Venezuela’s Impending Collapse

Fri, Oct 11, 2013 - 12:00am

We predicted Venezuela’s collapse when Hugo Chávez came to power, and we’ve reiterated this opinion every few years since. The movement towards economic collapse is accelerating. In addition to enriching himself from the public purse, Chávez was profoundly incompetent, and his policies have laid waste to the Venezuelan economy.

We’ve Seen It Many Times Before

A familiar pattern was repeated in Venezuela, just as it has been repeated numerous times before in Latin America and in other developing countries: ignorant and self-serving leaders sell a bill of faulty goods to the uneducated and poverty-stricken masses.

While making grandiose promises of social and economic transformation that would help the people, Mr. Chávez did nothing to lay the groundwork for real growth. For example, his policies did nothing to encourage education or inspire entrepreneurship. Rather, he squandered the national resources that he appropriated, using the national oil company to provide unsustainable handouts internationally and domestically. These handouts can’t last, as he allowed the oil company’s infrastructure to deteriorate and failed to reinvest to maintain and upgrade their facilities. His program was not about growth — it was about wealth redistribution; first to himself, his cronies, and then eventually to the poor. Without growth, the end of the redistribution is close at hand.

Why Is Venezuela’s Strategy Failing?

First, waste. Natural resources, one of the foundations of a country’s wealth and strength, have been distributed to other countries in acts of grandstanding and foolish posturing. Venezuela did this with its oil for several ideological co-travelers in Latin America.

Resources are also wasted through corruption and inefficiency. The state operation of large enterprises tends to become corrupt because the appointment of managerial staff doesn’t depend on competence, but is a matter of distributing political spoils to supporters. Competent technocrats get fired for not kowtowing to the powers that be, and they get replaced by less competent bureaucrats — whose sole qualification is unquestioning support for the regime, not the ability to excel at their job.

Thus, the state oil firm ended up saddled with managers and executives who are not geologists or petroleum engineers — and who aren’t even competent in management itself, let alone the technicalities of the business. The consequence? Falling oil production, increased handouts, and outright theft — and lo and behold, the economic surplus that could have been reinvested in the country’s economy is gone. So, the promises of social programs made to the country’s poor at the start of the whole process can’t be kept. And one of the bones tossed to them — suppressed domestic prices for energy — ensures extravagant waste of petroleum resources in the domestic economy itself. Ultimately, it has led to the squandering of the geological asset that national oil reserves represent for the nation.

Second, much of Venezuela’s program was based upon confiscation. But if you take enough from the rich, they eventually leave — taking financial, intellectual, and entrepreneurial capital with them. So after a certain amount of looting, there’s little left to steal.

Third, when the wealthy are drained, the confiscation moves on to the middle class — who may not be able to leave the country, but can certainly be so demoralized and beaten down that they no longer act as an engine of growth for the economy.

Finally, the whole system begins to collapse, the government takes as many private resources as they can, and takes over all the businesses that they can. Of course, since the government lacks the personnel with acumen to run the businesses well, they damage or destroy them. In Venezuela, the result has been that the poor remain poor. The middle class joins them in that misery, and the former rich now live in other countries. Many moved on to countries where the rule of law allows them to employ their experience and skill to build a new fortune. In their new country, they may have middle-class status, but they are able to enjoy life and rebuild something in their new surroundings.

Venezuela’s National Oil Company Is a Failing Enterprise

It could be resuscitated, but only if its management of political appointees is replaced by experienced and competent managers. Their predicament is made worse by the type of oil in their reserves — mostly heavy, sour crude oil. It’s expensive to refine. While they may be able to sell to some Latin American refiners, the U.S. is going to want less and less of it as domestic U.S. production continues to ramp up and use U.S. refinery capacity for U.S. crude oil. Currently, as global investors see the house of cards tottering, Venezuela is experiencing higher borrowing costs on government bonds used to finance their economic activities and there is a growing danger that things will get worse before they improve. President Nicolás Maduro looks to be following in Chávez’ footsteps in a revealing way, seeking to secure emergency powers from the legislature that will allow him to pass laws by decree — a process Chávez used during his tenure to enact more than 200 laws.

After all this negative reporting, let us end on a positive note. Mexico, on the other hand, is improving its energy situation. Mexico now seems poised for decisive energy-sector reforms that will begin to solve the problems which have developed due to 70 years of state control. We are happy for Mexico, and suggest that Venezuela begin to follow its lead.

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Chief Investment Officer
guild [at] guildinvestment [dot] com ()

tdanaher [at] guildinvestment [dot] com ()