Cubanálisis El Think-Tank 

ARTÍCULO ESPECIAL EN EL THINK-TANK DE CUBANÁLISIS

 

An Understanding of Venezuela’s Economy

 

Dr. Antonio E. Morales-Pita, DePaul University

Anthony J. Ibrahim, graduate student with a major in Economics, DePaul University

 Matthew Caminiti, Junior student with a major in Economics, DePaul University

 

After decades of growth and prosperity, the country of Venezuela underwent difficult economic turmoil during the 1990’s.  A recession had spread throughout South America; even a nation that once thrived such as Venezuela experienced high levels of poverty and inflation as a result of internal and external problems.  It was an economic situation such as this, which spurred the radical left-wing socialist leader Hugo Chavez to be elected into office as president in 1998.  As a result, the nation of Venezuela has undergone a massive economic upheaval.  Chavez and his followers described their aim as "laying the foundations of a new republic."  As a result, the former neo-liberal globalizing nation of Venezuela has seemingly closed its doors to foreign nations in an attempt to nationalize the major industries of the country.

 

In 1922, oil was first discovered in Venezuela, an event that shaped the economic structure of the nation structure for decades to come. It wasn’t long till the government lead by Perez Alfonso, devised a plan for an international oil cartel. That cartel, of which Venezuela was a founding member, would one day become the widely criticized Organization of the Petroleum Exporting Countries, better known as OPEC.  As a result of these government actions, the Venezuelan economy was the strongest in South America from the 1950s to the early 1980s. Thus, in order to comprehend the GDP structure and economic health of Venezuela, one must analyze the nation’s dependence on its nationalized petroleum industry (1).

 

This paper will begin by analyzing the structure and composition of Venezuela’s GDP structure and composition.  The importance of oil to the economy will then be examined, which will lead into a discussion on their current trade policies.  The factors leading to a recent fall in Venezuela’s FDI, which are its move towards a closed economy, its harmful taxation system, and its adoption of a dual exchange rate, will also be examined.  The country’s domestic issues, such as its high inflation will be analyzed as well.  The paper will conclude with a discussion about Venezuela’s strained foreign policy towards the United States and several of its Latin American neighbors.

 

GDP Structure by sectors and by components under the expenditure approach 

 

The Venezuelan real GDP in the period 1998 – 2008 has shown a relatively decreasing trend from 1998 until 2003 greatly influenced by the drop in the oil price, and an increasing trend until 2008 when its economy was affected by the world wide recession and the reduction of the price of oil. According to the Economic Intelligence Unit, the growth of the economy has been steady since President Hugo Chavez came into office although the GDP growth started to shrink after 2008.  The situation by years up to 2008 is depicted in the following figure.

 

Venezuela Real GDP in the period 1998-2008 (In Bolivares)

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The GDP was around 42.1(all in billions of $) in 1998 when Chavez took office.  The next year in 1999, the GDP fell shortly to 39.6, but rose again to 41 in 2000.  The GDP growth remained minimal with an increase to 42.4 in 2001.  It then decreased two consecutive years from 2002, which has a GDP of 38.7, to 2003, which had a GDP of 35.7. 2003 began a period of GDP growth with a GDP of 35.7, which was followed by a GDP of 42.2 in 2004, a GDP of 46.5 in 2005, a GDP of 51.1 in 2006, a GDP of 55.3 in 2007, and finally a GDP of 57.9 in 2008. The current recession in Venezuela led to a decrease of the GDP beginning in 2009, which had a GDP of 56, followed by a projected GDP of 52.3 in 2010.  According to data from the Economic and Financial Indicators section of the Economist, the GDP growth in the third and fourth quarters of 2009 and the first and second quarters of 2010 were equal to -4.5% , -5.8% ,  -5.8% and -1.9% respectively.

 

As of 2009, the gross domestic product of Venezuela was estimated at 350.1 billion dollars. As a percentage of GDP, the service sector is 58.7%, manufacturing is 37.5%, and agriculture at about 3.8%.  These figures reveal that a very large share of domestic output is driven by the service sector. This can be at least partially attributed to the new government structure imposed by President Hugo Chavez, which has included multiple nationalizations (4).  Chavez has nationalized key sectors of the economy, including oil and petroleum industries.  As of 2007, the communications and electricity sectors have been added to the list of nationalized industries. On May 25th, 2009 the Venezuelan government purchased the Bank of Venezuela for 1.05 billion U.S. dollars.  This act further contributed to Chavez’s goal of nationalization, which seems to have no end (5).

 

Structure of the GDP components under the expenditure approach. Table # 1 shows the structure of the GDP broken down by components in the period 2000 to 2010. In general terms the percentage of consumption ranges from 47 to 65%; government spending from 11 to 15%, gross fixed investment from 15 to 25% and exports from 18 to 40%. The variations are considerably high and will be analyzed immediately after the table.

 

Table # 1 – Structure of the GDP by components under the expenditure approach

 

GDP component as % GDP 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*
Consumption 51.7 54.9 53.5 54.8 49.2 46.8 47 52.9 53 64.2 64.6
Government expenses 12.5 14.2 13 12.9 12 11.1 11.7 12 11.5 13.3 14.7
Gross fixed investment 21 24.1 21.9 15.5 18.3 20.3 22.3 24.5 20.4 22.1 16.4
Stock building 3.2 3.5 -0.8 -0.3 3.5 2.7 4.6 4.6 5.5 2.7 2.2
Exports 29.7 22.7 30.4 33.9 36.2 39.7 31.2 31.2 30.7 18.3 30.1
Imports 18.1 19.4 18.1 16.7 19.2 20.5 25.3 25.3 21.1 20.5 28

* projection

 

Consumption shows a generally decreasing trend from 2000 to 2006 to reach 47%, and a remarkably increasing trend to almost 65% from 2006 to 2009. The formidable percentage increase in consumption was partially caused in 2009 by the reduction of exports, most likely due to the decrease in the oil price, the reduction of US demand, and inefficiencies of oil production after its nationalization.

 

It is interesting to observe the fluctuations in net-exports (exports minus imports). The balance of trade registered surpluses from 2000 to 2008 and a deficit in 2009.  In 2010 the projection indicated a surplus, and in fact during the second quarter, as per the Economic and Financial Indicators of The Economist issue dated October 23rd, Venezuela reported a surplus of 31 billion dollars.

 

The percentage of government spending fluctuates in the range 11 – 14%.  Given the escalating increase in nationalizations carried out by the government, this percentage should go up as long as Chavez stays in power.

 

The gross fixed investment fluctuates in the range 15 to 25% of the GDP although in 2010 the projection indicated a considerable reduction consistent with the naturalization policy of the government. This policy is reflected in the statistical behavior of foreign direct investment in the Venezuelan economy, shown in table # 2

 

Table # 2 – Participation of the foreign direct investment in Venezuela in the period 2000 - 2010

Indicator 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Inward FDI/GDP 17 7 13 17 23 31 32 23 46 19 33
Inward FDI/Fixed Investment 1 1 1 1 1 1 2 2 2 2 1

 

The considerable fluctuations of the ratio   indicates the ups and down of Chavez’s policy in relation to the foreign direct investment through nationalizations and signing agreements with foreign governments such as China, and Brazil.  The limited role of inward FDI in relation to the fixed investment indicator plus the discouragement to domestic private investment suggest that most of the fixed investment (which is supposed to be private) in reality should correspond to the public sector. Thereby, the percentage of government spending in the GDP should be considerably larger. 

 

Investors have become increasingly wary of the direction of the country’s economic policies under President Chavez.  Due to the latest wave of nationalizations, global firms have become watchful of the security of contractual obligations in Venezuela.  After Chavez’s move to extend the nationalization of firms, there was a public outcry by major firms investing in the nation, especially those in the lucrative petroleum industry.  Oil giants such as BP, Chevron, and Exxon Mobil decreased their stake in the Venezuelan economy after the move by Chavez.  As a result of the current actions by the government, numerous oil companies have become reluctant to continue their investments in the economy of Venezuela (1).

 

This is Chavez’s attempt to form a competitive “21st century communist country.” It is also apparent that as the price of oil rises, so does government revenue, from which nearly 50% is derived.  Chavez has used this extra income to fund his socialist programs and his own pocket over the past ten years.  Government expenditures are completely reliant on the oil industry and if the price of oil falls so will the level of government expenditures by the nation.  Since the nationalized petroleum industry contributes upwards to 80% of Venezuelan government revenues, a stagnant global demand in the world for oil can have a dramatic negative impact on the country (1).

 

Oil & the Economy

 

The movement towards nationalism is fundamentally fueled by one major factor, oil.  Venezuela’s current and past economic history has been one that is dominated by the petroleum sector which accounts for roughly a third of GDP, around 80% of exports and contributes more than half of government revenues.  As a result of maintaining the largest oil and natural gas reserves in the world, the nation consistently ranks among the top ten crude oil producers in the world.  Venezuela is the fifth largest member of OPEC in terms of production.  According to the International Energy Agency (IEA), Venezuela has reduced oil production in the last few years, producing only 2.3 millions barrels per year.  This comes as a tactical standpoint with the Energy Information Administration revealing, “With the recent currency devaluation the oil incomes will double its value, allowing the government to have more money in local currency to spend.” (6).

 

After continued efforts to increase government control over the economy, President Hugo Chavez in 2008 and 2009 nationalized other leading industries in the country.  Firms in the most profitable sectors such as agribusiness, banking, tourism, oil, cement, steel industry and communications are now under the control of the Venezuelan Government. Venezuela is now becoming increasingly dependent on its agricultural sector.  Firms with latent potential for export driven growth in production are in both the coffee and cocoa crop industries, which is quite ironic since the country ranked close to Colombia in coffee production at one point in time.  However, in the 1960’s and 1970’s, after the resulting growth in the petroleum industry, coffee took a back seat in the Venezuelan economy.  Today, the nation produces less than 1% of the world’s supply of coffee (9).

 

The Closing of an Economy

 

The current state of Venezuela is moving from a relatively mixed economy to one that is rigidly closed. Throughout most of the past decade, Venezuela’s economic growth and economic health were completely dependent on its oil production.  However, due to the persistent restructuring by President Hugo Chavez, the economy of Venezuela has been moving towards socialism with difficult and closed markets. In January, 2010, Chavez revealed a dual exchange rate system for the fixed rate Bolivar currency.  The system requires a 2.6 Bolivar per dollar rate for imports of fundamental goods, including medicine, food, and machinery. The majority of all other goods have an exchange rate system of 4.3 Bolivar per dollar rate for imports of other products, including cars and telephones (1).  Through actions such as these, Chavez has limited goods and services entering the Venezuelan nation, and simultaneously improved the budget deficit that had been declining since 2004. According to the Intelligence Unit of the Economist, the budget in 2004 reached its maximum surplus of 2.6%, and started to decline until reaching a deficit of 0.6% in 2009 and a projected deficit of 2.5% in 2010. On The Economist October 16th issue, page 118 in the section Economic and Financial Indicators, so far in 2010 the Venezuelan budgetary deficit reaches 3.2%.

 

As it has been mentioned earlier in this paper, beginning in 2009 and continuing in 2010, the GDP showed negative growth. Most importantly, during the sub prime crisis in the United States, the Venezuelan economy contracted due to low oil demand in the global market. This reveals how dependent the Venezuela is on its exports.

 

Forecasts have generally shown a consensus of negative or relatively small growth in the economy in the years to come. This is also apparent through a relative trend in the unemployment rate in the country. As the reader can see in Table No. 3, the rate of unemployment has been consistently high over the past decade, being as high as 18% in 2003, with the lowest being 7.9% in 2009. As capital flight continues and investment decreases in the country as a result of the nationalization by Chavez, the availability of jobs will continue to decrease as a forecast of 2010 unemployment is estimated at 12.1% (1). According to The Economist issue of October 23rd, 2010, the unemployment rate in the second quarter of 2010 was equal to 8.2%.

 

Table No. 2  – Unemployment rate in the period 2003 – 2009 (1)

 

Year

Unemployment rate %

2003

18

2004

15.1

20005

12.2

2006

10

2007

8.5

2008

7.4

2009

7.9

 

Rising Inflation and Harmful Taxation

 

According to a recent article by USA Today, the Central Bank of Venezuela reported a 5.2% increase in consumer prices in the month of April in 2010, adding to the current inflation rate of 30.4%. The government under Hugo Chavez has had difficulty curbing the high rates of inflation.  This is one of the major concerns in Venezuela, since it has the highest inflation rate in South America at a time where the economy contracted by 3.3% last year.  The government has failed to solve the rise in consumer prices due to conflicting economic policies, such as considerable increase in wages to the military for political purposes of staying in power.  Recently the government devalued the currency, and shortly after, applied a dual exchange rate system.  These two policies act in contradiction to one another, which further hinder the prospect for saving and growth in the country (3).

 

Another direct factor in the contributing economic structure of Venezuela is the system of taxation and trade barriers in place.  The current system involves heavy taxation, not only on corporate profits, but on capital gains and dividends as well.  According to the Federation of International Trade Associations, petroleum companies and profit from oil related activities are taxed at a rate of 50%.  At the same time, mining royalties and transfers are taxed at a rate of 60% (10).  While the Venezuelan Government is in a favorable position from the high taxes on petroleum profits, the business environment discourages foreign direct investment.  In 2003, the World Economic Forum ranked Venezuela 82nd out of 102 nations in regards to how favorable investment was for financial institutions (8). 

 

Foreign Policy

           

As of 2010, Venezuela’s principal trading partners are the United States, Colombia, Brazil and Mexico. As soon as Chavez entered into office, he revealed his highly critical views on the United States’ political and economic system.  Through his media resources and other outlets he openly reveals his opinion of America, most notably comparing former President George W. Bush to “the devil” (2). 

 

Despite the political strain between the two nations, the United States consistently remains Venezuela's most vital trading partner.  According to the United States Department of State, “In 2009, bilateral trade topped U.S. $37.4 billion. Venezuelan exports to the United States were U.S. $28.1 billion, accounting for at least 46% of total Venezuelan exports, and U.S. exports to Venezuela were $9.4 billion, about 24.3% of total Venezuelan imports.”  Also, the United States is the single most important consumer for the Venezuelan oil industry.  In 2009, on average, Venezuela shipped 1.1 million barrels of crude oil and other petroleum products per day to the United States (11).

 

As time progresses, it is obvious that Venezuela is closing its doors to its economy to the rest of the world.  As a protectionist measure, Chavez declared a dual exchange rate system for the Bolivar currency.  By constantly devaluing the currency, Chavez has increased the wealth of the government, but as a result has lowered the general welfare of the people.  Today, Chavez is meddling in the internal politics of several Latin American countries such as Ecuador, Bolivia, Peru, Mexico, and many more. It is even reported that Chavez has established ties and alliances with Iran and other “rogue” states in the Middle East (IESA, 2008).

 

As a period of slow growth moves throughout the South American continent, the once thriving nation of Venezuela finds no shelter as it faces an economic situation of high inflation and poverty.  The once dominant nation that experienced simultaneous growth and prosperity due to its petroleum industry is now regressing after unsound economic practices from a socialist government.  Ever since the radical left-wing Marxist leader Hugo Chavez came into office, the structure of Venezuela as a whole has been reshaped.  Though the new government brought out political stability, the costs have outweighed the benefits as economic rationale has been disregarded.  Economist Hugo Faria says, “As an avowed Marxist, Mr. Chavez is in the process of destroying his country. Of this there is no doubt. But he is also an international menace, and a rich one at that (7).”  Time will tell the fortune of the once great nation of Venezuela. We can only hope with the use of sound economic judgment that one day the nation of Venezuela will return to the prestigious position it once held in the South America, and in the rest of the world.

 

Conclusion

 

As a period of slow growth progresses throughout the South American continent, the nation of Venezuela shows no signs of an immediate recovery.  Chavez is continually instituting harmful economic policies that impede growth.  For instance, his taxation policy, which demands an extremely high percentage of corporate profits, is a leading factor to the country’s decreasing FDI.  The dual exchange rate system and devaluation of the currency have also proven to be failed economic policies.  Inflation is at a dangerously high level and Chavez has yet to create a viable solution that will calm the rising in consumer prices. The president has also failed to boost employment in his country, which is currently around 9 %.  Oil revenue is the life and blood of this economy and funds Chavez’s socialist agenda.  Yet, Chavez has failed to recognize that his taxation policy, which demands too much from the oil company profits, as well as his nationalization policy, are driving away investment from the very oil companies that are keeping Chavez in control.  Time and time again, Chavez has failed to have any economic sense and this is what will bring his administration down.  Polls have shown that Chavez is losing support and it is only a matter of time before his people realize that their president is bringing down their country, while at the same time filling his pockets with money generated from their hard work. 

 

Works Cited

1. "CIA - The World Factbook." Central Intelligence Agency. Web. 09 May 2010. <https://www.cia.gov/library/publications/the-world-factbook/geos/ve.html>.

 

2. "CNN.com - Chavez: Bush 'devil'; U.S. 'on the Way Down' - Sep 20, 2006." CNN. 2006. Web. May 2010. <http://www.cnn.com/2006/WORLD/americas/09/20/chavez.un/index.html>.

 

3. Diaz, Manuel. "Venezuela Inflation Rate Hits 30%; Highest in Latin America - USATODAY.com." May 2010. Web. <http://www.usatoday.com/money/world/2010-05-08-venezuela-inflation_N.htm>.

 

4. "Economic Intelligence Unit: Venezuela." Http://data.eiu.com.ezproxy1.lib.depaul.edu/EIUTableView.aspx?geography_id=1540000154&pubtype_id=1253181310. May 2010. Web. 28 May 2010. <http://data.eiu.com.ezproxy1.lib.depaul.edu/EIUTableView.aspx?geography_id=1540000154&pubtype_id=1253181310>.

 

5. "Economy | Venezuelanalysis.com." Venezuelanalysis.com | Venezuela News, Views, and Analysis. May 2010. Web. 20 May 2010. <http://venezuelanalysis.com/features/economy>.

"EIA - International Energy Data and Analysis for Venezuela." Energy Information Administration –

 

6. EIA - Official Energy Statistics from the U.S. Government. U.S. Department of Energy. Web. 09 May 2010. <http://tonto.eia.doe.gov/country/country_energy_data.cfm?fips=VE>.

 

7. Faria, Hugo J. "Hugo Chávez Against the Backdrop of Venezuelan Economic and Political History." Instituto De Estudios Superiores De Administración XII.4 (2008). Web. 20 May 2010.

 

8. SALMERON, Victor. "Daily News -Venezuela-A Dual Economy." Daily News - EL UNIVERSAL. 2005. Web. <http://english.eluniversal.com/2006/08/17/en_eco_art_17A767757.shtml>.

 

9. "Venezuela Economy, Venezuela's Economy, Venezuelan Economic Profile | EconomyWatch.com." Economy Watch | World, US, China, India Economy | Economics, Investment, Stocks, Bonds, Forex, Industries | Personal Finance, Credit Card, Insurance, Mortgage, Loans, Jobs. Apr. 2010. Web. <http://www.economywatch.com/world_economy/venezuela/>.

 

10. "Venezuela Information, Income Tax Venezuela, Agriculture Venezuela, Venezuela Import, Venezuela Export & Venezuela Employment Information." Import Export Business & International Trade Leads - FITA Global Trade Leads. Jan. 2007. Web. <http://www.fita.org/countries/venezuela.html?ma_rubrique=fiscalite>.

 

11. "Venezuela." U.S. Department of State. Web. 2010. <http://www.state.gov/p/wha/ci/ve/>.