It should not come as a shock to anyone that Venezuela is facing one of the worst economic crises in its history. In fact, the country has been on the verge of collapse for quite some time now. For the last three years,  the Venezuelan economy has been stuck in a deepening recession. Beginning in 2014, the economy contracted  3.8%  and in 2016, the economy shrunk by 10%. Moreover, the IMF predicts that Venezuela will remain in a recession until at least 2019.  While the economy continues to contract, inflation is skyrocketing. According to American Institute for Economic Research, inflation reached an all-time high of 700 percent in December 2016. Researchers at John Hopkins University have added Venezuela to their Hanke-Krus World Hyperinflation Table. In order for a country to be classified as in hyperinflation, its monthly inflation rate has to exceed 50% for at least thirty consecutive days and Venezuela succeeded in doing just that. Critics of the current Venezuelan President, Nicolas Maduro, and his party condemn the government for its disastrous economic policies. Meanwhile, Maduro’s supporters have blamed falling global oil prices and foreign businesses for Venezuela’s poor economic performance. The reality is, however, that the economic crisis facing Venezuela is not a simple black and white issue. It is the combined result of poor government policies, bad luck and unexpected circumstances beyond anyone’s control.

An important question that has concerned economic analysts is why a country, that is sitting on the largest oil reserves in the world, not one of the richest countries in the world. Even more daunting is the question of why Venezuela is doing so poorly in comparison with other major oil-exporting countries in the world. For a country that generates 95% of its export revenues from oil, it becomes clear that having such a massive oil industry might have actually triggered this crisis Here’s why: According to the Organization of the Petroleum Exporting Countries (OPEC), oil in Venezuela makes up 25% of its GDP. This heavy dependence on oil for revenue makes Venezuela extremely vulnerable to oil price shocks. Hence, not surprisingly, as global oil prices began to fall steeply from $110 a barrel in 2014 to a low of $33 a barrel in 2016, the economy just went into free fall. Figure 1 demonstrates how heavily dependent Venezuela’s international reserves are on oil prices. In 2011, when global oil prices were approximately $95 a barrel, Venezuela had almost $30 billion in reserves (Figure 1). Today, as global oil prices are around $33 a barrel, Venezuela is left with only $10 billion in reserves.

Figure 1      Source: The World Bank

The fall of global oil prices is not, however, the only reason for the sinking oil revenues in Venezuela. Another problem is the fact that Venezuela’s government has failed to invest enough money into the centrally run and owned oil company, PDVSA. This lack of investment is an issue, since oil fields deteriorate in the long run and the crude found in Venezuela is heavy and hard to refine. As a result, oil production fell from approximately 3.2 million barrels each day in 2006 to 2.6 million in 2011. Oil production in Venezuela has been inefficient, even before the oil price crash in 2014. These issues, which were once masked with high prices and revenues, are now being amplified.  To make matters worse, due to the lack of funding, foreign companies, such as Schlumberger, which help Venezuela extract its oil, have cut their operations in the country because of unpaid bills.

The poor performance of the oil industry is not the only factor leading to Venezuela’s economic collapse. Another huge problem that Venezuela is facing is massive shortages of medical supplies, food, and basic staples such as soap and toilet paper. Experts believe that the government’s strict currency and price controls are to blame. In 2003, currency controls were initially introduced by the former President, Hugo Chavez. Currently, Venezuela has two legal exchange rates, Dipro and Dicom, which are kept at 10 and 658 bolivars per dollar respectively and are mainly used for priority imports. By selling U.S. dollars at two different rates, Maduro’s government has managed to create a black market, where the bolivar has continued to weaken to 4,000 bolivars per dollar this January (Figure 2). The gap between the free-market exchange rate, which is found on the black market, and the official exchange rate is widening more and more every day. Here’s the problem with this: Most businesses import goods at the free-market dollar prices (Figure 2). However, they are unable to convert these high dollar prices to bolivars to sell the imported goods because of the government’s strict price controls. This stopped importers from importing all the essential goods, such as food and medicine, because they were losing a lot of money. Consequently, food imports fell by almost 50% in 2016.

Figure 2:                                       Source:

The strict price controls were designed to keep goods available and affordable for all Venezuelans. However, they’ve achieved the exact opposite. The price controls set maximum prices for what firms could charge for their goods. These prices are well below those that would have existed in a free-market and, hence, below the firms’ cost of production. As a result, business owners have either cut back on production or shut down completely. The government has attempted to fix this problem by permitting select businesses to purchase dollars at preferential rates. This was supposed to ease the imports of priority goods like food and medicine while selling them at the government set prices. However, this proved ineffective, because businesses have reportedly just been selling their dollars in the black market for much higher prices than they could get by reselling imported goods. The result is that grocery stores are empty, there are massive shortages of medicine and food, and people are growing more hungry and sick with each passing day.

Price controls aren’t the only way that the government has limited the private sector. Experts state that increasing expropriations  have further diminishing productivity of businesses. Transparency International recently reported that there are at least 500 companies in Venezuela that are controlled by the government and 70% of which are operating at a loss. Last week, government authorities illegally seized one of General Motors’ (GM) plants in Venezuela. As a result, GM completely shut down its operations in the country. The automaker is one of several multinational companies that have reported huge losses from their operations in Venezuela. Foreign firms have lost confidence in the government and have, hence, either stopped counting their businesses in Venezuela in their overall operations or have shut down completely. This corporate exodus is further amplifying the economic crisis in Venezuela, which is in dire need of foreign investment to keep its economy from fully collapsing.

Another important factor that is contributing to this crisis is that the government, even before Maduro was elected in 2013, was spending more money than it was making. In 1999, Hugo Chavez was elected and began to implement huge social programs called missions which provided housing and food subsidies, education and health care for the poor. This led to a decline in the country’s poverty rate from 50% in 1998 to almost 30% in 2013. Here’s the issue with this: these redistribution policies completely depended on Venezuela’s oil revenue. Ricardo Hausmann, an economist at Harvard Kennedy school, stated that “Hugo Chávez did not use the massive oil price boom between 2004 and 2013 to put money aside for a rainy day but instead, over-spent and quintupled the public foreign debt.” The government wasn’t just spending all its oil revenue; it was spending a lot more than that.

Figure 3      Source: International Monetary fund

Figure 3 looks at the difference between the government spending and revenue. As is clear from the chart, spending and revenue diverged even before the global oil prices crashed in 2014.  In 2008, as oil prices were at an all-time high of $100 a barrel, government revenue was falling (Figure 3). The main problem was that oil production was  dropping in Venezuela before 2014. This explains why the government, which depends on oil for 40 percent of its revenue, was already experiencing a drop in revenues in 2008. Moreover, the chart shows that even though government expenditures initially followed the government revenue as they were decreasing, they eventually diverged. Beginning in 2010, the government was spending even more money on its welfare programs and subsidies than it was making from its oil revenues.

How is Venezuela paying its bills now that they can’t depend on their oil revenues? It is printing more and more money. The country is struggling to print money quick enough to keep up with the uncontrollable inflation. Ironically, printing such excessive amount of new bills is making the bolivar lose more of its value against the dollar.   As the bolivar has become completely useless, the government is forced to increase the number of bolivars in circulation even more. Here’s the bigger issue: Venezuela doesn’t print its own money. Rather, it pays foreign companies in dollars to print their bills for them. With hard currency reserves reaching an all-time low, the government will soon not have the money to pay for its own money. If Venezuela ever reaches this point, which could be very likely, there’s no going back.

The crisis in Venezuela is a clear example of what happens when extremely ineffective government policies are topped off with a global price shock: an economic collapse.  As of now, the Venezuelan economy is in free fall. It is uncertain whether the country could eventually get out of this crisis. However, one thing is clear. If the government continues to implement the exact same policies and magically hopes for different results, then it will continue to be disappointed.

Venezuela’s Economic Crisis: What Went Wrong?