How the World’s Largest Oil Reserves Couldn’t Save an Economy

In recent months, media outlets have portrayed a bleak picture of Venezuela: citizens waiting in line for basic items such as toilet paper and flour, babies being delivered in cardboard boxes and the national currency, the bolivar, being used as napkins. Unfortunately, these conditions are not an exaggeration.

Venezuela currently teeters on the brink of economic and social collapse. The country has the distinction of being the world’s worst performing economy. According to the IMF, its economy contracted by 6 percent last year and is forecasted to contract a further 10 percent this year. Inflation, the IMF predicts, is expected to reach 1,640 percent in 2017. Alejandro Arreaza, an economist at Barclays, estimates that the government has an 85 percent chance of defaulting on its debt over the next twelve months. The country’s murder rate has been steadily rising and is now the second highest in the world. Meanwhile, 10 percent of the population has already left for other countries.

Many economists predict that the nation may be stuck in its current economic rut for over a decade.

To understand how the crisis could have escalated to this extent, a brief background on the country’s economic and political environment is necessary. The current situation’s root causes can be traced to Hugo Chavez’s ascendance to power at the end of the 20th century. A controversial figure, Chavez built his campaign and his presidency on the creation of a Marxist social welfare state. In the first decade of his presidency, from 1998 to 2008, he nationalized many of Venezuela’s vital industries, such as oil, mining and transportation. He imposed price ceilings on a variety of basic goods, such as corn and flour, and simultaneously revamped the country’s healthcare system.

While his critics decried his government’s harsh response towards protestors and his use of socialist propaganda, they could not deny his results. According to World Bank statistics, Venezuela’s literacy rate, life expectancy and GDP per capita all increased during Chavez’s first 10 years. As record high oil profits filled the government’s coffers, Chavez expanded his use of social benefit programs and gave poorer Venezuelans access to healthcare and education. The country was not an economic powerhouse, but it was nonetheless beginning to develop and modernize.

Chavez’s success, however, depended on revenue derived from oil, and high oil prices masked many of the country’s underlying structural economic problems. For example, according to BBC reports, Chavez’s price ceilings on food items, though beneficial for the poor, incentivized producers to leave the country or stop producing altogether. Consequently, Venezuela began to import most of its food.

However, since the bolivar continued to appreciate due to high oil prices, this did not become an immediate issue. In fact, World Bank statistics indicate that, with oil constituting 97 percent of Venezuela’s exports, the country simply imported everything else, while still managing to run a current account surplus for 15 years due to its immense oil exports.

The nation failed to realize that if oil prices were to substantially decrease, severe economic hardship would ensue. Indeed, this is exactly what has been happening. The global oil glut, coupled with weak demand from China, has negatively impacted oil-producing countries around the world, and Venezuela is no exception. To add to its woes, Chavez’s death in 2013 has led to the rise of his party’s successor, Nicolás Maduro. In particular, Maduro retained some of Chavez’s outdated policies, such as turning away international humanitarian aid and refusing to devalue the official exchange rate in an effort to project the appearance of Venezuela’s strength and resilience.

Maduro’s political gaffes offer a clue as to why Venezuela has recently suffered so much: a lack of effective political leadership. The Wall Street Journal reports that while other oil-producing countries such as Brazil and Saudi Arabia have also had economic downturns, they have managed to diversify their economy or use financial savings to fund the economy while oil prices are low. Venezuela has done neither.

Mismanagement, rampant government overspending and possible theft has left the government with a nest egg of $3 million, according to the Washington Post, while other oil-producing countries have reserves in the hundreds of billions. As the government’s foreign currency reserves dwindle, it has turned to printing more money to repay its debts and has reduced its imports. Consequently, the Guardian reports that a sizable black market for everything from U.S. dollars to bacon has sprung up around the country, as consumer goods become increasingly scarce and runaway inflation makes the bolivar worthless.

As Venezuela descends even deeper, one must ask: what can be done?

One short term solution would be to allow humanitarian aid into the country, regardless of its impact on the government’s public perception. Professor Willian Burke-White, director of the Perry World House at the University of Pennsylvania, notes that Chavez was notorious for his anti-U.S. stance and built acrimonious relations with many countries in Latin America as well. Maduro has continued this policy, and as a result, Venezuela is short on allies who are eager to help in its time of need. Maduro would need to change or even reverse his diplomatic stances to gain favor and vital aid to help his people.

Another necessary measure is to allow market forces to determine Venezuela’s exchange rate, regardless of the inevitable depreciation that occurs. Bloomberg reports that the current official exchange rate ranges from 6 to 200 bolivars per dollar, while the black market rate is over 1000 bolivars per dollar. Although the official rate is cheaper, actually receiving this rate involves a complex application process, and only high-ranking government officials have consistent access. Unfortunately, corruption ensues, as officials obtain foreign currency legally and sell it at a higher price. This causes further friction between the public and the government.

A longer-term solution would be to reduce the economy’s dependence on oil. Tourism used to be a substantial driver of the economy, but safety issues and a restriction on Americans entering the country have marginalized its impact. Other industries, such as fishing and manufacturing, have also lost ground as the government has continued to pour any available investment into the oil industry. Professor Alejandro Velasco, who focuses on Latin American issues at New York University, notes that such a dynamic shift in the economy’s structure could only be accomplished by a complete change in the country’s leadership.

There is a chance, albeit a slim one, that this could occur as soon as December 2016. If the current opposition party gains enough political clout to push for a recall referendum this year, then they are favored to win. If the referendum is held after 2016, then the new president would be the current vice-president from Maduro’s incumbent party, since the Venezuelan constitution prohibits a new party’s leadership two years before the end of the current party’s term, which ends in 2019.

Venezuela thus faces a very steep mountain to climb over the next few years. Ultimately, pressure for change may come from the public itself. Although Maduro has thus far remained insistent on not accepting foreign aid, he may not have much of a choice as the country continues to deteriorate.

The scale of Venezuela’s economic and political collapse should serve as a warning to other nations that depend on volatile commodity prices. Political strife, economic deterioration and social conflicts are just a few of the symptoms Venezuela currently faces and will face for years, perhaps decades, to come. Similar countries must diversify their economies immediately or risk causing larger-scale global conflicts when the next commodity crash occurs.