Venezuela Economy

AN UPPER-MIDDLE INCOME, oil-producing country, Venezuela enjoyed the highest standard of living in Latin America. The country's gross domestic product ( GDP) in 1988 was approximately US$58 billion, or roughly US$3,100 per capita. Although the petroleum industry has dominated the Venezuelan economy since the 1920s, aluminum, steel, and petrochemicals diversified the economy's industrial base during the 1980s. Agriculture activity was relatively minor and shrinking, whereas services were expanding.
Venezuela possessed enormous natural resources. The country was the world's third largest exporter of oil, its ninth largest producer of oil, and accounted for more oil reserves than any other nation in the Western Hemisphere. The national petroleum company, Venezuelan Petroleum Corporation (Petróleos de Venezuela, S.A.--PDVSA), was also the third largest international oil conglomerate. Because of its immense mineral wealth, Venezuela in 1990 was also poised to become an international leader in the export of coal, iron, steel, and aluminum.
Despite bountiful natural resources and significant advances in some economic areas, Venezuela in 1990 continued to suffer from the debilitating effects of political patronage, corruption, and poor economic management. The country's political and economic structures often allowed a small elite to benefit at the expense of the masses. As a result, Venezuela's income distribution was uneven, and its social indicators were lower than the expected level for a country with Venezuela's level of per capita income. Many economic institutions were also weak relative to the country's international stature. The efforts of the administration of Carlos Andrés Pérez (president, 1974-79, 1989- ) to reform the economy, especially if coupled with political and institutional reforms, would likely determine whether the country would reach its extraordinary potential.


<>GROWTH AND STRUCTURE OF THE ECONOMY
<>ECONOMIC POLICY

Venezuela - GROWTH AND STRUCTURE OF THE ECONOMY

Spanish expeditionary arrived in what is present-day Venezuela in 1498, but generally neglected the area because of its apparent lack of mineral wealth. The Spaniards who remained pursued rumored deposits of precious metals in the wilderness, raised cattle, or worked the pearl beds on the islands off the western end of the Península de Paria. Colonial authorities organized the local Indian into an encomienda system to grow tobacco, cotton, indigo, and cocoa. The Spanish crown officially ended the encomienda system in 1687, and enslaved Africans replaced most Indian labor. As a result, Venezuela's colonial economic history, dominated by a plantation culture, often more closely resembled that of a Caribbean island than a South American territory.

Cocoa, coffee, and independence from Spain dominated the Venezuelan economy in the eighteenth and nineteenth centuries. Cocoa eclipsed tobacco as the most important crop in the 1700s; coffee surpassed cocoa in the 1800s. Although the war of independence devastated the economy in the early nineteenth century, a coffee boom in the 1830s made Venezuela the world's third largest exporter of coffee. Fluctuations in the international coffee market, however, created wide swings in the economy throughout the 1800s.

The first commercial drilling of oil in 1917 and the oil boom of the 1920s brought to a close the coffee era and eventually transformed the nation from a relatively poor agrarian society into Latin America's wealthiest state. By 1928 Venezuela was the world's leading exporter of oil and its second in total petroleum production. Venezuela remained the world's leading oil exporter until 1970, the year of its peak oil production. As early as the 1930s, oil represented over 90 percent of total exports, and national debate increasingly centered on better working conditions for oil workers and increased taxation of the scores of multinational oil companies on the shores of Lago de Maracaibo. In 1936 the government embarked on its now-famous policy of sembrar el petróleo, or "sowing the oil." This policy entailed using oil revenues to stimulate agriculture, and later, industry. After years of negotiations, in 1943 the government achieved a landmark 50 percent tax on the oil profits of the foreign oil companies. Although Venezuela reaped greater benefits from its generous oil endowment after 1943, widespread corruption and deceit by foreign companies and indifferent military dictators still flourished to the detriment of economic development. Nevertheless, despite unenlightened policies, economic growth in the 1950s was robust because of unprecedented world economic growth and a firm demand for oil. As a result, physical infrastructure, agriculture, and industry all expanded swiftly.

With the arrival of democracy in 1958, Venezuela's new leaders concentrated on the oil industry as the main source of financing for their reformist economic and social policies. Using oil revenues, the government intervened significantly in the economy. In 1958 the new government founded a new noncabinet ministry, the Central Office of Coordination and Planning (Oficina Central de Coordinación y Planificación--Cordiplan) in the Office of the President. Cordiplan issued multiyear plans with broad economic development objectives. The government in 1960 embarked on a land reform program in response to peasant land seizures. In 1960 policy makers also began to create regional development corporations to encourage more decentralized planning in industry. The first such regional organization was the Venezuelan Corporation of Guayana (Corporación Venezolana de Guayana--CVG), which eventually oversaw nearly all major mining ventures. The year 1960 also marked the country's entrance as a founding member into the Organization of Petroleum Exporting Countries (OPEC), which set the stage for the economy's rapid expansion in the 1970s. Throughout the 1960s, the government addressed general social reform by spending large sums of money on education, health, electricity, potable water, and other basic projects. Rapid economic growth accompanied these reformist policies, and from 1960 to 1973 the country's real per capita output increased by 25 percent.

The quadrupling of crude oil prices in 1973 spawned an oil euphoria and a spree of public and private consumption unprecedented in Venezuelan history. The government spent more money (in absolute terms) from 1974 to 1979 than in its entire independent history dating back to 1830. Increased public outlays manifested themselves most prominently in the expansion of the bureaucracy. During the 1970s, the government established hundreds of new state-owned enterprises and decentralized agencies as the public sector assumed the role of primary engine of economic growth. The Venezuelan Investment Fund (Fondo de Inversiones de Venezuela--FIV), responsible for allocating huge oil revenues to other government entities, served as the hub of these institutions. In addition to establishing new enterprises in such areas as mining, petrochemicals, and hydroelectricity, the government purchased previously private ones. In 1975 the government nationalized the steel industry; nationalization of the oil industry followed in 1976. Many private citizens also reaped great wealth from the oil bonanza, and weekend shopping trips to Miami typified upper-middle-class life in this period.

A growing acknowledgment of the unsustainable pace of public and private expansion became the focus of the 1978-79 electoral campaign. Because of renewed surges in the price of oil from 1978 to 1982, however, the government of Luis Herrera Campins (president, 1979-84) scrapped plans to downgrade government activities, and the spiral of government spending resumed. In 1983, however, the price of oil fell and soaring interest rates caused the national debt to multiply. Oil revenues could no longer support the array of government subsidies, price controls, exchange-rate losses, and the operations of more than 400 public institutions. Widespread corruption and political patronage only exacerbated the situation.

The government of Jaime Lusinchi (president, 1984-89) attempted to reverse the 1983 economic crisis through devaluations of the currency, a multi-tier exchange-rate system, greater import protection, increased attention to agriculture and food self-sufficiency, and generous use of producer and consumer subsidies. These 1983 reforms stimulated a recovery from the negative growth rates of 1980-81 and the stagnation of 1982 with sustained modest growth from 1985 to 1988. By 1989, however, the economy could no longer support the high rates of subsidies and the increasing foreign debt burden, particularly in light of the nearly 50 percent reduction of the price of oil during 1986.

In 1989 the second Pérez administration launched profound policy reforms with the support of structural adjustment loans from the International Monetary Fund ( IMF) and the World Bank. In February 1989, price increases directly related to these reforms sparked several days of rioting and looting that left hundreds dead in the country's worst violence since its return to democracy in 1958. Ironically, Pérez, who oversaw much of the government's expansion beginning in the 1970s, spearheaded the structural reforms of 1989 with the goal of reducing the role of government in the economy, orienting economic activities toward the free market, and stimulating foreign investment. The most fundamental of the 1989 adjustments, however, was the massive devaluation of the bolívar from its highly overvalued rate to a market rate. Other related policies sought to eliminate budget deficits by 1991 through the sale of scores of state-owned enterprises, to restructure the financial sector and restore positive real interest rates, to liberalize trade through tariff reduction and exchange-rate adjustment, and to abolish most subsidies and price controls. The government also aggressively pursued debt reduction schemes with its commercial creditors in an effort to lower its enervating foreign debt repayments.

Venezuela - ECONOMIC POLICY

Fiscal Policy

The government's fiscal accounts generally showed surpluses until the mid-1980s because of the immense oil income. In 1986, however, the drop in oil prices triggered a fiscal deficit of 4 percent; the deficit exceeded 6 percent in 1988.

The major actors in fiscal policy were Cordiplan, which was responsible for long-term economic planning, and the Budget Office of the Ministry of Finance, which oversaw expenditures and revenues for each fiscal year ( FY). Cordiplan also oversaw the fiscal status of the FIV, PDVSA, the social security system, regional and municipal governments, the foreign exchange authority, state-owned enterprises, and other autonomous agencies. But economic planning and budgeting suffered from a serious lack of inter agency cooperation, and five-year plans and annual public-sector investments often lacked cohesiveness.

Total government spending reached about 23 percent of GDP in 1988. Current expenditures accounted for 70 percent of overall outlays, compared with 30 percent for capital expenditures. Capital investments, after a decline in the mid-1980s, expanded slowly during the late 1980s. Interest payments, two-thirds of which serviced foreign debt, represented 11 percent of total expenditures in 1988, a typical figure for most of the decade.

The revenue structure in the late 1980s remained excessively dependent on oil income. In 1988 petroleum revenues, both income taxes and royalties, provided 55 percent of total revenue. Although oil's contribution to total revenue had declined in the 1980s, most economists felt that it had not declined sufficiently. Overall, taxes contributed 80 percent of total revenue in 1988, with the remaining 20 percent derived from such nontax sources as royalties and administrative fees. Tax exemptions, deductions, allowances, and outright evasion greatly reduced the effectiveness of fiscal policy. Officials planned to inaugurate a value-added tax in 1990 as another means to widen the revenue base.

Monetary and Exchange Rate Policies

The Central Bank of Venezuela (Banco Central de Venezuela-- BCV) performed all typical central bank functions, such as managing the money supply, issuing bank notes, and allocating credit. As part of the country's overall financial sector reform, the BCV embarked in 1989 on numerous revisions of monetary policy aimed at improving the bank's control over the money supply. The most important policy change was the government's decision to allow the interest rate to fluctuate with market rates. Despite its initial inflationary effect, the policy created incentives for savings and investment, thereby attracting and retaining capital. Deposits swelled noticeably during 1989. In 1990, however, the Venezuelan Supreme Court declared that the BCV was legally responsible for setting interest rates. The BCV hoped to rescind the law in the early 1990s.

Venezuela traditionally enjoyed general price stability; inflation averaged a mere 3 percent from 1930 to 1970. Annual price increases did not exceed 25 percent until the mid-1980s. During the 1970s, many economists credited the FIV with successfully managing and investing overseas the country's oil windfalls in a way that prevented inordinate price instability. By the 1980s, however, financial deterioration, weakening BCV authority, numerous devaluations, and fiscal deficits had combined to push consumer prices and inflation up dramatically in the late 1980s. The average consumer price index rose by an unprecedented 85 percent in 1989. Some price increases were associated with the 1989 structural adjustment program, and thus represented what some economists refer to as "correctionary inflation," the trade-off for eliminating previous distortions in prices. By 1990 only a handful of price controls remained in effect.

The bolívar was traditionally a very stable currency, pegged to the United States dollar at a value of B4.29=US$1 from 1976 to 1983. The bolívar experienced several devaluations from 1983 to 1988, when monetary authorities implemented a complicated fourtier exchange-rate system that provided special subsidized rates for certain priority activities. The multiple exchange-rate system, however, proved to be only a stopgap measure, eventually giving way to a 150 percent devaluation at the market rate in 1989. The 1989 devaluation unified all rates from the official B14=US$1 rate to the new B36=US$1 rate, which was a floating rate subject to the supply and demand of the market. By late 1990, the value of the bolívar had crept down to B43=US$1.

In a related matter, the Differential Exchange System Office (Régimen de Cambio de Dinero--Recadi), the organization that oversaw the various exchange rates, became the focus of one of the largest scandals in the decade. Between 1983 and 1988, businessmen bribed Recadi officials in return for access to halfpriced United States dollars to funnel an alleged US$8 billion overseas. When the scandal broke in 1989, law enforcement agents investigated as many as 2,800 businesses, and more than 100 executives from leading multinational enterprises fled the country in fear of prosecution.