The roadmap, part IV: saving our way to prosperity

???????????????????????????????(This is the fourth part in a series of essays exploring the common policy choices made by high-growth countries, and what Venezuela needs to do to implement them. The motivation for the series can be found here. In Part II, I tackled the importance of inserting Venezuela into the global economy. In Part III, Quico discussed getting the macroeconomic fundamentals right.

I know we are all focused on the street protests, but we need to remember that once the dust settles and the tear gas canisters have been put away, we still have a country to rebuild. In my view, there is never a bad time to discuss these issues).

A few years ago there was a highway construction boom in Chile. As some of you may know, highways in Chile are incredibly modern, and they are all privately owned and managed.

I recall a great sign I saw on one of these highways while it was being built. The sign had a piggie bank, and it read:

“Your pension is helping build this highway. This highway will help pay for your pension.”

That, in a nutshell, highlighted the link between savings and investment, the third characteristic of high-growth economies listed in the Growth Report.

Notice how the two are linked together – in order for firms to have available financing, there needs to be savings, either by the government or by households. High-growing economies have both high levels of savings and investment. In the words of the report’s authors:

“In the mid-1970s, Southeast Asia and Latin America had similar savings rates. Twenty years later, the Asian rate was about 20 percentage points higher. China has saved more than a third of its national income every year for the past 25 years. This saving has been accompanied by prodigious rates of domestic investment.”

High savings rates make investment – roughly understood as the buildup of capital and technology in a society – more available and, hence, cheaper. It allows for new machinery to be built. It helps firms expand and increase their productivity. But if the government is taking up what little savings there is, little investment will take place.

This is not to say that only private investment is necessary. The report highlights the role of public investment in infrastructure as a critical component for growth – the roads factories need, the ports exporters want, and the electricity grid everyone demands. But when the government is more focused on selling rationed household staples, there will be little funding left for investing in infrastructure.

How do you get the economy – households, businesses, the government – to save more? Part of it is fiscal sanity, which we covered already. Part of it is taming inflation, since unexpected inflation is basically stealing from savers to give to people who took out loans – as anyone with a savings account or a fixed-rate loan in Venezuela can attest to.

Yet another part has to do with creating incentives. It’s not that Venezuelans save too little – it’s that we don’t really know how much they save because most of their savings are in foreign currency. Macroeconomic stability will go a long way to helping Venezuelans save in their own country, and domestic savings are better for fostering long-term growth than fickle foreign investment.

Take the Chilean example. Chile’s financial system is highly sophisticated. But in order for a system such as this to grow, it needs an institutional framework, such as the one that practically forced Chileans to save in their pensions and feed the economy. We need something like that in Venezuela. Luckily, we have oil wealth to help us set it up.

There are other things involved in fostering a “savings” culture. One of the main ones, obviously, is a monetary policy that fosters savings. When inflation is low, interest rates will encourage people to save no matter what their ethnic background is.

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Another thing that a healthy savings policy does is decrease the cost of risk to households.

I am reminded of ten years ago, when I took my first and only trip to Margarita Island.

One of the things that caught my eye as Katy and I were travelling across the island was the sheer number of unfinished homes. I don’t know if this has changed or not, but there seemed to be an inordinate amount of houses with bare beams sticking out of their roofs, as if they had started to build a second floor but had to stop and leave it at that.

I asked a few of the locals why that was so, and they confirmed what I suspected: in boom times, people on the island do well, and they begin renovating their homes, adding a second floor to their restaurants, or making their small posadas a bit bigger. But then, sooner than you can say “exprópiese!” the bad times come, the funding dries up, and the beams are left there as makeshift concrete-and-metal monument to the oil cycle, a viga pelá.

No Venezuelan needs reminding that our economy is highly dependent on the oil cycle. When the price of oil is high, we all enjoy the benefits. Subsidies seem to spontaneously materialize, and we even have a term for it – “fat cow time.” But then the oil market dries up, the fat cows quickly start looking famished, and we start “tightening our belts.” This affects not just the government or some arcane macroeconomic variables – it affects homes, businesses, and livelihoods directly.

It shouldn’t be this way. One of the points of having a government is that it is big enough and (supposedly) wise enough to do what homes and small businesses cannot do: isolate the population from the risks that emanate from natural economic cycles.

We all dislike risk. Human beings are naturally risk averse, and the only reason we agree to take risk on is if there is some reward that comes with it. But there are ways to safeguard yourself from risk – to diminish the cost of risk. Households do it, and so do governments, but the tools at the government’s disposal are much more powerful.

Think of it this way: what resources do you have available if you hit on hard times? For most of us, the list is short. A few savings here and there. A few connections – family, friends – and some assets that we can sell to stay above water. Perhaps some of us can get loans from a friendly bank. But once that stops, we’re on our own.

Governments are different. The magnitude of financing and the variety of instruments available to a petro-state means that it is much better placed to ride out tough times than households are.

However, in order for governments to act as a buffer, they need to get their finances in order: save in good times and only take out loans in bad times. This requires fiscal discipline. If our government spends more than it earns both in good times and in bad ones, it ends up eating up precious resources that would otherwise be used to build up the economy. It also ends up transferring the risk to households. This only perpetuates the cycle and creates huge costs for society.

There is a term in economics for the effect that a rapacious government has on businesses and households: crowding out. Available funds in the banking system are limited. If the government continuously spends more than it earns, it will need to borrow from local banks in order to pay its bills. In effect, the government ends up competing for available loans with the private sector. The more the government borrows, the less that will be available for businesses.

The unfinished homes in Margarita tell the story. They should be able to ride out the wave, They should focus on the long term, and if the addition to their homes makes sense, they should be able to borrow even if times are bad in order to get the addition done.

But they don’t … because borrowing is expensive, or the funding is simply not available. The government needs to be financed, and that’s the top priority. In effect, a profligate governments means the oil cycle arrives at your doorstep. The few financial tools needed to ride out the storm are simply not available.

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There are other regulatory changes we need as well. For example, the government should discourage loans for consumption in favor of investment loans. We need more funding for machinery and technology, for factories and physical capital, and less funding for credit cards. 

Currently, we don’t have that in Venezuela. Overbearing regulations mean that banks are desperate to lend to anyone, for practically anything. Just to give you an example, my brother-in-law just got a loan for a large amount of money that he is going to use to … buy up dollars and pay for my niece’s wedding. You don’t need to be an economist to know that this is not how you build up GDP.

In essence, the third ingredient in the “recipe” for growth is unsurprising. Frugality begets a healthy financial sector, one that will help companies and households ride out the oil cycle and make available the funds we need to invest in the future.

That is an essential element in buidling a country up, and one we must tackle.

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