Sunday, April 13, 2008

Nationalizations don’t deal with Venezuela’s REAL problem 

In the past two weeks the Venezuelan government has announced that it will be nationalizing, or better expressed, buying out, the private owners of several cement manufacturers and Venezuela’s only sizable steel firm, Sidor. This comes after last years large buyouts of the main telecommunication company, CANTV, and some electric companies.

Given that the Venezuelan government spends billions of dollars to compensate the former owners of these companies respect for property rights isn’t the main issue here (unless, as could be argued, you think Venezuela is being too respectful of property rights). Most of the former owners seem to pocket their money and walk away happy.

However, even if these nationalizations aren’t so bad for the private owners the question remains, are they good for the country? Are they the best use of the countries limited resources?

To answer those questions lets look at the before and after effects of the nationalizations and then at what some alternative uses of the state resources used for these nationalizations could be.

In most, if not all, of the cases the companies being nationalized are solvent and operational. They produce goods or services, employee people, make investments, generate income, pay taxes, and, of course, make a profit for their owners – just as any private company does. All these companies could have been left in private hands and would have continued to function normally.

Further, they all represented an asset to the Venezuelan economy. By producing productive economic output and jobs they added to Venezuela’s overall economic output and hence its well being. The jobs they created, taxes they paid, investments they made are all sorely needed in an underdeveloped country like Venezuela.

Of course, being private companies often owned by foreigners there was one benefit of these firms that did not accrue to Venezuela – the profits. The profits (and by profits I mean only those profits NOT reinvested in the company) go to only a few individuals who likely take the money out of the country and in any event use that money simply to pad their personal fortune.

One question that therefore arises is what proportion of the companies revenues are profits? Given that I haven’t seen that information made public we can only guess. But for most manufacturers true profits are somewhere in the neighborhood of 10%. That is, 90% of their revenue goes to paying salaries, buying materials, paying taxes, making investments, etc, and only about 10% is skimmed off by the owners.

What is the significance of that? The significance of that is that Venezuela’s economy gets 90% of the benefit of these firms and only roughly 10% doesn’t do anything to help the country. Hence, it is good for Venezuela that these companies exist, producing goods and services in Venezuela, and through their economic activity they help increase the standard of living of Venezuelans.

Now, what changes when these companies are purchased by the Venezuelan government? There are a couple of possibilities.

The first is that the company is poorly administered by the government, under invests, doesn’t respond to changes in markets, etc, and ceases to be a profitable firm. In that case the government generally has to keep putting more and more money into the company and it becomes a permanent drain on the states resources. This is the worst case scenario.

An alternative outcome, and a much better one, is that company continues to be well run and generates profits. Given that the government now gets the profits too 100% of the wealth generated by the firm now remains in the country. So in this case it may seem as if the nationalization was a good idea.

However, before being able to say that we need to take account of another VERY, VERY big factor - what the alternative uses of the money used by the government to purchase a company could have been.

Let’s say the government pays the owners of Sidor $2 billion to purchase it (I’m just making up this number for the sake of example).

After spending the $2 billion the only thing NEW that Venezuela has is the rights to Sidors profits. That may or may not be a good “investment” depending on what the exact profit rate turns out to be.

But what is important to note is what Venezuela will NOT get through any of these nationalizations; new steel mills or cement factories or new telephone systems – those already existed and simply changed hands. There won’t be any new jobs as all the jobs working for those firms already existed. There won’t be any new economic output as the goods and services produced after nationalization were already being produced before it.

In sum, the only benefit that Venezuela gets from nationalizing these companies is it now controls their profits and it only even gets that if it ensures the companies are well run and remain profitable.

Now let’s turn to an alternative use of that money. Instead of buying existing steel mills or cement factories suppose the government built new ones.

By contrast if the government built a new steel mill with the same $2 billion it would create thousands of NEW jobs, it would generate NEW economic activity, it would generate NEW tax revenue and, if the company is run well, it would even get NEW profits.

In summary, if the Venezuelan government uses its oil revenues to purchase an existing company its Venezuela’s only gain is whatever the profits of that company are. But if it instead uses those resources to build NEW industries it gets far more as much new wealth is created, economic output increases, and the standard of living of Venezuelan’s increases. This is not to even count other tangential benefits that may accrue such as increasing the skill level of your work force, obtaining new technologies, reducing the economies dependence on oil, etc.

It is more than clear that from an economic point of view it would be better not to nationalize Sidor and the other companies and instead invest the money in building up new industries. These nationalizations are therefore a misguided and a wrong policy for Venezuela to be pursuing.

The fact that the Venezuelan government is pursuing this type of policy is evidence that it is fighting the wrong battles. Yes, Venezuelan’s are generally underpaid and have a low standard of living.

The reason for that, however, is not that they are exploited by foreign companies who take vast sums of wealth out of the country. The principle reason is that the country is underdeveloped and simply doesn’t generate enough wealth for Venezuelans to live well, even if all of that wealth remains in the country. Hence, the central issue facing Venezuela isn’t how to distribute the countries economic output more equitably (though that too can be worked on in various ways) but how to INCREASE its economic output.

Putting this in terms that would be familiar to Marxists, Venezuela’s problem isn’t who OWNS the means of production; it is that it doesn’t have ENOUGH means of production. For that reason the precious resources the Venezuelan government has would be much better employed creating new means of production rather than simply changing ownership of existing ones.


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