Laissez-Faire Structural Transformation (and other myths)

Having oil doesn’t make us rich, and we won’t evolve into a prosperous nation by doing nothing but doubling down on its extraction – especially as oil’s role in the world economy becomes increasingly uncertain. We should think hard about how to diversify into different economic sectors for which our competitiveness has been neither proven nor ruled out.

We need to promote an economic environment where productive experimentation is encouraged.

We need to promote an economic environment where productive experimentation is encouraged. Not enough thinking is being devoted to this adaptive challenge, and the sooner we start thinking about it in proper scale, the better.

That was broadly the point of one of my last pieces for CC, which hoped to be a conversation starter on the topic of modern productive development policies for Venezuela. A big argument against their use is that while diversification is a key development goal for Venezuela, the best we can do about it is not to actively pursue policies to promote it. The reason being that “there is precious little sign that Venezuela will ever be able to reach the level of institutional maturity needed as long as those outsized petro-rents are at the disposal of its politician”.

Now again, if “Sembrar el Petróleo” hasn’t worked in the past, why try again?

Agreeing on diversification as a policy priority is remarkable, as both perspectives would agree on policies that aim at the provision of public goods that lack a sectoral bias. Managing oil rents to achieve competitive exchange rates, for example, would fit that policy description. That already takes us far away from discussing whether the dutch disease is a treat or a problem, which I think makes the conversation much more productive from the get go.

You may not realize that you are choosing between agents facing different constraints, but you are.

But does the promotion of a competitive exchange rate lack bias? Not really – managing oil rents to keep a depreciated Bolivar would -at least in the short term- hurt importers and benefit exporters. It would make it more expensive for me to buy an iPhone, while it would make Venezuelan Rum more affordable for foreign consumers.

You may not realize that you are choosing between agents facing different constraints, but you are.

This is a generalizable insight for pretty much every policy decision – especially when it comes to structural transformation as a policy goal. Different economic activities are built on specific inputs, a lot of which can only be provided by the State. Dani Rodrik and Ricardo Hausmann argued that in order to provide the complex network of public inputs required by different activities, policy-makers are doomed to chose where to place resources and attention.

Let’s take an example: on my earlier piece, Michael Giambra made an incisive comment about how personal security is a key constraint to foreign investment in our country, and how we must have some iron-coated cojones/ovarios to be talking about FDI without bringing the issue up.

Mr. Giambra’s concern is spot-on: while extractive sectors might yield profits big and steady enough to justify private solutions to the personal security issue, that’s probably not the case for most of the investments that we need in order to diversify.

But does this mean that we will be productively stuck until we are able to bring national violent death rates from around 70 per 100,000 to, say, the Latin American average of 16 per 100,000?

Well, according to the Laissez-Faire point of view, no prioritization should be put on productive grounds. Investment constraints (such as law and order) would remain untackled until overall problems are somehow addressed in time and organically, through means that do not actively seek out region and sector specific productive goals.

But in terms of security, you can orchestrate how gains are achieved geographically. Security experts increasingly argue for the need to place special attention to “hot-spots” where crime concentrates. Early attention could also focus on the limited geographical areas determined for the concentration of greenfield FDI and expat residence in different sectors. This would immediately overcome security constraints on FDI, allowing for faster job creation and growth.

But you can’t do that without actively deciding where these places will be, which already gets you to the “doomed to chose” scenario in terms of regions and sectors. A more purposeful approach would recognize that you don’t get very far by having part of the sector-specific inputs everywhere, but you need to have all such inputs somewhere, and for that you need to identify sectors, their public input requirements and the places where those could be provided most economically.

While security is a necessary condition for all sectors, it is probably not sufficient for any sector. Economic activities require a all kinds of specific institutional guarantees, regulations, infrastructure, public services, human capital, licensing and certification, etc… How can all these be provided and coordinated quickly and economically? Different countries and organizations have argued for successful development ideas like industrial parks, special economic zones, industrial development corporations and even charter cities. The idea here is that if you solve the coordination failures and get the inputs and incentives right in some places and for some sectors, you’ll get a better shot at mobilizing the FDI that the whole country needs.

Nowhere is this clearer than with tourism:  no one will build a hotel if there is no attraction to visit nearby and a convenient way to get to it. No one will build an airport without an attraction to visit and a place to stay. No Disney will come about without connectivity and lodging. And none of those will happen without personal security in that particular place. Jointly, the whole deal makes economic sense, but because of this chicken-and-egg problem, nothing happens. In the economist’s jargon, robust development in this sector can’t spring without internalizing the coordination problems between different components of the tourism experience.

To deal with specific constraints on investment, you need specific solutions that may not organically come about by waiting long enough.

So nothing happens… unless the government purposefully sets out to develop an area for tourism activities. The government could provide things like airports, urban planning, water pipes, security, regulations to keep beautiful areas free of pollution, etc. and then pay back development loans with the returns from selling the land. Broadly, this was the experience of Cancún. Alternatively, the government could sell the land and provide full development authority for private parties to internalize the coordination failures, as was the case of Punta Cana.

The point here is not to promote Tourism as our next oil-like cash cow. My point is more general than that: to deal with specific constraints on investment, you need specific solutions that may not organically come about by waiting long enough.

Improving broadband internet access could help Uber finally come to Venezuela, but that’s hardly the only thing Uber needs Venezuela to get in order before making a move. We will not know what Uber needs and how to make it happen unless we actually go and talk to them. Mechanisms for public and private dialogue and cooperation are key to identifying interventions that improve the prospects of profitable investment. But not all ways to improve business profitability are positive.

Hausmann and Rodrik’s arguments are not naive to concerns of private capture, rent-seeking and corruption in this policy process. The goal is to identify win-win opportunities, which improve profitability while producing more and better jobs along with higher long-run tax revenues and environmental sustainability.

To identify and implement such interventions with public legitimacy, the authors argue for an open architecture of self-organizing private counterparts that group by commonality of needs, and that interact with independent government agencies under complete transparency. In order to mobilize effectively, the government organizes specific agencies according to the different policy instruments available, and orchestrates groups of interventions by the common needs of different counterparts.

This is the logic is behind Colombia’s Programa de Transformacion Productiva (PTP). This government initiative has a very specific goal: Raising private non-extractive and non-energy exports to $30bn by 2018. To do this, the Colombian government opened a number of public-private dialogue spaces and identified 20 groups of sectors with specific policy needs, which range from health tourism to software development to steel manufacturing.

Finally, the government coordinates cross-agency interventions for each sector around their needs in 5 broad policy instruments: Human capital development, Regulation optimization, Infrastructure and logistics adequation, Productivity and quality improvement and Access to finance. Government agencies involved in this work are Procolombia (FDI promotion agency); Bancoldex (export development bank); InnpulsaColombia (private sector development agency); the Ministry of Commerce, Industry and Trade; among others.

I don’t know if this particular approach is the right one for Venezuela, or even if the PTP will actually reach its goals in Colombia. But they are going hard at it despite two things that we do know of:

  1. Colombia’s dependence on extractive exports is less intense than Venezuela’s.
  2. Propensity to private capture of public policy is not lower in Colombia than in Venezuela.

There is this cynical, self-flagellating assumption behind the Laissez-Faire narrative, suggesting that we should not try anything until we’ve become better people, or for as long as oil extraction exists.

That’s silly. The problem with oil is not inherent to its nature, as the problem with Venezuela is not inherent to our nature. The problem with oil in Venezuela is an institutional condition that affects policy decisions in all fronts, not only when it comes to productive development. A new constitutional arrangement, one that hopes to improve the outcomes of investments in health, education, security and diversification, should drastically constrain the capacity for the executive to use oil rents with today’s level of discretion. Such institutional revision should be a priority today, as we go through the vivid consequences of opportunism, voracity and mismanagement.

We do not argue against public hospitals because of past mismanagement in the health sector.

But this institutional conversation is different from the productive development debate. We do not argue against public hospitals because of past mismanagement in the health sector. We do not argue for dollarization because of prior monetary irresponsibility. In both fronts, we argue for institutionalization. The same should go for productive development policies: we should not argue against a Venezuelan PTP because of the rent-seeking failures of the past, but we should strive for its adequate institutional design.

The Laissez-Faire idea that to achieve diversification we should ignore diversification – a sort of diversification zen – would actually undermine our shared development goal, as it would continue to hide the necessary information about absent public inputs constraining investments in different economic sectors. Abstaining from modern productive development policies would limit private investments to sectors where profitability is immediately apparent and high enough to allow for the private procurement of services that should be public – that is, it would limit private investment to extractive activities, furthering the dependence we want to overcome.

So let’s not fool ourselves: Market fundamentalism plays no role in structural transformation.

José Ramón Morales Arilla

I work in development economics for countries with governments that want to deal with (some of) their issues. I think I'm a fiscally-responsible progressive. I've thought a bit about the Political Economy of oil in Venezuela, and I worry about the politics of the things that need to happen. I think Rómulo Betancourt, Adolfo Suárez and George Washington were exemplary politicians. What I miss the most about Venezuela: My family, my friends, my weather, my food, my band, and teaching in my university.