Sunday, May 06, 2007

If not now, when? 

As is well known the Venezuelan economy has been doing phenomenally well over the past few years on the back of high oil prices. Virtually every economic indicator is positive and Venezuelan’s are living much better than they did just a few years ago.

However, it needs to be kept in mind that Venezuela is still an underdeveloped and poor country. Most Venezuelans have a low standard of living and there is a significant percentage living in poverty. The Venezuelan economy would probably have to grow another 300% or more before most Venezuelans would enjoy what most of us would consider a good standard of living. Given that to date under Chavez the economy has grown a cumulative 25% or 30% we can see Venezuela has a long, long ways to go.

Further, if Venezuela is to make further gains the next stage of its development will be different from what has occurred up to this point. Venezuela’s economic improvements during the first eight years of Chavez’s rule have come from 1) a successful policy of supporting OPEC and helping to maximize oil revenues and 2) a more equitable distribution of Venezuela’s wealth.

As successful as this line of development has been it has likely reached its maximum extent. That is, while these gains in Venezuela’s standard of living can hopefully be held on to it is unlikely, in my view, that Venezuela’s standard of living can be improved much more by simply selling natural resources. All of Venezuela’s oil income currently comes to little more than $5 per person per day – hardly what most people would want to live on. The prospect of oil going up still more in price such that the $5 would become even $10 is probably dim – and in any event it certainly isn’t something that can be counted on.

This leads to the uncontroversial point that Venezuela needs to move beyond selling oil and greatly expand other types of exports. For Venezuelans to ever have a decent standard of living in addition to exporting $50 billion worth of oil they also need to be also exporting a hundred or two hundred billion dollars of other goods.

I say this is an uncontroversial point because most everyone across the political spectrum, from the opposition to Chavistas, recognizes it. Yet, as much as this may be recognized and paid lip service to by everyone no-one has been successful in increasing non-oil exports – and Chavez is no exception to this poor performance.

This is illustrated by the following graph of non-oil exports:

The tan bars show total Venezuelan non-oil exports. What is notable is that they haven’t changed very much over time. They were about $7.5 billion before Chavez came to office and they were about $8.75 billion last year (as a frame of reference oil exports last year were $58 billion). In relation to the size of the economy and Venezuela’s population this is almost unchanged. The blue bars show the portion of the non-oil exports that are by government owned industries and the red bars show non-oil exports by private industry.

If Chavez has had as his goal increasing non-oil exports he certainly hasn’t been very successful. [Parenthetically, it should be noted that the opposition did no better and that their whining about Venezuela being so heavily dependant on oil revenues is just cheap propaganda]. The question is why have non-oil exports been stagnant?

There is more than one reason why but among the most important, if not THE most important, is that Venezuela has historically kept its currency very overvalued. Its oil revenues have allowed it to keep its exchange rate fixed at a high level and this adversely effects most non-oil industries in a phenomena known as the Dutch Disease.

Why does having an overvalued currency hurt exports and domestic industry in general? Simple. It makes imports cheaper so that Venezuelans will tend to purchase more foreign goods than domestic ones. If 2,000 Bolivares buys a dollar then a $50 imported pair of jeans will cost 100,000 Bolivares. If a lot of Venezuelan’s have 100,000 bolivares to spend on jeans then they may well buy the imported pair. However, if it takes 4,000 Bolivares to get a dollar (from the Bolivar being devalued) that same pair of jeans will then cost 200,000 Bolivares which will lead to fewer Venezuelans wanting imported jeans. They will instead find Venezuelan made jeans cheaper and will be more likely to buy them.

The same goes for exports - the less valuable the Bolivar is relative to the dollar the cheaper Venezuelan goods will be to people in other countries and this will serve to boost Venezuelan exports.

Knowing that a strong currency tends to increase imports and stymie exports we can now look at a graph that will speak to why Venezuelan non-oil exports haven’t grown:

The graph on the right shows one economic analysis firm's calculations of how over valued the Venezuelan currency is. The sharp drops are where the Bolivar was devalued, though even during those times they still considered it overvalued. The increases come when the fixed exchange rate between the Bolivar and dollar is maintained (as it is right now). As the chart shows the Venezuelan currency has consistently been overvalued, only the extent of its overvaluation has varied between 10% and 40% overvalued.

This may sound like mumbo jumbo and the chart may seem meaningless. But to see that it isn’t refer look at the how the chart on how overvalued the currency is and compare it to Venezuela’s total non-oil exports. Note for example that as the Venezuelan currency became more overvalued during 2006 its non-oil exports dropped!

This is the key point – to boost exports other than just oil Venezuela must make its exports more competitive by making them more competitive. And that is precisely what devaluing the Bolivar will do. It will also reduce imports so that domestic Venezuelan industry will get two boost; one from increased exports and the other from more internal consumption.

Are there downsides to devaluing the currency. Sure. It means Venezuelans won’t be able to consume as many imported goods and may therefore see their standard of living drop to an extent. For example, last year Venezuelans purchased almost 400,000 new automobiles. Most all were either imported or made extensively from imported parts. So they will become more expensive and a lot fewer of them will be sold. All imported goods will experience the same phenomena to a greater or lesser extent.

This makes this makes devaluation politically tricky. It will almost certainly be unpopular at least in the short term. However, that is the short term pain that must be endured if Venezuela is to move forward. Yes people will have less for a time (though it is mainly middle class people who consume the imported items likely to be affected and they are largely anti-Chavez to begin with). But longer term there will be more industry, more exports, more jobs, and a higher standard of living. The single act of devaluing the currency will do far more to spur Venezuelan industry than the newly announced Fabrica Adentro program. In fact, with out a devaluation Fabrica Adentro is doomed to failure as Venezuela will import more and export less manufactured goods.

Having just passed through an important election cycle this is the perfect time for the government to do the right thing even if it causes some short term pain. This truly is a case of if not now, when. We are already 5 months into 2007 and if much more time goes by “when” will sadly start to look like “never”.


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