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What’s Wrong with Venezuela

What’s Wrong with Venezuela

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Venezuela is going through very tough times.

According to the World Bank, Venezuela’s economy will contract 10% this year, the most of any in the world. In order to keep the country afloat, the central bank of Venezuela has already burned through $25 billion in cash reserves. The International Monetary Fund (IMF) has stated that inflation is heading toward near unprecedented levels – 159% during this year alone – and the Venezuelan economy is expected to remain in recession until at least 2016. During the next year, export revenues from oil will barely cover providing for the country’s import needs and servicing its debt.

As Venezuela enjoyed unprecedented windfall revenues during the 2000s oil boom, many are wondering how its fortunes have reversed so completely.

The roots of Venezuela’s economic misfortunes are rooted in five factors: corruption and authoritarianism, the resource curse, the decline of Venezuela’s state oil company, state control over the economy, and drug gangs and violence.

Unfortunately, these negative trends reinforce each other and lead to their further entrenchment in the fabric of Venezuelan society. Until these five interrelated factors are addressed, the situation in the Venezuela will continue to worsen.

Corruption and Authoritarianism

Corruption is on the rise in Venezuela. It is nearly impossible to discuss any of the other issues facing the country without considering the degree to which a small group of individuals has progressively come to control politics, the economy, and society. Corruption in Venezuela has manifested itself in many forms ranging from a rising level of elite capture of resources to increasingly authoritarian government.

In 2014, Transparency International ranked Venezuela as tied for the country with the eighth highest perception of corruption in the world and the worst in South America. Similarly, Freedom House, in a recent report, has assigned Venezuela low scores in freedom, civil liberties, and political rights, with a downward forecast for the future.

Domestically, Venezuelan President Nicolás Maduro has arbitrarily prosecuted political opponents, unfairly disqualified opposition leaders from running for office, used state media to promote his party and its candidates, and gerrymandered voting districts. Internationally, Maduro has stoked conflicts with neighboring countries such as Guyana, Colombia, and the United States. The administration often frames these conflicts as part of a U.S. plot to overthrow the Venezuelan government and gain control over its oil reserves. However, most critics of the government and opposition figures have stated that the administration is fabricating foreign threats and conspiracies to increase support for itself.

The Resource Curse

Since the mid-20th century, Venezuela’s economy has been heavily dependent on oil production. Oil sales currently provide 95 percent of total export earnings, and the oil and natural gas sector constitutes around 25 percent of gross domestic product (GDP).

However, while states with higher levels of governance and institutional development such as Norway have been able to utilize natural resource wealth effectively, the lack of such safeguards in Venezuela has meant that oil has been more of a curse than a blessing.

During the oil booms of the 1970s and 2000s, Venezuelan governments spent lavishly on unproductive, poorly planned economic diversification projects, expansive social welfare programs, and a far-­reaching international aid and development apparatus. Simultaneously, the sense of abundance spurred the government to reach beyond its means by running up an impressive debt whose maintenance depended on ever increasing oil prices. As a result, the oil booms extended Venezuela’s economic liabilities without laying the foundation for future growth.

Following the prescriptions of developmental economists in his administration, former Venezuelan President Hugo Chavez did attempt to set up a consolidated wealth fund (FUS) in order to curb the tendency to overspend during windfalls. However, from the beginning of the fund’s existence, Chavez openly violated its provisions and engaged in the same type of reckless spending for which he had criticized the previous Venezuelan administrations.

Now that oil prices are experiencing one of the sharpest declines in history, the effective investments that would help Venezuela weather the storm simply do not exist.

The Decline of Venezuela’s State Oil Company

The tenure of former President Chavez and current President Maduro has been particularly problematic because of increasing state control, and hence elite capture, of the state oil company, Petróleos de Venezuela, S.A. (PDVSA).

Prior to Chavez’s tenure, PDVSA, although nominally controlled by the Venezuelan government, maintained a substantial degree of technical, bureaucratic, and fiscal independence.

Importantly, as a result of its independence, PDVSA avoided the inefficient leadership of Venezuelan elites whose mismanagement devastated the state’s other economic sectors. Moreover, PDVSA’s technocratic managers were able to prevent the government from completely looting the oil company to line their own pockets.

However, in 2002, Chavez fired most of PDVSA’s existing management and researchers and replaced them with his political allies, leading to the same sort of mismanagement that had previously prevailed in other state-controlled enterprises. Chavez’s newfound control over PDVSA allowed him to siphon off its substantial capital reserves, which the company had traditionally used in order to fund technological innovation and exploration, and significantly damaged its technical and productive capacity. Although Venezuela now enjoys the largest oil reserves in the world, its productive capacity has stagnated for the last five years.

Other than redirecting the capital from the oil company to other initiatives, there is also emerging evidence that the figures within the Venezuelan government may be using PDVSA for criminal purposes. U.S. officials are currently investigating whether Venezuelan officials used PDVSA to steal billions of dollars through kickbacks, trade misinvoicing, and other illicit financial practices. Moreover, Venezuelan leaders may have used the oil company and its foreign bank accounts to facilitate other crimes such as black-market currency schemes and laundering drug money.

State Control over the Economy

Throughout his tenure, Chavez presided over a campaign of nationalization that extended across multiple sectors. The scale and intensity of the nationalizations exceeded those which had existed previously in Venezuelan society and those that neighboring governments implemented around the same time such as Evo Morales’ Bolivia. Given Chavez’s increasing control over PDVSA, the state oil company, he moved to assume some of its most valuable foreign assets.

As oil production began to fall because of increasing mismanagement, Chavez nationalized many of PDVSA’s joint ventures with foreign oil companies at disadvantageous terms. In doing so, Chavez assumed control of the ventures’ oil production and vested capital, cannibalizing them in order to support his weakening oil policy in sectors that he already controlled.

This series of events has proved particularly problematic in the wake of falling oil prices because one of the only ways that Venezuela could emerge from its current economic turmoil is through cooperating with foreign oil companies and significant attracting foreign investment. Both outcomes have become much more unlikely given the recent history of nationalization and poor industrial management. Current risk is so high that Venezuela’s 2022 bonds currently trade at about 49 cents on the dollar and possess a yield of more than 31 percent, the highest of any emerging market.

With substantial damage to the oil industry’s technical expertise, persistent underinvestment, and a poor climate for foreign investors, even if oil prices increase, it is unlikely that Venezuela and its oil industry will be able to rebound as readily as they did during the early 2000s.

Drug Gangs and Violence

Venezuela is an attractive point of departure for drug traffickers because the country’s position on the northern coast of South America allows ready transit of drugs to lucrative markets in the United States and Europe. Moreover, whereas neighboring Colombia – the production site for much of South America’s cocaine – has received more than $10 billion to combat the illicit drug trade since 2000, Chavez expelled the U.S. Drug Enforcement Administration (DEA) from Venezuela in 2005.

Given these incentives, many drug enforcement agencies believe narcotraffickers have relocated much of their operations from Colombia to Venezuela. U.S. officials estimate that, during 2013, Colombian drug traffickers shipped about half of the cocaine that they produced in Colombia to Venezuela for further transit. Given the country’s other governmental and economic problems and the revenues from the sale of their product, drug traffickers have been able to gain high levels of influence over key figures in Venezuela’s government and military.

Many suspect prominent members of the military and government work with drug traffickers to oversee the country’s illicit drug trade. U.S. prosecutors have tagged National Assembly President Diosdado Cabello, second only in power to President Maduro, as a possible high-level participant. More recently, DEA agents intercepted two of Maduro’s nephews in Haiti and has charged them with conspiring to import 800 kilos of cocaine into the United States.

Not only does the growth of drug trafficking further undermine Venezuela’s poor governance, but also it has helped bring about the sharp increase in violence that typically accompanies the presence of the drug trade in Latin America. Over the course of former President Chavez’s tenure, the level of violent crime and homicide in Venezuela rose substantially and it continues to surge under current Maduro. Currently, one police officer dies every day in Venezuela and the number of homicides per capita is the second highest in the world.

Along with a contracting economy, increasing corruption, and a repressive government, Venezuelans must now fear for their lives as they go about their daily routine.

Venezuela’s Future

As the parliamentary election on December 6 approaches, the Venezuelan public and international community are pressing for change.

Current polls indicate that President Maduro’s governing coalition could lose its majority in the National Assembly for the first time in 16 years.

On November 10, Luis Almagro, the secretary general of the Organization of American States (OAS) sent an 18-page letter to the chief of the Venezuelan election commission expressing his concerns for the upcoming election. Moreover, in the wake of the letter, a group of 157 lawmakers from the United States, Chile, Colombia, Costa Rica, and Peru sent another note urging Maduro to allow international observers to monitor the vote. The critical tone of these messages is particularly noteworthy because of the historic reluctance of the OAS and its member states to criticize Latin American leaders.

Despite these encouraging signs, many international observers doubt that the election will be held fairly. Moreover, even if Maduro loses in the polls, there is a strong possibility that he will hang onto power. During late October, Maduro stated that, if his United Socialist Party of Venezuela loses the election, he will not “not hand over the revolution” and that he will govern “with the people in a civil-military union.”

Regardless of the political outcome of the election, Venezuela must address these five negative trends or risk falling even further backward.

Featured image courtesy of the photographer