Oil and industrial policy in Venezuela: what went wrong?

Nodding-Donkey-pump-Venezuela-By-Rjcastillo-CC-BY-SA-3.0Marxist economist Michael Roberts recently posted on the dire economic and social situation in Venezuela. An oil price boom in the 2000s allowed the government of Hugo Chavez to pour the resultant tax revenues into boosting the incomes and welfare of the poor. Significant progress was made with poverty reduction during this period and the economy grew relatively rapidly for a number of years.

All that is now going into reverse as the economy experiences a deep contraction, galloping inflation, and shortages of basic goods in the shops, alongside a consolidation of anti-democratic forces. With oil prices subdued and a lack of industrial diversification, the sources of any future economic recovery remain unclear.

As he has often argued when confronting the downsides of capitalism, Roberts argues that the problem is ‘not enough socialism’. His favoured policy response would be increased government ownership and direction of the economy via central planning, in order to boost investment and diversify the structure of the economy.

The intended ends of such a response are indeed laudable: during the boom years, the government relied on oil revenues to reduce poverty, as already mentioned. But it failed to encourage the diversification of production into higher value-added goods and services.

Oil prices rise and fall over time, and the government of any resource-rich country cannot rely on one source of income to drive growth and development over the longer term. A windfall created by high oil prices needs to be exploited productively, and used to transform the structure of the economy, so that growth can be sustained once prices fall again, as they inevitably do. This does require state intervention, but in a way that encourages the expansion of a competitive private sector.

Thus Venezuela’s problem has not so much been not enough socialism, rather it is a failure to diversify the productive sectors of the economy, in order to sustain longer term development. This is not a new problem. Successive governments attempted forms of industrial policy over a number of decades, but these efforts have been unsuccessful, particularly when compared with economies such as South Korea and Taiwan, but also with Malaysia, another resource-rich country.

Industrial policy, the practice of promoting those sectors in the economy which are potentially dynamic, has found renewed favour among some policymakers since the Great Recession. In truth it never really went away, and has been used, according to economists such as Ha-Joon Chang, by every rich country on its path to developed status. Such countries then ‘kicked away the ladder’ by preaching the virtues of free markets and free trade to developing nations once they had benefited from the selective protectionism of industry over many years.

Of course there have also been many industrial policy failures in the history of economic development. The key lesson is not to abandon it altogether, but to learn from the successes and failures and to apply it in appropriate ways, given the stage of development of the country in question. Just as importantly, such policies also need to be compatible with the politics of the relevant country.

WindfalltoCurseJonathan Di John, a political economist at SOAS in London, has written a fascinating study of the political economy of Venezuela from 1920 to the 2000s, From Windfall to Curse? (2009).

Di John is critical of a number of popular explanations for Venezuela’s relatively poor economic performance in recent decades, but his main constructive thesis is that there has been an incompatibility between the country’s political settlement and its stage of development. In particular, a ‘big push’ and import-substitution policy package from the 1970s, designed to encourage the expansion of heavy and capital-intensive industry, led to declining non-oil productivity growth and eventually a slowdown in economic growth and subsequent collapse.

The Venezuelan economy had actually performed quite well in the early and middle parts of the last century, when industrial growth was dependent on smaller scale, labour-intensive manufacturing. The government was correct in realising that continued development would require diversification into sectors with a greater potential for increased productivity via economies of scale, which meant that they could become internationally competitive and export successfully onto the world market.

They were also right in thinking that rapid development and catching up with richer nations requires state intervention, most importantly to encourage the accumulation of organisational capabilities via learning-by-doing. Such intervention might include temporary protection for infant industries, coordination of investment or even setting up state-owned enterprises in desirable sectors and the management of competition.

All of this requires a degree of experimentation and sufficient monitoring and enforcement by the state so that the relevant firms are given the right incentives to ‘grow up’ and become internationally competitive. The threat of withdrawing financial support to nascent firms whose competitiveness does not improve sufficiently needs to be credible, and this requires particular governance capabilities on the part of the state.

As Di John documents, the political settlement, or the balance of power between competing interests in society, and the structure of the state itself, were not conducive to the more advanced stages of industrialisation, particularly a successful big push industrial policy.

From 1900 until the late 1950s the Venezuelan state can be described as consolidated and centralised. However, from the late 60s onwards, power became increasingly fragmented, subject to numerous competing interests which made an effective coordination and monitoring of industrial investment difficult. The relationships between factions of the state, business and labour involved significant conflict rather than the cooperation that was needed to achieve a successful pathway of continued development.

It was not so much that the policy aims were wrong, rather that they were poorly executed by state institutions that had become ill-suited to stimulating rapid structural change and industrial development.

Ultimately, the policies failed and successive governments were unable to change course due to the incompatibility of the nation’s politics and the necessary development strategies. The windfall of oil revenues has been cited as one reason for poor economic performance, perhaps because it reduced incentives for the state to modernize the economy. But while successful late developers such as South Korea and Taiwan were resource-poor, Malaysia, which is rich in natural resources, has been quite successful as a late developer and certainly more so than Venezuela.

Malaysia has also experienced its share of inter-ethnic political conflict, which has been managed to some extent by centralised state redistribution. This has provided political stability, which has helped encourage inward investment by multi-national enterprises and some degree of technology transfer to domestic producers.

Di John makes a strong case for a comparative historical political economy analysis of growth and development. This should integrate insights from politics and history as well as economics. It should compare country case studies, which can in many cases offer greater insight than a more formal model-based economic analysis.

For Di John, issues of incentives and efficiency should not be separated from those of distribution and equity. From this it follows that political and institutional factors interact with economic ones in the process of development. Growth is better seen as non-linear, subject to unevenness and potential conflict over resources, which makes it inevitably political. How this is managed is one of the big questions in development, not least in the tragic case of Venezuela.

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2 thoughts on “Oil and industrial policy in Venezuela: what went wrong?

  1. One thing to add is that the economic crisis in Venezuela can be partially explained as a case of Dutch disease. The reliance on oil exports pushed up the bolivar and made it difficult for domestic industries to compete with imports. These producers were further hurt by government price controls.

    • Thanks for your comment. That may be right at certain times in Venezuela’s history, but Di John argues that the bolivar has been through periods of strength and weakness which don’t seem to have any relationship to its industrial growth performance. In other words, Dutch disease has not been a key factor over the long term in either hindering or promoting industrial development and diversification.

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