Throughout Venezuela’s record-breaking economic expansion, the government’s opponents – which includes most of the international media as well as Washington – were "crying, waiting, hoping," as the rock and roll legend Buddy Holly once sang. The "oil bust" had to be just around the corner, they prayed and wrote. But for five and a half years from the first quarter of 2003, when the Chavez government first got control of the state-owned oil company, the real economy grew by 95 percent. Poverty was cut in half and extreme poverty by more than 70 percent, social spending per person more than tripled, and access to health care and higher education rose sharply. The voters rewarded Chavez with a re-election by his widest margin ever, 63% in 2006.
Then, at the end of 2007, as the U.S. economy lapsed into recession, the Venezuelan economy began to slow. In the fourth quarter of 2008, world oil prices suddenly collapsed, falling in six months from a peak of $137 to just $41. Venezuela went into recession for the first time since the opposition oil strike of 2002-03, with the economy contracting by 3.3 percent in 2009. The prayers of Chavez’s enemies where answered; Venezuela’s "oil boom," like the last one from 1973 – 1977 had finally gone bust. Economic collapse would follow.
But will it? If we look at what happened in Venezuela’s recession, it does appear that it could have been avoided altogether. Private spending, which was already slowing throughout 2008, dropped further when oil prices collapsed in the last quarter of 2008. At this time, the government needed to provide a strong fiscal stimulus, expanding public spending as necessary to compensate for the fall-off in private demand. But it did not. Instead, public sector growth fell off sharply, increasing by only 0.9 percent in 2009, as compared to 16.3 percent in 2008.
There has long been a double standard regarding fiscal policy – one that the IMF and other multilateral lenders have often promoted – which says that rich countries like the United States or the UK should run large deficits to counteract an economic downturn, but that developing countries cannot. Or worse, that they must do the opposite – cut spending and reduce public deficits during recessions. But in fact developing countries can successfully use expansionary fiscal policy to counteract recessions. China plowed right through the world recession with 8.7 percent growth in 2009, thanks to a large stimulus package. Of course it helps that the Chinese government controls the banking system, and could force banks to lend; and that 20 percent of GDP is public investment. But even Bolivia, which does not have these advantages, used a large and well-timed fiscal stimulus – several times bigger, relative to their economy, than that of the United States – to grow by about 3 percent last year. (It was the best performance in the hemisphere; most of the other economies contracted).
The constraint that developing countries face in pursuing expansionary fiscal policy during a recession is that they must maintain an adequate level of foreign exchange to avoid a balance of payments crisis. This is different from the United States, which can pay for its imports in its own currency.
Venezuela ran a huge current account surplus in 2008 – meaning that it was accumulating dollars. When oil prices plunged, this surplus quickly collapsed into a deficit – but only for six months. The government dipped into its international reserves in order pay for imports. But it did not need to let the economy shrink. It could have dipped further into reserves, since these have remained sizeable, reduced capital flight, or even borrowed internationally as much as necessary. Venezuela foreign public debt is quite low, just 11 percent of GDP, and its total pubic debt is only 20 percent of GDP (as compared to about 100 percent of GDP in the U.S.). Remember, the government does not need foreign currency for the stimulus itself; it only needs enough to cover its imports in a growing economy (as opposed to a shrinking economy, in which imports also fall), and to maintain adequate reserves.
All this is important because it shows that the growth of Venezuela’s economy is not so directly tied to oil prices as most people think it is. The government has the capability to maintain steady growth as oil prices fluctuate, especially when it has such a low level of public debt and a relatively high level of international reserves.
The other major economic problem faced by Venezuela over the last 7 years has been its overvalued currency. In 2003 the government fixed the exchange rate at 1600 (now re-denominated as 1.6 bolivares) per dollar. It was devalued twice, to 2.15 in 2005, where it remained until January of this year.
The problem is that Venezuela’s currency has grown increasingly overvalued at this fixed rate. Venezuela’s inflation has been much higher than that of its trading partners (it has averaged 21 percent annually over the last 7 years). This means that if the nominal exchange rate is held fixed, the currency appreciates in real terms. Assuming that the currency was not overvalued when it was originally fixed, it would have to have fallen to about 5.13 to the dollar by the beginning of this year, in order to keep the same real exchange rate. At the fixed exchange rate, it was probably more than 130 percent overvalued.
An overvalued exchange rate makes Venezuela’s exports expensive in foreign markets and its imports artificially cheap. This makes it difficult, and perhaps impossible, for Venezuela to diversify its economy away from oil – and in fact the country has not done so during the past 7 years.
On January 9 the government devalued the currency to 4.3 bolivares per dollar, for most imports. At the same time, a higher rate of 2.6 per dollar was established for sectors deemed essential, which include food, education, science and technology, health, machinery and equipment, family remittances and transfers to students living abroad.
The devaluation brings the exchange rate much closer to a competitive level. But it probably has farther to go, and unfortunately as inflation continues at high rates, the currency’s overvaluation in real terms will increase rapidly. The inflation itself is a secondary problem; at 25.1 percent for 2009 (down from 30.9 percent the prior year), it needs to be lowered. But it is not that far over the boundary of 20 percent that much of the macroeconomic research sees as reducing growth (although there is a wide range of disagreement on this among economists).
Venezuela would probably be better off with a more flexible but still managed exchange rate regime, keeping its capital controls but maintaining a competitive exchange rate so that the economy can diversify away from oil. This would at least allow for the possibility of pursuing an economic development strategy, something that – after decades of neoliberalism – is still pretty much absent among governments in the western hemisphere.
In the mean time, oil prices have recovered quickly and are currently at $80 per barrel. It should not be difficult for the government to restore rapid economic growth this year if it so chooses. The U.S. Energy Information Administration is projecting that world oil prices will rise fairly steadily to $98 dollars per barrel by 2020, although such long-range projections are uncertain. Venezuela is sitting on what are now acknowledged to be the largest oil reserves in the world, an estimated 500 billion barrels; the country currently takes less than a billion barrels per year out of the ground. Foreign oil companies are showing renewed interest in joint ventures with the government.
The Chavez government will most likely have plenty of room to try new economic and political experiments and learn from its mistakes as well as successes, so long as the government continues to have control over its oil resources, and gets its basic macroeconomic policies right.