by Pablo Duarte*
Venezuela is in deep political and economic crisis. According to Reuters – quoting a leaked document from the Venezuelan Central Bank – output fell 19% and prices increased 800% during 2016. Even though the “Socialism of the 21st Century”, the political program initiated by former President Hugo Chavez, has been losing support in other countries, in Venezuela it is still alive. The government has responded to people’s discontent with violence rather than with economic reforms. One reason for the reluctance to reform can be that the government would have to assume high political costs if it wanted to solve the current economic crisis.
The regulated foreign exchange market is an insightful example. Venezuela introduced exchange controls in February 2003 and has experimented with different exchange rate settings. The current exchange rate regime has two official exchange rates. The (subsidized) Dipro, set at 10 Bolivares (Bs) per US Dollar, is guaranteed for the import of medicine, food and other priority goods. The Dicom, for all other purposes, is meant to float “freely”. Today it is at approximately 710 Bs per US Dollar. People, however, cannot always buy all the dollars they want to. They first have to request the dollars from the government and a government official has the discretion to decide how many dollars somebody is allowed to buy.
The alternative is buying foreign exchange on the black market. A famous estimator of the black market exchange rate is plotted below. It shows that today a US Dollar can be acquired for almost 4,000 Bs, 400 times the government guaranteed Dipro rate. This disparity opens the door for a lucrative “arbitrage” and an effective way to subsidize selected individuals or firms. Government officials with the discretion to decide who gets the subsidized dollars, for example, also benefit as they may exchange positive decisions for a bribe. The recipients of the dollars, who may sell them on the black market, and the government officials can benefit from the difference in the exchange rates.
Foreign exchange indeed has largely flown from the official to the black market. As the former central bank economist and now deputy José Guerra pointed out, in 2009 over 9 billion US Dollars were sold on the black market, which is more than the oil exports of the country during the same year. Where could the black market dollars come from other than from the officially allocated dollars? Getting rid of the exchange-rate system by, for example, dollarizing the economy (as has been often proposed as a solution to hyperinflation) would hurt the groups benefiting from the “arbitrage” and undermine the government’s already weak political support.
Meanwhile, as the figure shows, the central bank has been depleting its international reserves since 2008, and at a faster pace since the oil prices drastically declined in 2013. After having sold most of the liquid assets, the Venezuelan government is now trying to swap its gold reserves to prevent a sovereign default this year.
With very high inflation rates, painful shortage of goods, falling output, and increasing social unrest, the government is urged to reform its Socialism of the 21st Century. As the example of the exchange rate system shows, however, economic reforms can be politically costly. Instead, the government prefers to make use of its military power and violence to maintain stability. The question is, for how long can this situation be sustained?
*Pablo Duarte is a PostDoc at Leipzig University’s Institute for Economic Policy. He was a visiting PhD student at NYU and a member of the Colloquium from 2014 to 2016.