Putting Venezuela on the path to prosperity

Demonstrators hold signs and Venezuelan flags during a protest outside of the Goldman Sachs headquarters in New York in May. Photo: Bloomberg.

With the current Maduro regime on the ropes due to increased discontent and unrest from all sectors of Venezuelan society, many analysts are beginning to ponder about what lies ahead for Venezuela’s future.

A country that has not only coped with nearly two decades of destructive socialist polices under the helm of Hugo Chávez and his successor Nicolás Maduro, it has also experimented with socialist policies of varying degrees for the past five decades.

To fully recover from these detrimental policies, Venezuela will have to implement substantial market-based reforms. It is no secret that Venezuela is experiencing a brain drain of sorts, where estimates of nearly 2 million Venezuelans have fled the country in search of greener pastures.

With so much instability at the political and social level, it will be difficult to convince Venezuelans to return to their country. Thus, there is an urgent need for reforms that will make Venezuela sufficiently attractive for foreign investors and Venezuelan expatriates alike to come back to and help rebuild the country from the ground up.

Chile as a model for inspiration

Luckily, there is a Latin American country that Venezuela could look to as a reasonable model of economic recovery in times of political and economic crisis.

Enter the Chilean model.

Just like Venezuela, Chile had the misfortune of confronting a socialist regime that brought it to the point of economic collapse in the 1970s. Long lines for basic goods and services, hyperinflation, growing black markets, and social instability were the norm in Chile under Salvador Allende.

In 1973, the military stepped in to prevent further harm from Allende’s socialist policies.

But even in his first years of power, military dictator Augusto Pinochet maintained many of the previous economic controls ushered in by Allende’s government. The Chilean economy would continue to sputter with inflation and exploding public debt spiraling out of control.

Luckily, a group of economists trained at the University of Chicago, better known as the “Chicago Boys” stepped into the scene and would serve as advisors to the Pinochet regime.

Cooler heads would eventually prevail as Pinochet turned economic matters over to the Chicago Boys.

Once behind the steering wheel, the Chicago Boys did not play around the margin.

They did away with all price and exchange controls, liberalized industries that were completely nationalized under Allende, cut spending, slashed tariffs, and implemented a revolutionary social security reform that turned Chilean workers into capitalists.

And what was the result?

Chile boasted a sustained growth rate of 4.3 percent from 1983 and onwards. As of today, Chile is the most economically and politically stable country in Latin America all thanks to these far-reaching reforms.

While the authoritarian nature of the Pinochet regime should be condemned, this regime at the very least allowed the reforms that gave Chile a strong dose of economic liberty. Such unprecedented degree of economic freedom not only allowed for substantial economic growth, but it also paved the way for the democratization of Chilean society.

The period of prosperity allowed for the development of a robust civil society that helped oust Pinochet from power in 1988 during a plebiscite. This was a watershed moment in Latin American history, as Chile would be buttressed by one of the most stable constitutional orders in the region’s history.

Reforms that Venezuela must make

So what can Venezuela learn from this experience?

The reality is that “shock therapy” is not only necessary to revitalize the Venezuelan economy in the short-term, but also to create a sustainable institutional foundation for the country in the long-term.

Venezuelan policymakers simply cannot beat around the bush and pursue half-measures. They must be willing to make the hard call and strike at the root of Venezuela’s institutional ills.

They can do so by pursuing the following landmark reforms:

Eliminate price controls

The rampant scarcity of basic goods that Venezuela has gained a lot of notoriety for in recent years is no mere coincidence. It is the logical result of Hugo Chávez’s and Nicolás Maduro’s price control policies.

These policies originated in 2002, when Hugo Chávez implemented series of interventionist measures that aimed to stem capital flight following a failed coup attempt against his government. These measures consisted of expropriation of key industries, exchange controls, and price controls.

Thanks to the flow of petrodollars brought about by high oil prices in the mid-2000s, Venezuelan businesses had considerable wiggle room in importing basic goods and raw materials as a short-term, fallback measure.

However, when oil prices started to fall, harsh economic realities emerged. Scarcity would soon become the norm in Venezuela because of stringent exchange controls that did not allow for the free entry of dollars into the economy combined with a burdensome price control regime that prevented the price system from functioning properly.

Once high levels of inflation became a factor, Venezuela’s socialist government would double down in its price control efforts. By passing the Fair Prices Act in 2014, the Venezuelan government aimed to tame shortages by banning profit margins over 30 percent and tightening price ceilings on basic goods.

The Fair Prices Act has only aggravated Venezuela’s shortage crisis, practically leaving it in a state of famine. The Venezuelan government has followed up these polices with even more interventionism through the establishment of CLAPS, local supply and production committees, that ration food in a way that favors government supporters.

Simply put, when the government establishes an artificial price ceiling for goods and services, it will increase the demand for said good or service.

Therein lies the problem; supply does not adjust accordingly to meet this demand under price controls. Consequently, shortages emerge, as more consumers demand the good while suppliers have no incentive to keep up with demand because of the artificially low price.

To solve Venezuela’s scarcity crisis, policymakers must immediately abolish all price controls so that prices can reach their natural equilibrium and allow for resources to be allocated efficiently. A transitional government can begin by abolishing the Fair Prices Act, and then continue hacking away at remaining price controls.

Eliminate capital and currency controls

Another legacy of Hugo Chávez’s economic authoritarianism is Venezuela’s byzantine system of exchange rates. If the black-market rate is included, Venezuela currently has a total of four different exchange rates. Established to supposedly strengthen the Bolívar and prevent capital flight, Venezuela’s exchange controls have done considerable damage to the Venezuelan economy.

Hugo Chávez created The Commission for the Administration of Currency Exchange (CADIVI) in 2003 for with the aim of stemming capital flight by limiting the amount of foreign currency Venezuelans can buy or use in daily transactions.

This system would later morph into CENCOEX (the National Center for Foreign Trade) and other variants such as SIMADI and SICAD.

Akin to the effects of price controls, exchange controls have forced multiple multinational corporations, such as Ford to shut down operations in Venezuela because of dollar shortages.

These controls have also affected the airline industry, where there is now a shortage of plane tickets.

Due to these perverse controls, the border town of Cúcuta, Colombia has become the go-to airport for many Venezuelans that must travel by bus just to find an airport that has tickets available. More than just a form of financial control, currency and capital controls represent a form of social control. At their very essence, these heavy-handed policies are designed to limit Venezuelans’ travel options and keep them locked in.

Venezuelan policymakers must work to repeal the “organic laws” that established these controls. Markets must be allowed to function freely in order for dollars to flow back into the economy and international companies to restore their normal operations in the country.

Constitutional reform

From its ratification in 1999, the Constitution of the 5th Republic was based on faulty institutional premises. This constitution granted the state far-reaching powers, and legitimized Venezuela’s despotic regime. The power of socialism of the 21st century lies in its facade of democratic and institutional legitimacy.

Operating under the guise of democracy, 21st-century socialist regimes are viewed as legitimate in the eyes of the international public. Even the Venezuelan government’s most tyrannical actions are respected by international bodies due to their “legal” status.

What Venezuela needs is true constitutional reform. Policymakers must push for reforms that can transform Venezuela’s political system into a system of market-preserving federalism which fosters competition among administrative units below the federal level. A genuinely federalist system grants states and municipalities a strong degree of autonomy, so that they can vie access to labor and capital.

Privatization of the oil industry

Venezuela became one of the richest countries in Latin America thanks to a hands-off government policy when it came to managing its oil sector. From the 1920s to the 1970s, Venezuela experienced unprecedented economic growth thanks to its relatively free market economy. Unfortunately, the government decided to nationalize the petroleum industry in 1975. The nationalization of Venezuela’s petroleum sector fundamentally changed the relationship of the Venezuelan state with civil society.

Instead of Venezuelans paying taxes to the government in exchange for the protection of property and similar freedoms, the Venezuelan state would take on a patrimonial role by bribing its citizens with a plethora of handouts in order to maintain its legitimacy.

Rather than buying off their citizens with generous subsidies, countries based on more liberal frameworks of governance have their subjects pay taxes, and in return, these governments provide basic public services that protect the life, liberty, and property of their citizens. The state is not the proprietor, thus giving the citizens a strong check against state abuse should the government overstep its boundaries.

In an ideal world, the state oil company, PDVSA (Petroleum of Venezuela) would be fully privatized. But due to political constraints, a more realistic alternative would be to carry out gradual privatization measures that liberalize state control of PDVSA and develop a sovereign wealth fund in the Norwegian mold. This will not only make Venezuela’s petroleum sector more dynamic on an international scale, but it will also de-politicize the sector by keeping politicians hands off of petroleum revenues to finance unsustainable government largess. This will set the stage for a complete privatization of Venezuela’s oil industry.

Regardless of the political circumstances and opportunities available, Venezuelan policymakers should have the privatization of PDVSA as their long-term goal.

Conclusion

All in all, Venezuela will need its very own Chicago Boys if it wants to not only get out of its current crisis, but also create a stable institutional foundation that promotes economic growth.

The challenges ahead are daunting and will require strong political leadership to effectively tackle them. The harsh reality is that the country needs a facelift when it comes to its economic and political institutions.

A strong dose of capitalist reforms is paramount. The good news is that Venezuela has a regional model in Chile to look towards for inspiration. By emulating the Chilean model, Venezuela can move forward and undo the horrific legacy of Hugo Chavez’s socialist policies.

Now, it’s just a matter of the opposition taking power in Venezuela and having the political courage to follow through with tough reforms to right Venezuela’s economic ship.