Monday, December 17, 2007

The flabby revolution - II 

In the previous post we looked at how the government is wastefully giving huge subsidies to the wealthy through its exchange control entity CADIVI. That waste is conservatively estimated at between $5 and $10 billion dollars. No small amount given that the total oil profits for the government last year came to around $50 billion.

Today we will look at another way the government is wasting money - and this time it will be even easier to quantify exactly how much money the government is wasting.

It is widely known that in Venezuela gasoline is sold for next to nothing. No its not exactly free, but darn close to it. Most Venezuelans can completely fill up the tank on their car for about $1. This makes gasoline not only extremely cheap by foreign standards but it makes it very cheap by Venezuelan standards too and people make no effort to economize on it.

A clear example of this is that in Venezuela one can easily take taxi's between cities. For a price that is significantly higher than a bus ticket, but still not all that high, you can share a cab with 3 or 4 other people and be driven between cities that are hundreds of miles apart - say Merida to Maracaibo. To my knowledge this practice exists virtually no where else - the reason being it would be to expensive taking into account how much the gasoline costs and whatever the wear and tear is on the car.

But in Venezuela where gasoline is essentially free the cab driver can charge whatever he thinks is a fair price for his time (and the little wear and tear on the car) and that is it - the gasoline involved is so inexpensive it simply isn't a factor. So in Venezuela there are a large number of taxis traveling between cities and it is a common form of transport for people who don't want to bother with a bus. Such are the effects of (almost) free gasoline.

Filling up the tank in Barquisimeto, Venezuela

For less than one dollar!

Currently Venezuela produces about 3.2 million barrels of oil per day. Of this the best estimate is that about 700,000 thousand barrels are consumed internally. When it was last detailed in a financial statement it was about 550,000 but since then huge numbers of cars have been sold, 450,000 being sold this year alone. So while 700,000 barrels of oil per day is an estimate it is probably a conservative estimate of Venezuela's internal consumption.

Now, here comes the key concept - opportunity cost. Opportunity cost is where you give up income that you could otherwise have. For example, if you are a consultant who earns a thousand dollars a week and you decide to take a week off then we say the opportunity cost of your week off was one thousand dollars because you didn't earn that money. It could be said you "lost" one thousand dollars or that the vacation "cost" you a thousand even though you didn't actually pay out any money - simply not getting money you COULD be earning is the same spending it or giving it away.

This concept comes into play when Venezuela sells oil internally. The oil sold domestically generates virtually no income for the government whereas if that barrel of oil were exported rather than consumed it would fetch full market price (currently $80 per barrel). This may not sound like a big deal but when we start going over the numbers it will be very clear that the revenues being lost by the Venezuelan government to give out free gasoline are simply enormous.

Just to calculate what it is right now we can note that Venezuelan oil is selling for over $80 per barrel. If there are 700,000 barrels consumed domestically rather than exported this comes to $56 million per day in lost revenue.

Just looking at that on a daily basis is bad enough but multiply it by 365 to get the annual cost and you get over $20 BILLION dollars that it is costing it is costing the Venezuelan government to give its citizens free gasoline!!!! (quick question - who do you think owns the VAST majority of cars in Venezuela and therefore benefits the most from free gasoline - the higher income social sectors A,B, and C or the lower income sectors D and E ? )

Now remember, this isn't $20 billion dollars that the government is having to pay out to anyone. So it seems painless. But it isn't because they are losing $20 billion dollars per year that they COULD get if they exported it rather than having Venezuelans use it for free.

This is an enormous loss of revenue for the government. Obviously if the government had another twenty billion dollars at its disposal it could do a lot more for its social programs, build more public works, pay down debt, and maybe invest in some new industries.

But before going on I want to step back and clarify one more concept that could be confusing to people. People should not read this and think "Oh my god, the Venezuelan government has been losing $20 billion dollars every year for the past 8 years" - it hasn't.

The reason why is that the amount of this "opportunity cost" depends on the price of oil. I did the calculation at $80 per barrel which is the current price and is very high. But oil hasn't been nearly that high for most of the past 8 years and the lower the price is the less are the opportunity cost losses.

For example, in 1998 before Chavez came to office Venezuelan oil sold for $8 per barrel. Assuming domestic consumption had been 700,000 barrels (it wasn't, but just to keep things simple I will leave that number alone) the lost revenue per year would only have been $2 billion, or one tenth as much just as the price of oil was only one tenth as high as it is now.

And that is a key concept - the higher the price of oil goes (which is otherwise good for the Venezuelan government) the greater the lost revenue from domestic consumption. So while Chavez did a great thing by rallying OPEC and helping boost prices he at the same time made it a much bigger loss for Venezuela to keep giving away free gasoline to its own public.

Of course, as anyone who knows Venezuelan history is aware the price of gasoline in Venezuela can be an explosive issue. A price hike in the late 1980s is what precipitated - via public transport price increases - the deadly Caracazo riots.

So care has to be taken when addressing this issue. Clearly huge amounts of money are being lost on this subsidy of Venezuelans who are affluent enough to own cars (by and large NOT Chavez supporters) but if possible efforts need to be made to ensure public transport fares are not effected.

There are probably a number of creative ways this could be done. The price of gasoline (which private cars use) could be increased while diesel (which buses and trucks use) would be left unchanged. Or ration coupons could be given to bus companies allowing them to get their gasoline at the cheaper old price while all private motorists have to pay the higher new price. There are probably other ways this could be accomplished too and the government should simply choose what it thinks will work the best. But increased bus and trucking fares and the specter of another Caracazo should NOT be used as an excuse to maintain the highly wasteful current policy - the government has plenty of ways to mitigate the effect of any of these changes on lower income Venezuelans.

Now, for the government to reduce this "opportunity cost" revenue that it is losing does it need to increase prices to full market rates that people pay in other countries?

The answer is no. They could make it that Venezuelan gasoline would still be fairly inexpensive by world standards, they just can't have it be almost free as it is now.

Here is why. If prices are increased by even fairly moderate amounts it would still be inexpensive by world standards but it would be expensive enough by Venezuelan standards that Venezuelan motorists would be more careful about how much they use - it would no longer be a trivial expense.

In fact, that is the whole idea here - not that people would stop using their cars and consuming gasoline altogether but that it will cost enough they will economize in what use. If gasoline cost say 50 or 75 cents per gallon (still very cheap by international standards) it would be expensive enough to most Venezuelan car owners that they would cut back on their gasoline use. Maybe people would take the bus to the beach sometimes instead of driving. Or take mass transit to work rather than sit in hours long traffic jams burning no longer free gasoline.

Hence the Venezuelan government doesn't even have to have a specific number in mind for how much it should the price of gasoline. Rather, it can decide how much it wants to reduce consumption and then increase prices until consumption is in fact reduced by that amount.

Just to see what this might look like lets go over some numbers. Lets say they decide they want to reduce domestic consumption by 200,000 barrels per day. This seems realistic - that is a reduction in consumption of less than a third and could be done probably with some lifestyle adjustments (carpooling, taking public transportation, etc.).

If the Venezuelan government exported that 200,000 barrels of oil per day it at today's prices of $80 per barrel it would get an additional $16 million in revenue per day. Again that may not seem like much but annualize it and the Venezuelan government could get an extra $5.8 billion dollars per year!!!! That is a staggering amount of money which could surely be put to good use by the government rather than burned up by the cars of upper class Venezuelans.

And even if the price of oil goes down somewhat - to $60 per barrel for example, it still comes to $4.6 billion dollars per year. This is not chump change for even for a government which may seem at the moment to be flush with cash.

So there you have it, by administering some pain, mainly to better off Venezuelans who would never consider voting for Chavez anyways, he could get large amounts of revenue that could be put to good use benefiting the country. Lets keep in mind that while the government is losing all this money by subsidizing rich peoples cars it still has 10% of the population living in extreme poverty!

Chavez himself knows this as earlier in the year he briefly mentioned the possibility of raising prices. But then the issue was dropped, with no mention of why, and hasn't been brought up since.

This matter needs to be revisited immediately. The government simply can't afford to keep handing out $20 billion of free gasoline - at least some portion of that has to be recovered for the government by reducing domestic consumption. And again, the ideas outlined here are only some ideas that I have - there are many other possible ways of doing this. For example, they could just flat out ration gasoline, everyone gets only a certain amount each month, and once you use that up you start hitch-hiking or riding the bus. I have no doubt that Chavez and his advisers with some study of this issue and deliberation could quickly come up with a good plan.

Yet so far they don't. How much longer can this be allowed to go on? And why is so much money being wasted on the affluent when the poor and Venezuela as a whole have so many unmet needs?

The "revolutionary" government of Venezuela really needs to review its priorities, make some changes, and lose the flab it really can't afford to have.


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