Real appreciation for dummies

Quico says: Economists are constantly going on about the bolivar’s “overvaluation,” about the horrors of “real appreciation,” and the way it “erodes competitiveness in the manufacturing sector.” This stuff is important, but I imagine it sounds like total gibberish to non-economists.

With Katy newly exercised about Mision Cadivi and Dutch Disease, I thought this was a good time to try to demystify this whole knot of issues. Here’s, in the simplest possible terms, is what we’re so worked up about:

(“widget” is just a non-sense word economists like to use for their examples)

This is what all those rants about “the overvalued bolivar” are about: an overvalued currency is one that has more purchasing power when you trade it for foreign currency than it does in the domestic economy. When a currency is overvalued, rational businessmen will choose to import more and to produce at home less. “Real appreciation” is what happens when domestic inflation goes faster than currency depreciation – the process that makes a currency overvalued. And in a country where inflation is 20% but the rate of currency depreciation – due to exchange controls – is zero, well, it’s not exactly hard to figure out that the currency will get overvalued.

Think about it this way: these days, the only thing that isn’t getting more expensive in Venezuela is the dollar. Potatoes are getting more expansive, shampoo is getting more expensive, cars are getting more expensive, everything is getting more expensive…but the price of dollars, magically, stays the same! What does that tell you? That Cadivi is subsidizing the people it sells dollars to, and the group that benefits the most from that policy is the group that buys the most dollars: importers.

Ultimately, this is just the Nth twist on a story line economists love: it doesn’t matter how high-minded your intentions are, when you start messing around with the market mechanism you create distortions, weirdly warped incentive-structures you probably didn’t foresee, and that usually run counter to your policy goals.

Calling yourself a socialist doesn’t change that one bit: Cadivi’s architects may think they’re reining in the savage free market, but in fact what they’re doing is reshuffling incentives in a way that depresses employment in Venezuelan factories and fills the pockets of importers.

(Though there’s also the possibility that crushing Venezuelan capitalists by making their products uncompetitive with imports was exactly Chávez’s game plan all along.)

One last thing: notice that this mechanism only works if Cadivi actually sells you the dollars you need to import goods and then lets you repatriate your profits at the official rate. Now, ask yourself this: what kind of businessman is more likely to have his Cadivi requests approved, one who goes along and gets along with the revolution, or one who expresses dissent? The Cisneros of the world or the Graniers of the world?

Enforced consent, thine homes are many…