The Economic Crisis Before the Storm

After years of policy paralysis, Venezuela simply ran out of money when oil prices failed to recover in time. Sound familiar? Reading about Venezuela’s economic conditions in 1989 is a drawn out exercise in déjà vu. But how real are the parallels, and to what extent do we forget about the differences?

By the beginning of 1989, Venezuela was facing the consequences of more than a decade of economic mismanagement. There were severe economic imbalances on both the internal and the external front; the country was struggling to pay its debts abroad and its expenses at home. The economy was isolated, and choked with every type of controls. Problems had burst the banks of economic statistics: there were shortages, long lines, rationing, and hoarding both by merchants and consumers. Poverty had increased significantly by every measure.

And oil revenue was not coming to the rescue.

While the need for structural reforms dated back to well before 1989, the governments of Luis Herrera Campins and Jaime Lusinchi worked hard to avoid any real change. Controls were the answer to most problems: Herrera rolled out foreign exchange controls in 1983, and Lusinchi expanded price controls to hundreds of products, from milk to dry cleaners to funerals.

Lusinchi’s economic policy was particularly irresponsible. In 1986 public spending increased by 10%, even though revenue from oil had dropped by around 40% due to a similarly sized drop in oil prices. Oil revenue didn’t recover, but he kept the fiscal party going until 1988. Between 1986 and 1988, the economy grew on average 5.3%, fueled by debt, with the fiscal deficit averaging -7.6% in those three years. The high deficit in turn fueled inflation, which averaged 23%, and set records in both 1987 and 1988.

With elections scheduled for the end of 1988, the government went far out of its way to avoid any unpopular changes, especially increases in official prices. As Moíses Naím puts it in his book Paper Tigers and Minotaurs, during that year “decisionmakers in government were repeatedly told to adopt what was half-jokingly referred as “the x-ray exam” stance –don’t move, hold your breath, and wait for the election.”

When the government of Carlos Andrés Pérez took over in February of 1989, years of pent-up bad news came out all at once: the fiscal deficit was at a record-high — 9.4% of GDP. There was no money, and all prices would have to increase.

But as bad as the pre-Caracazo Venezuela was, today is worse by any objective measure.

The external balance was the worst of the dumpster fires. Foreign reserves (excluding gold) stood at around $6.6 billion. But the government was behind on a rash of payments: there were $6.3 billion worth of expired letters of credit issued for 1988 imports and private foreign debt. So once you discounted that private debt from reserves, there was only $300 million left. But the country had to pay $4 billion in public foreign debt during 1989. Perez’ government was forced to declare a moratorium on payments, and negotiate a restructuring of the foreign debt — largely with creditor banks though, not bondholders.

The country had become inordinately dependent on imports, due to the unrealistic exchange rate at the heart of the multiple-exchange rate regime. RECADI, as it was known, was the source of the same kind of perverse incentives and corruption that we have witnessed with CADIVI.

As for the private sector, it had become a stunted sloth. Fed a steady diet of subsidies, controls, and protected from foreign competition by trade barriers, it had grown complacent and inefficient.  The mix of bad incentives and extreme protection took its toll: Productivity decreased, on average, by 1.4% per year between 1983 and 1988. Yet in 1989 the number of industrial companies was the same as ten years earlier: the industrial sector was top-heavy with Zombie Companies who survived entirely through protection.

Instead of looking to improve or grow, the main concern was to extract rents from the public sector and game the system. In 1988, with everyone expecting a devaluation after the election, the best game in town was importing using cheap RECADI dollars, stockpile goods and wait until after the devaluation to sell. Big fortunes were made playing this game.

The most worrisome statistics were those living in poverty. According to Naím, in the eight years prior to 1989, the percentage of households living in poverty had increased from 32%, to 53%. A fifth of all households could not afford their daily food needs. The price controls and the expected devaluation combined to make 1988 a year of long lines, shortages and rationing.

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It’s easy to see parallels between 1989 and 2016: a highly controlled and isolated economy, a worsening social situation, a government on the brink of default, and terrible policy decisions. But as bad as the pre-Caracazo Venezuela was, today is worse by any objective measure.

The shortages and lines was something new and shocking in 1988 and 1989 but they were by far less severe that the dystopian devastation we see today.

Probably the biggest difference is in attitudes to the private sector: whereas Maduro has been enormously hostile and persecutorial towards the business sector, Lusinchi ran a crony capitalist regime, only too happy to acquiesce to its friends’ demands for rents. Yet whether with a smiling face (then) or a snarling face (now), the results have been the same: businesses that face no incentives to produce don’t produce, not because you’re nasty to them, but because it’s not in their interest to produce.

The most striking similarity between the two moments is how they were both born of government inaction —not to say catatonia. Lusinchi, whether by luck or design, masterfully dumped the mess he had made on the next government: a feat of timing. The current government has also been in “wait until the election” mode, but for far longer.

Since at least 2011, they have been postponing reforms until the next election. After three elections between October 2012 and December 2013, they wasted 2014, and went back into the hold-it stance in 2015.

Today they are doing the bare minimum changes, aimed squarely at avoiding a foreign debt default and nothing else. The deeper reforms will have to wait, until the next election. Which election that might be, no one knows.

Pedro Rosas Rivero

Pedro Rosas Rivero is an Economist living in Caracas, with graduate studies in Economics, and Politics. He wishes we could talk more about policy than politics. News addict, and incurable books junkie.