How to Manage a Commodity-Based Economy, and Where Venezuela Failed
July 04, 2016
Venezuela’s ongoing collapse is not a simple function of sustained low oil prices. Yes, the commodity supply glut set off a chain reaction of economic failures, but the country’s breakdown was preventable. Maduro’s economy was sick. It had caught, along with the largest crude reserves in the world, an economic affliction called Dutch Disease.
Author: Gleeson Ryan, C’17 W’17
Dutch disease is the negative impact of a valuable natural resource, such as crude oil, on a country’s economy. If that resource generates a strong revenue stream, the heavy inflow of foreign currency has severe consequences for the rest of the economy. Other industries attract less investment, and the value of the currency may appreciate, further damaging domestic production. Another risk of resource-reliance is that commodity prices are unpredictable and government income can be irregular. Doctor’s orders say that some smart policy could have alleviated the worst symptoms of Dutch Disease, but Venezuela ignored the warning signs and is now careening into possible collapse while its citizens face debilitating food shortages and power outages.
Fifteen years ago, when oil sales began to strengthen the Venezuelan bolivar and cheapen imports, the country relied increasingly on food and goods bought from abroad. The sudden increase in cash flow also resulted in a spending spree by the Venezuelan government, who increased social spending on education and housing and heavily subsidized oil. Venezuela seemed to be prosperous, until short-sighted government policies went too far.
Once 95% percent of Venezuela’s exports were comprised of oil, Venezuela’s strong cattle and coffee industries began to decline . The heavy-handed government spending ultimately poured too much money into the economy and increased inflation up to 700%. Chavez defied the rapidly declining value of the bolivar, fixing the exchange rate in 2003 and indirectly creating a massive black market that crippled trade. The resulting dearth of dollars—and of course the low oil prices which further stripped the country of income—meant that Venezuelans could buy fewer imported products, causing the food and goods shortages that we are now seeing .
But how could have Venezuela prevented this? When the public sector depends heavily on a resource with volatile pricing like hydrocarbons—what are the options?
The clearest solution is to diversify, but this takes capital investment, time, and a level of access to training and experience that is not easily attainable in many developing countries that rely on commodities. However, there were other methods available to balance Venezuela’s economy in the meantime: primarily, more prudent spending of commodity revenue. Venezuela spent its oil profit rather than investing it: energy for citizens was subsidized for up to 4.6 percent of GDP in 2010, and the national oil firm PDVSA began to finance welfare programs . All that spending meant that when prices crashed, the money ran out. The government should have invested into other education and other industries, creating an alternative revenue stream in the event of an inevitable cyclical downturn. Additionally, Venezuela’s production is currently declining because the oil industry has not been supported by new technologies or workers. Punctual investment could have at least protected future oil production.
In addition to investing, it is important to simply save. Many countries have sovereign wealth funds, which save and invest extra income from boom times for use during an inevitable bust. Many commodity-rich countries have these in order to smooth spending—Norway and the UAE have sovereign wealth funds, and Chile has a copper stabilization fund—but Venezuela did not.
There are many more macroeconomic tips that would have benefitted the Chavistas, especially letting the exchange rate float, but in general, Dutch Disease is a question of controlled spending, smart investment, and supporting the viability of other industries. Of course, these policies are most feasible in a transparent and democratic system, which Maduro’s semi-authoritarian attitude has thwarted: he has been ignoring an opposed congress and stalling the process of a democratic referendum.
Venezuela’s road to health seems long and complex, especially while Maduro remains in power. Defaulting, as Argentina did, is not an option because the seizure of Venezuela’s productive assets abroad would further cripple the oil sector . Obtaining a loan from the IMF is also extremely unlikely, given Maduro’s pride and inflexibility. The increasing social unrest of hungry citizens is building the pressure on him to do something, but political change will need to occur before economic change can.
 S. Tong, “Oil pushes out Venezuela’s agriculture,” Marketplace, April 18, 2016. [Online], Available: http://www.marketplace.org/2016/04/18/world/resource-curse/venezuela-ranchers
 A. Grisanti, “Venezuela’s Oil Tale,” Americas Quarterly, Spring, 2011. [Online], Available: http://www.americasquarterly.org/node/2436
 S. Lubben, “The Coming Mess in Venezuelan Debt,” The New York Times, January 28, 2016. [Online], Available: http://www.nytimes.com/2016/01/29/business/dealbook/the-coming-mess-in-venezuelan-debt.html?_r=0
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