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The Cause of the Recent Collapse
of the Venezuelan Economy

This material is to trace and analyze the recent collapse of the Venezuelan economy. The general observer probably attributes that collapse to the attempt of the Chavez regime and its successor to institute socialism. While socialism is definitely detrimental to an economy the consequence of peacefully instituted socialism or any other governmental operation of the economy is stagnation rather than catastrophic collapse. The immediate cause of the Venezuelan collapse is the setting of prices at foolishly unrealistic levels by the government. It is important to establish this because there are many politicians who are willing to set prices arbitrarily who would never consider adopting socialism. For example, Richard Nixon's fixing of gasoline prices in 1973. Currently in the U.S. many politicians see no danger in setting the minimum wage at $15 or $20 per hour. They seem to think that a rise in the minimum wage can only help workers, without recognizing that setting a wage or price different from the market level helps some and hurts others. The proportions hurt and helped depend upon how much the fixed price deviates from the market price. Even the advocates of raising the minimum wage to $15 per hour would recognize, if they think for a moment, that raising it to $100 per hour would help very few and to $1000 per hour would help no one and destroy the economy.

The supply and demand for products and services are discontinuous functions for prices. Fixing prices beyond critical levels, as the Venezuelan government did, will result in the collapse of a market.

Before going into the details of the mistakes of the Venezuelan government it will be helpful to have a quick review of the history of Venezuela.

Timeline of Venezuelan History

  • 1498-99: Columbus on his third voyage visits the north coast of South America.
  • 1521: Spain establishes first colony in the area of what is now Venezuela.
  • 1549: An unsuccessful rebellion against Spanish rule occurred.
  • 1810: Spanish colonies on the north coast South America declare independence from Spain which had been invaded and conquered by Napoleon Bonaparte. Venezuela is politically joined with Colombia in a state called Gran Colombia.
  • 1829-30: Venezuela withdraws from Gran Colombia.
  • 1870: Antonio Guzman Blanco takes power in Venezuela. He seeks foreign investment to develop Venezuela.
  • 1888: The Blanco regime ends.
  • 1902: Venezuela defaults on its foreign loans and British, Italian and German warships blockade Venezuelan ports.
  • 1908: Juan Vicente Gomez gains dictatorial control over Venezuela. Explorations for petroleum deposits in Venezuela are successful.
  • 1935: The rule of Venezuela by Gomez ends.
  • 1945: A military coup establishes civilian rule in Venezuela.
  • 1948: Romulo Gallegos elected as the head of government in Venezuela. After eight months in office Gallegos is overthrown by a military coup led by Marcos Perez Jimenez.
  • 1958: Jimenez is overthrown in a coup led by Admiral Wolfgang Larrazabal. An election for civilian government is held. The leftist party, the Democratic Action Party, led by Romulo Betancourt wins the election.
  • 1964: Dr. Raul Leoni wins the election and takes power from the previous civilian government.
  • 1973: The oil and steel industries of Venezuela are nationalized.
  • 1983-84: A drop in petroleum prices forces a cut in social welfare programs. Jaime Lisinchi is elected president. In office he approves a pact involving the trade unions and business with the government.
  • 1989: Venezuela experiences an economic depression. Carlos Andres Perez is elected president. To deal with the financial problems of Venezuela Perez negotiates a loan from the International Monetary Fund (IMF). As a condition for the loan Venezuela has to institute an austerity program which involves a cut-back in the government's social welfare programs, There are riots and a general strike in which hundreds are killed. The Perez government institutes martial law.
  • 1992: A military coup is attempted. Among the supporters of that coup attempt was one Colonel Hugo Chavez. One hundred twenty people were killed in that attempted coup. Chavez is sentenced to prison.
  • 1993: Impeachment proceedings begin against President Perez for alleged corruption.
  • 1994: Chavez, along with others. is pardoned and released from prison.
  • 1995: President Perez's impeachment for corruption ends with his removal from office.

    As can be seen from the above past history, Venezuela was not without its political, financial and economic problems. But what took place under Hugo Chavez was of a whole order of magnitude greater in difficulty than what occurred before.

    The Chavez Era

  • 1998: Hugo Chavez runs for office and is elected president. He declares the Bolivarian Revolution. His party is able get the passage of a new constitution which involves socialist and social welfare policies. These are affordable at the time because of the high price for petroleum. Chavez becomes more vocally anti-American.
  • 1999: Severe floods and subsequent mudslides occur in the northern regions of Venezuela' Tens of thousands of people are killed and many more are impoverished.
  • 2001: President Chavez gets passed 49 laws involving the redistribution of land and other wealth. Business and labor organization begin to fear that Chavez intends to make the Venezuela economy into something like that of Cuba.
  • 2002 April: Chavez tries to take the control of the Venezuelan petroleum industry away from the managers and labor unions of Petroleos de Venezuela, the state oil monopoly. Violence results and the military carry out a coup. Chavez is arrested and held in custody by the military. Business federation leader Pedro Carmona is made leader of the government but his regime collapses in a few months and Chavez returns to power.
  • 2002 December: Opponents of Chavez in the petroleum industries carry out a nine-week strike and fuel shortages develop.
  • 2003: The Venezuelan Government imposes price controls on basic food items.
  • 2003 May: Opponents of Chavez with the assistance of the Organization of American States negotiate an agreement for a referendum about removing Chavez from rule.
  • 2004 March: Violent clashes between the supporters of Hugo Chavez and his opponents result in several deaths and many injuries.
  • 2004 August: The referendum fails to recall Chavez from office and he is allowed to finish his term that runs until 2007.
  • 2005 January: Legislation is passed and signed calling for the breakup of the landed estates and their distribution to the rural poor.
  • 2005 March: Other legislation is passed and signed that calls for stiff fines and prison terms for anyone slandering public officials.
  • 2005 June: Chavez creates a regional oil company to sell petroleum to 13 Caribbean states at a discount price. Cuba is one of those states.
  • 2005 December: Parties opposing Chavez boycott the election and Chavez's Socialist Party gains overwhelming domination of the legislature.
  • 2006 July: President Chavez signs a $3 billion deal for Venezuela to buy military equipment from the Russian Federation. This includes jet fighter planes and helicopters.
  • 2006 December: Hugo Chavez wins a third term as president with 63 percent of the vote.
  • 2007 January: President Chavez announces that under legislation passed by the National Assembly, important energy and telecommunication companies will be nationalized.
  • 2007 May: The Chavez government announces that it is taking control of petroleum exploration projects in the Orinoco Delta.
  • 2007 May: The Government refuses to renew the broadcasting license of a television channel that had been critical of the Chavez regime. There are public demonstrations concerning this act.
  • 2007 June: The American oil companies, Exxon Mobil and Conoco-Phillips refuse to hand over control of their petroleum exploration operations in the Orinoco Delta to the Venezuelan government. Those operations are subsequently expropriated.
  • 2007 December: Chavez loses a referendum intended to give him more control over the Central Bank of Venezuela and more power to expropriate private property.
  • 2008 March: A diplomatic and strong level of crisis develops between Venezuela and Colombia. Chavez mobilizes Venezuelan troops along the Colombian-Venezuelan border.
  • 2008 July: Tension between Venezuela and Colombia moderate with the president of Colombia visiting Chavez for talks concerning their problems.
  • 2008 August: President Chavez announces the impending nationalization of one of Venezuela's largest private banks, the Spanish-owned Bank of Venezuela. The Venezuelan subsidiary of the Mexican-owned cement company Cemex had been nationalized by Venezuela. Cemex sought the World Bank to review the case and judge whether the nationalization was legal. The Government lifted price controls on some basic items to alleviate shortages.
  • 2008 September: The Venezuelan Government announces the nationalization of household fuel distributors and gasoline service stations.
  • 2008 September: Russia and Venezuela sign an accord of cooperation concerning petroleum and natural gas. Russian war planes visit Venezuela. Venezuela expels the U.S. ambassador and the U.S. expels the Venezuelan ambassador.
  • 2008 October: The first Venezuelan telecommunication satellite is launched by China.
  • 2008 November: Opposition parties make notable gains in regional elections but Chavez's party still controls 17 out of 22 provisional governorships.
  • 2008 November: Russia and Venezuela sign an accord on civilian nuclear cooperation. Russian warships arrive in Venezuelan for joint naval exercises.
  • 2009 February: A referendum is held on abolishing the term limits on elective offices. The voters approved this. This will allow Chavez to run for a fourth term in 2012.
  • 2009 August: Tensions between Venezuela and Colombia escalate. Colombia accuses Venezuela of supplying weapons to rebels in Colombia. Venezuela accuses Colombia of allowing its troops to cross the border in pursuit of rebels.
  • 2009 November: Venezuelan-Colombian tensions further escalate. Chavez orders 15 thousand Venezuelan troops to the Colombian border. Colombia signs an agreement with the U.S. to allow Americans to use military bases in Colombia.
  • 2010 January: The level of GDP dropped nearly 6 percent in the last quarter of 2009. President Chavez changed the official exchange rate of the Venezuelan Bolivar for the U.S. dollar.
  • 2010 January: The Government closes six television channels for not adhering to the rules for transmitting government material.
  • 2010 July: Venezuela breaks off diplomatic relations with Colombia briefly after being accused of harboring Colombian rebels.
  • 2010 September: There are National; Assembly elections in which Opposition parties make significant gains.
  • 2010 December: Parliament grants President Chavez significant new powers to deal with floods.
  • 2011 June: Hugo Chavez commences his treatment for cancer in Cuba. It extends off and on for a year.
  • 2011 November: The Government imposes price controls on many items in an attempt to curb inflation, which at that time was running at a rate of 27 percent per year.
  • 2011 December: Venezuela attempt to create a regional organization of states to replace the Organization of American States (OAS). It is called the Community of Latin American and Caribbean States (CELAC). It excludes the U.S. and Canada and the Dutch, British and Danish dependencies, but includes Cuba which is excluded from the OAS.
  • 2012 April: The Government extends price controls to more basic goods. President Chavez threatens to expropriate any business that does not comply with price controls.
  • 2012 May: Hugo Chavez completes his program of cancer treatment in Cuba. He says his doctors say that he is fit to fulfill his duties in political office.
  • 2012 June: Hugo Chavez registers as a candidate for the presidential election to be held in October.
  • 2012 July: An opposition television station Globovision pays a $2.1 million fine to prevent its assets being confiscated. The fine was imposed by a media regulator for Globovision's coverage of a prison riot. The jails and prisons are severely overcrowded and the Government does not have the resources to build more. Crime rates are elevated considerably because of the collapse of the economy.
  • 2012 July: Venezuela becomes a full member of Mercosur, (Mercado Comun del Sur = Common Market of the South).
  • 2012 October: Hugo Chavez wins election to a fourth term as president of Venezuela. He got 54 percent of the vote. The turnout was 81 percent.
  • 2012 December: Hugo Chavez returns to Cuba for cancer treatment and Vice President Nicolas Maduro, a former bus-driver, assumes power.
  • 2013 March: Hugo Chavez dies at age 58.
  • 2013 April: Nicolas Maduro wins election as president by a narrow, contested margin.
  • 2013 May: The Government formulates a scheme for using the army to curb Venezuela's high murder rate.
  • 2013 August: The High Court of Venezuela rejects an appeal contesting the vote of the April presidential election.
  • 2013 September: There is a massive power failure that leaves 70 percent of Venezuela without power. Maduro blames the power failure on sabotage.
  • 2013 October: Venezuela expels three U.S. diplomats on the basis of a charge that they were plotting sabotage.
  • 2013 November: The National Assembly gives President Maduro emergency powers to combat inflation which is running at 50 percent per year. He uses limits on profit margins as the principle for setting prices.
  • 2013 December: Candidates of the Socialist Party of Maduro win local elections.
  • 2014 February-March: Concern over high crime rates and reduced levels of public safety lead to public protests in the western provinces. These protests spread across the country including to Caracas. The Opposition supports these demonstrations and Maduro accuses the Opposition of trying to carry out a coup. Maduro has the demonstrations suppressed and at least 28 people are killed.
  • 2014 September: Venezuela's inflation rate rises to over 63 percent per year. Leopoldo Lopez, one of the main Opposition leaders, is brought into court and charged with inciting violence in public demonstrations. A mandatory finger-print recording system is established for supermarkets to impose ration limits on purchases. The Government renews its system for using the army to reduce the high murder rate.
  • 2014 November: The Government announces reductions in public spending resulting from lower petroleum prices.
  • 2014 December: The chief prosecutor of Venezuela formally charges the major Opposition leader, Maria Corina Machado with conspiring to assassinate President Maduro. The GDP of Venezuela contracted for the third quarter in a row and so it was officially in a recession.
  • 2015 February: The Maduro government devalued the Bolivar and raised the fares on public transportation. Antonio Ledezma, the mayor of Caracas, is formally charged with plotting a coup with support from the U.S.
  • 2015 March: The Venezuelan government formally accuses the U.S. of using its embassy to interfere in Venezuelan affairs and orders it to reduce its staff by 80.
  • 2015 May: Venezuela states that it has an ownership claim to any petroleum found in the sea bed off the Essequibo Coast.
  • 2015 September: Guyana seeks U.N. mediation of the dispute over possible petroleum deposits in the seabed off the Essequibo Coast.
  • 2015 December: Democratic Unity, a coalition of Opposition parties, wins a two thirds majority in the Venezuelan National Assembly. This ends a 16 year period of Socialist Party control.
  • 2016 January: The high court of Venezuela pressures three Democratic Unity members of the National Assembly to resign. This action deprives the Democratic Unity coalition of the two thirds majority needed to block legislation proposed by President Maduro. The high court declares unconstitutional measures passed by the Democratic Unity coalition, such as the release of political prisoners like Leopoldo Lopez. The Government declares a 60 day economic emergency which gives the president special powers.
  • 2016 February: President Maduro announces a currency devaluation and an increase in the price of gasoline.
  • 2016 April: The Government imposes a two-day work week for public sector employees to deal with an energy shortage.
  • 2016 September: Demonstrations involving hundreds of thousands of people take place in Caracas calling for the recall of Nicolas Maduro and accusing the Election Commission of deliberately delaying the approval of a referendum to decide the issue.

Hugo Chavez used the funds from the sale of Venezuelan petroleum as his personal slush fund to use however he wanted, including alleviating the consequences of past policy mistakes. In the days of petroleum above $100 per barrel the funds from the export of Venezuelan gas and petroleum were an enormous tens of billions of dollars. But as enormous as those funds were, they were not enough for Hugo Chavez. From the very beginning he was spending more than Venezuela received from its energy exports. The excess spending was covered by printing money. The Venezuelan money supply increased from 334 million VEF in January of 1993 to 3.3 trillion VEF in October of 2016. The effect of the continual increase in the money supply was high levels of inflation. He and his successor tried to deal with inflation by fixing price at arbitrary levels.

When he fixed prices below the level that retailers needed to import those items consumers faced empty shelves even though they had the funds to make purchases at the control prices. Chavez used petroleum funds to have the Government import the goods that were missing from the retailers' shelves. He had the Venezuelan army distribute them. It should not have surprised anyone that the army personnel carrying out the distribution diverted a substantial share to themselves which they could sell on the black market. This kept the army supportive of the Chavez regime.

Chavez had built millions of new houses and corner medical clinics (staffed by Cuban doctors). He gave away laptops and washing machines. Not everyone got such items but they could believe it was just a matter of time. But that largess was only possible in the early days of the regime and when the price of petroleum was high.

Chavez's largess extended to other counties he wanted to support him in international politics. He sold Venezuelan oil to Caribbean nations, including Cuba, at a discount. But for Cuba the sale was on credit and no rational person could expect Cuba to pay its debts. So soon the funds the Government had to spend freely diminished considerably and when the price of petroleum dropped to $40 per barrel and below they disappeared entirely.

Then the waiting lines, los colas, became a fact of life in Venezuela. As Time magazine (Aug. 22, 2016) describes them

the lines form before dawn and last until nightfall, several bodies thick and zigzagging for miles in leafy middle-class neighborhoods and ragged slums alike.

Fights frequently break out in those lines.

But the shortages are not just annoying inconveniences. Time goes on. In Caracas

a doctor watched a 73-year-old woman die of kidney failure because the hospital lacked the medicine to perform routine dialysis. In a Caracas police station, more than 150 prisoners crowded into a cell made for 36, standing shirtless (there was no room to sit) in the stench of sweat and feces.

These are examples of the catastrophic collapse of the economy. Venezuela is suffering a recession. Last year the GDP declined 6 percent and is expected to decline 10 percent. Venezuela needs to import items to keep the petroleum industry operating. In particular, Venezuela needs to import lighter grades of petroleum to mix with its own heavier petroleum to make a more marketable product.

The figures 6 and 10 percent economic decline are terrible but they are not like the 100 percent disappearance of items from retailers' shelves. This came only as a result of price controls.

Hyperinflation is also bad. Funds for shopping that used to be carried in wallets and purses, now require backpacks. But not having commodities available at all is worse than having them available only at inflated prices.

The usual diagrams in economic textbooks showing how a market price is established by supply and demand are of the following form.

But they should have a form like this.

This diagram emphasizes the limited range that a controlled price can be without precipitating a catastrophic collapse of supply or demand.

For a social welfare analysis of a control price see Social Welfare Analysis.

(To be continued.)


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