Lessons from Venezuela, Part I

After a long period finalizing a book manuscript, I now have time to return to this blog. I developed this forum to discuss issues in the interface between economics and reality - a place where a surprising number of economists have never set their foot - and I have been yearning to get back to writing here again... 

Economics - and its less-recognized brother called "political economy" - can help us a great deal in making the world a better place. The problem is that most of modern economics is too quantitative to give people a chance to see its applicability. I want to use this blog to highlight the older, more useful side of economics. 

These are aspects of economics that I myself would have liked to become more acquainted with as a graduate student, but also after I earned my Ph.D.; if you want to make it in the narrowly defined, academic practice of economics, you have to walk a thin line between pure sophistry (the kind of economics where you study one consumer and one commodity - yes, some economists actually make a career out of doing that) and eclectic flea killing (only topics that can be processed through the econometric meat grinders). 

I veered off that thin line into public policy, also known as the unforgiving territory where economists misunderstand politicians, and vice versa. I have not regretted my choice, though, because despite all its challenges, public policy can be tremendously rewarding. It is possible for you to have major influence on politics, to contribute to solutions to difficult legislative problems and help improve people's lives a little bit. 

It is also in the public-policy arena that you can contribute to the education of coming generations of politicians, activists, voters, taxpayers and - maybe, maybe... - future economists. That educational effort is badly needed, especially now that no person under 30 has any living memory anymore of the Soviet Union and its atrocious practices. There is, namely, no better way to vaccinate people against totalitarian ideas of any kind than through the proper teaching of economics. Hopefully I can make a small contribution toward that. This blog is one of my efforts. 

As an example of how economics helps us understand the difference between liberty and totalitarianism, consider the practices of totalitarianism in Venezuela. This is a country that, without socialism, would have been a thriving economy, with a highly educated labor force and natural resources enough to elevate the country to the top tier of global prosperity. Instead of enjoying and building on the potentials of free-market capitalism, the Venezuelan people chose to inflict socialism upon themselves. 

The country's political history is a fascinating example of how the destructive forces of socialist policies can set roots, conquer and ultimately ruin a country, simply because people in power do not understand the theory, practice and profits of freedom. In a paper for the Council of Foreign Relations from November 2005, Richard Lapper, the Latin America editor for the Financial Times, explains the ideological and political lineage that ultimately led to the destruction of the Venezuelan economy. 

According to Lapper, the nationalist legacy of Simon Bolivar - the leader of Latin America's independence movement in the early 1800s - has over time been fused with socialist ideas brought to the region in particular through the Cuban revolution. Conveyed to power in many Latin American countries by a military with leftist political leanings, this Castro-Bolivarian national socialism had a major influence on many Latin American political leaders in the latter half of the 20th century. The late Hugo Chavez was one of them. But, says Lapper, there was also another side to the movement that Chavez led: 

These three diffuse influences—the new pro-Cuban left, the military left and Bolivarian nationalism—combined in Chavez and Chavismo. For Chavez to put this nationalist Bolivarian project into effect however he would first have to overthrow the two-party corporative system of government established by the 1958 agreement at Punto Fijo. North American and European political scientists in the 1970s and 1980s praised this model as epitomizing a healthy democratic trend within a region where until the early 1980s at least most countries were governed by military dictatorships. But Chavez and his supporters viewed the system as socially exclusive and corrupt. For example, welfare benefits were concentrated among well-organized urban workers affiliated to the social democrat Democratic Action (AD)-controlled Confederación de Trabajadores de Venezuela (CTV). The two parties had privileged access to state resources. Rural migrants who had arrived in large cities during the 1950s, 1960s and 1970s, accounting for the growth of sprawling shanty-towns or ranchos, especially around the western edges of Caracas, were largely excluded from this system. 

In other words, Venezuela was a country governed by a corrupt, statist elite. One might even go as far as to call the structure corporatist: only members of organizations favored by the political elite were eligible for tax-paid entitlements. 

Without a doubt, there is a great deal of truth to the criticism that this system is "exclusive and corrupt". The problem is that the Chavez movement replaced one cronyist, corrupt form of government with another. The theory behind socialist policies is nowhere near its totalitarian practice. 

Its core concept is "egalitarianism", which essentially means reducing economic differences between citizens. Egalitarianism has been practiced widely in Europe since at least the 1930s, when the modern welfare state was born. In its absolute form - practiced initially only in Sweden - it demands that all economic differences be literally eradicated. Everybody should earn the same wage and have the same standard of living, regardless of their education, skills, experience, work ethic, sloth or indolence. 

Regardless of whether egalitarianism is practiced generally or absolutely, it disables productive forces in our economy. Taxes on high-earning workers discourage them from putting in the extra effort in furthering their own education and skills. At the same time, entitlements paid out to low-income families discourage them from working more. As a result, the economy grows more slowly. 

As growth slows down, the ability of the welfare state to keep its spending promises weakens. Here, we have the starting point of the downslope, from well-intended egalitarianism into the dark political sink hole we also know as totalitarianism. When growth slows down and egalitarians have maxed out taxation, they turn to other, more confiscatory methods to maintain their pursuit of their egalitarian ideal. Those methods range from gradual statist escalation to outright revolutionary confiscation: 

Gradual escalation takes such forms as regulations forcing producers, consumers and investors in individual industries, or the entire economy, into spending their money as government wants them to; 

Revolutionary confiscation comes in the form of seizing property, beyond taxation, in the form of complete transfer of ownership to government, or imposing management controls that effectively end private ownership. 

The Venezuelan government was not too impressed with the gradualist approach, which Europeans and Americans will recognize as the welfare state. Their path to egalitarianism was more radical, clearly inspired by revolutionary Communism than reformist European social democracy. Richard Lapper again: 

Early in 2005, the government began to implement radical economic measures. "Unproductive" agricultural land was appropriated; takeovers have been running at the rate of roughly one per week since the beginning of this year [2005]. The government has begun to renegotiate oil contracts imposing tougher terms and higher royalties and scrapping the association contracts signed with a number of oil majors in the 1990s in favor of more restrictive joint-ventures dominated by PDVSA. The state has increased its control over the banking sector. Interest rates caps were imposed in 2004. This year the [2005] central bank has issued guidelines stipulating how much credit can be allocated to each sector of the economy. The government has also appointed directors of its own to sit on the boards of private banks. 

Regardless of whether socialists go the gradualist path to their egalitarian goal, or they cut straight through the jungle by means of revolutionary confiscation, they upset established economic behavior. When people are left to go about their business on their own, they build relationships with others; they form habits that repeat successful economic behavior and avoid failed ones; and they pursue gains from trade by protecting the proceeds of all kinds of economic activity. 

In short: in a free society people create contracts, protect property and find ways to enforce both contracts and property rights. By seizing property, or by rendering property meaningless through confiscatory taxation, the egalitarian eliminates the incentive for building property in the first place. This undermines the very purpose behind his measures to control or seize property: the egalitarian expects an endless stream of profits from the businesses he takes control over, profits that he can then use toward advancing the egalitarian agenda. 

When one intrusion into the economy fails, the egalitarian takes another step in the same intrusive direction. His seizing control over productive resources is, of course, motivated by the same ideology, namely to maximize the proceeds from productive activity for egalitarian ambitions. Yet for every step the egalitarian takes, he destroys yet more productive activity: 

Taxation and entitlements discourage work and encourage idleness; and 

Property confiscation discourages entrepreneurship and the pursuit of positive profits in a business. 

By now, the egalitarian project builds a perfect storm of economic distortions. Egalitarian projects are always driven by entitlements, which in turn cost money. The entitlement costs are defined by the promises embedded in them, not by the ability of the economy to produce the resources needed to bankroll those promises. The compounded effect of taxation and confiscation further widens the gap between promises and resources. 

As this gap widens, an egalitarian government is faced with increasing difficulties to maintain its egalitarian policies. Its responses can range from conciliatory to authoritarian, with European welfare states falling into the former category. Venezuela, on the other hand, has ended up at the opposite end of the scale. 

More on that in Part 2.