Why would Goldman Sachs lend them almost a billion dollars at a 50% interest rate? Can someone explain the rationale behind that?
Hausmann explains it in the interview.
@Scott Sumner,
Great post. My cousin's wife is a highly skilled worker in Houston's oil industry. She came here from Venezuela. Their loss is our gain.
Thanks, Scott. Great that she more than landed on her feet. I have a friend who lives in Miami who sometimes mentions the Venezuelans displaced to Miami.

Antischiff writes:

Dr. Henderson,

Yes, econ 101 can explain virtually all the economic problems Venezuela has. One needn't read much into it to understand, but the political background is interesting.

I wasn't aware it took so long to roll out many of the extremist socialist policies.

Todd Kreider writes:
"if the numbers are adjusted for reality, one of the poorest countries in South America."

This part of the interview isn't correct as Hausmann says things like take the official GDP, then change the price of oil..." But that is how you calculate that part of GDP.

The IMF says Venezuala's GDP was $14,000 in 2016 compared with Argentina at $19,000. It is lower in 2017 but the official number will give a good indication for where GDP per capita (PPP) was at this year:

Brazil $15,000
Peru $13,000
Equador $11,000
Paraguy $10,000
Bolivia $6,400

That is, probably near Peru, not Bolivia, which is still quite poor.

David R Henderson writes:

@Todd Kreider,
Thanks for those numbers.
There are two problems with those numbers. First, they are on GDP per capita not wealth per capita. The two measures tend to be highly positively correlated, and so in normal times, I would say that the GDP per capita number is roughly right as an indicator of wealth. But these are not normal times. In particular, the assault on property rights make assets worth much less. Which means that the ratio of wealth per capita to GDP per capita is probably lower in Venezuela than in anywhere else in South America.
The second problem is with purchasing power parity. Again, in normal times, you would be right. But with widespread price controls, the prices at which the official data say you can buy things are prices at which you often can’t. So GDP per capita in PPP overstates the actual GDP per capita in Venezuela, possibly by a large percentage. My gut feel is that Venezuela, in wealth per capita, is probably somewhere between Ecuador and Paraguay.

Tom West writes:

Of course Venezuala's decisions were utterly disastrous.

But the real question is what causes a population to elect someone who makes such disastrous decisions?

It may be that we have to accept "second best" governance because "first best" governance alienates enough people that they eventually vote to destroy it.

David R Henderson writes:

@Tom West,
But the real question is what causes a population to elect someone who makes such disastrous decisions?
It’s certainly an important question, but it’s not the real question. There are many real questions.
Also, when people elected Chavez, they probably didn’t know exactly what they were getting. Then, when he ran for re-election, he had amassed lots of powers and made it hard for opponents to challenge him. Then, when he ran for his third (and last) term, it was even harder.
It may be that we have to accept "second best" governance because "first best" governance alienates enough people that they eventually vote to destroy it.
That could be, but your comment is too cryptic for me to understand how it applies here. Are you saying that the predecessor to Chavez was first-best?

Tom West writes:

Sorry about being too cryptic.

What I was implying is that a government that might be considered "first best" by limiting its scope to maximizing growth might alienate enough voters as to ensure its own eventual destruction.

Perhaps a substantial set of non-growth-optimal social programs are necessary in the long term to prevent the populace from voting to burn society down.

*Something* about the previous Venezuelan administration motivated the voters to happily vote for a would-be dictator.

(Of course, this can apply on the other side as well. Perhaps having even a moderately socially progressive gov't in the US alienates so many voters that they choose not the opposition, but the most Chavez-like candidate available.)

David R Henderson writes:

@Tom West,
*Something* about the previous Venezuelan administration motivated the voters to happily vote for a would-be dictator.
Yes, and the something, according to Hausmann, was the dramatic drop in the price of oil. Given their consequent huge government budget deficit--10% of GDP--the previous administration had little room to engage in the spending you suggest.
More evidence for co-blogger Bryan Caplan’s book on voters.


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