By Emily Skarbek
Often economists want to isolate questions of public debt and analyse these issues as if public choice considerations weren’t at play. Perhaps less studied are the ways in which debt practices can systematically exert pressure on formal political institutions. But if you want to understand what is going on in Venezuela today, you can’t do so without looking at this political-economy nexus.
For regular people living in Venezuela, the situation is bleak. As the Economist reports, food queues start at 3am, with the real possibility there won’t be anything for those at the end of the line. And the queues are growing longer and violent. Real wages fell by 35% last year, 76% of Venezuelans are now poor, supplies of medicines have fallen to 1/5 of their normal level.
“The government has admitted that in the 12 months to September 2015 the economy contracted by 7.1% and inflation was 141.5%. Even Nicolás Maduro, Chávez’s hapless heir and successor, called these numbers “catastrophic”. The IMF thinks worse is in store: it reckons inflation will surge to 720% this year and that the economy will shrink by 8%, after contracting by 10% in 2015. The Central Bank is printing money to cover much of a fiscal deficit of around 20% of GDP.”
In a case study of Venezuela from 1984 to 2013, Reinhart and Santos examine the relationship among domestic debt, financial repression, and external vulnerability. The paper begins with a narrative of the evolution of domestic and external debt in Venezuela over the period.
“Despite soaring oil prices from 2006 to 2013, net consolidated external debt of Venezuela rose from US $26.9 to US $104.3 billion. The central government, however, only accounted for roughly a fifth of that increment. The difference, US $60.9 billion (78%), owed to standard practices of the Bolivarian revolution, and was issued by state owned enterprises and the relatively new Fondo Comun China-Venezuela (FCCV). The FCCV is a special-purpose vehicle that allows Venezuela to withdraw from a rolling line of credit at the Chinese Development Bank in exchange for future shipments of oil.
Domestic debt in local currency also climbed, rising from 36.298 million bolivares (VEF) in 2006 to 420.502 million in 2013. The nominal increase of 1,060% (an average annual rate of 42%) was partially offset by an accumulated price increase of 528% (or an average annual rate of 30%), reducing the cumulative increase in real domestic debt to about 85% (or 9% per annum). During much of this period, the combination of exchange controls and interest ceilings created a captive domestic audience for domestic government debt despite markedly negative real ex post interest rates. The significant losses imposed on domestic bondholders escalated over time, owing to accelerating inflation.”
Unlike foreign currency-denominated debt, debt in domestic currency may be reduced through financial repression (i.e. taxes on bondholders and savers producing negative real interest rates). Reinhart and Santos find the financial repression “tax rate” is significantly higher in years of exchange controls and legislated interest rate ceilings. In Venezuela, the “haircut” on depositors and bondholders via negative ex post real interest has exceeded 30% per annum on several occasions.
Confiscating the wealth of those responsible for capital savings can partially ameliorate the existing stock of domestic debt in the short run, but at the expense of encouraging capital flight and undermining any semblance of trust in crucial economic institutions. The paper documents that capital flight has been a chronic feature in the Venezuelan economy, “representing on average of 4.7% of GDP at the official exchange rate and 7.1% of GDP at the parallel market exchange rate, while siphoning away 17.2% of total exports”. By all measures, exchange controls proved ineffective at reducing capital flight. In fact, “when measured as percent of GDP at the average parallel market, rate capital flight turned out to be significantly higher in years of controls (8.0% vs 5.2%).
Hayek would not be surprised. Over his professional career he argued disastrous monetary policy commits the state to taking measures that weaken the proper functioning of the market. In order to combat inflation, states will attempt to impose further controls that “would not only make the price mechanism wholly ineffective, but also make inevitable an ever-increasing central direction of all economic activity” (pg. 127).
In Venezuela, Chávez turned the would-be checks and balances of the state–the Supreme Court and the electoral authority–into extensions of executive power. He packed the court and they then threw out those legislators necessary for the opposition to get the two-thirds majority needed to change the constitution. President Nicolás Maduro seems prepared to continue the repression and price controls, calling the owner of Venezuela’s largest privately-held company a thief and publicly blaming him for the country’s dire economic condition.
It is perhaps fitting that it was at a Mont Pèlerin Conference in Caracas where Hayek famously quipped:
“We now have a tiger by the tail: how long can this inflation continue? If the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished! I’m glad I won’t be here to see the final outcome . . .”