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DontBlameItOntheOil|ForeignPolicy

Dont Blame It On the Oil


Yes, Venezuelas economy is cursed by its political regime, not its natural resources.
BY JAVIER CORRALES

MAY 7, 2015 - 2:51 PM

Venezuela is a formidable petro-state. It has more proven oil reserves than Saudi Arabia, and exports most of the
oil that it produces. Between 2004 and mid-2014, when historically high oil prices were the norm, Venezuela
enjoyed one of the largest revenue windfalls in the world. Now it is experiencing one of the most severe
recessions. All oil-based economies have suered from the decline in oil prices since June 2014. But Venezuelas
economy has essentially collapsed, ravaged by what we might call RIDDS: recession, ination, dwindling foreign
reserves, debt, and shortages.

According to the government, Venezuelas woes are the fault of foreign actors and local capitalists. Saudi Arabias
refusal to cut oil production, the United States reckless fracking, rumor-mongering by Wall Street speculators,
hoarding of products by Venezuelas own parasitic bourgeoisie this is all president Nicols Maduro talks
about these days.
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Despite Maduros claims, Venezuelas RIDDS is not the result of external shocks, or even the local bourgeoisies
economic warfare. Its not the result of oil dependence, either. Neither does it have much to do with the
economic incompetence of the countrys leaders, conspicuous as that factor may be. Venezuelas economic woes
started long before the current downturn in oil prices and the start of Maduros administration. Rather, the blame
for Venezuelas RIDDS must be laid on the nature of the countrys regime, which disincentivized its leaders from
competently managing the oil boom, and is now crippling the governments ability to respond to the downturn.
In the early 2000s, Venezuelas regime under Hugo Chvez became semi-authoritarian and hyper-populist. Such
regimes have four inherent characteristics, all of which aect how they manage their economies. First, the ruling
party engages in frequent elections, but constantly breaks the rules to ensure acceptable outcomes. Second, the
executive branch erodes or eliminates institutions that can check its power. Third, the ruling party spends in a
partisan fashion: it grants huge resources, typically unaccountably, to its followers, while denying them to its
enemies. Fourth is the regimes hostility to the private sector. These features help explain the countrys descent
into economic hell.
The electorally competitive aspect of the regime helps explains why, under Chvez, and now Maduro, the
Venezuelan state developed a chronic spending problem. Venezuelas spending was done mostly in secret, but
much of it clearly went to generate a consumption boom, with the aim of counteracting the ruling PSUV partys
waning electoral competitiveness. All forms of scal stimuli were tried: direct cash transfers to low income
groups, subsidized consumer goods, multi-million dollar contracts for local rms, low taris, and preferential
access to inexpensive dollars. By the end of the Chvez era in 2013, Venezuelas scal decit reached
approximately 15 percent of GDP. This contrasts with the OPEC countries during this period, most of which took
advantage of the recovery in oil prices since 2009 to re-accumulate surpluses. Until the price of oil began to
decline, Maduro did nothing to cut back.

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We know that this spending had political aims because Chvezs own minister of planning, Jorge Giordani, said as
much in a letter he published online after being red by Maduro in 2014. The governments objective of
consolidating the revolution and more specically, of winning the October and December 2012 elections
led to extreme levels of spending, Giordani wrote.
Comedians had a eld day in late April when a women threw a mango at President Maduros head, asking him to
call her back, which he did. It turned out that the woman wanted a new apartment and Maduro obliged. The
incident became an Internet sensation because it served as a perfect parody of Venezuelas consumption-oriented
populism: hit the government hard with a petition, and you might get lucky enough to win a new house.
Lavish spending wouldnt have been nearly as bad if it hadnt been accompanied by the simultaneous destruction
of the countrys only milk cow its oil industry. Venezuela is one of the few petro-states in the world that,
despite registering increasing levels of proven oil reserves since the mid-2000s, has experienced decreasing
production and rising debt for over a decade. This is the result of two fateful decisions by the government. The
rst was to deprive the state-owned oil company, PDVSA, of much-needed capital. The second was to replace
trained personnel with hordes of revolutionaries eager to go along with any of the presidents wishes. The result
has been a productivity crisis almost unheard of in the oil world.
In a well-run oil company, one would see the opposite trend: employment would expand only when production
was expanding, and always at a slower rate. Such companies do exist Ecopetrol, in neighboring Colombia, is a
good example. Oil production in Colombia increased 92 percent between 2005 and 2015, but employment in
Ecopetrol increased by only 50 percent. Meanwhile, in Venezuela, production declined during this period, but
PDVSAs employment expanded by 256 percent.
The connection between PDVSAs woes and regime features is clear. The erosion of checks and balances granted
the president full prerogative to use revenues at will. Populism directed the president to spend oil revenues on
consumption (and corruption) rather than on production-enhancing investments, such as rigs. Sectarianism
explains why PDVSA was bloated with loyalists rather than technical experts. In Colombia, where checks and
balances have been increasing since 2010, and populism has never been a major part of the states DNA, oil
management has been of an entirely dierent quality.

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The regimes harmful eects are evident not just in PDVSA, but in the economy as a whole. Venezuela responded
to the oil boom by engaging in massive statism. Nobody disputes that some state intervention in the economy is
crucial to encourage growth, reduce poverty, protect the environment, and tackle inequality. But Chvez and
Maduro have gone far beyond whats reasonable. Under their directives, the state nationalized, over-regulated,
and over-spent like few other contemporary petro-states.
Any basic economics textbook teaches that monetized decits lead to high ination, and Venezuela was no
exception. The countrys annual ination rate averaged 27.4 percent per year between 2007 and 2013, at least ve
times the rate for all of Latin America. Even countries ideologically aligned with Venezuela, such as Nicaragua, or
those equally resource-dependent, such as Mexico, or both, such as Bolivia, have signicantly lower ination.
Currently, Venezuelas ination may be as high as 68 percent possibly the highest in the world.
Populist governments, like all governments, worry about ination because it increases poverty. But populist
governments are distinct in how they react: with price controls rather than scal adjustment. Following this
script, Chvez imposed one of the most convoluted systems of price controls in the world, in at least three
markets: retail prices on a large number of products, labor markets, and foreign exchange markets.
Controls on foreign exchange have been one of Venezuelas most self-destructive economic policies. To contain
ination and capital ight, both Chvez and Maduro have relied on a complicated multiple exchange-rate system
supplemented by increasing rationing. A serious balance-of-payments crisis forced Maduro to devalue the
currency in 2013 and again in 2014, leading to an even less transparent system of three exchange rates, of which
two were pegged ocial rates and one was a oating unocial rate. Multiple exchange rates cause the cost of
capital to have dierent values, and only enterprises with access to preferential rates can remain competitive and
survive. The rest disappear as entire sectors of the economy have. In combination with price controls and
nationalizations, these distortions are causing severe shortages of food and consumer goods.

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Unfortunately for the government, but not surprising to anyone minimally literate in basic economics, exchange
rate controls have stimulated rather than stopped capital ight. As Francisco Rodrguez at Bank of America has
argued, economic actors are so eager to acquire dollars that they are paying fortunes in bolvares for dollars, and
quickly taking them out of the country. Todays bolvar is trading at around 285 to a dollar in informal markets, an
astronomical distance from the ocial exchange rates of 6.30 to 197.00 to the dollar. This heightened demand for
dollars is one reason that international reserves have been shrinking at an average of $38 million per day,
bringing total reserves today to the dangerously-low levels they were at in 2003, right before the oil boom started.
As bad as RIDDS might be, it is only the tip of the iceberg. Venezuela is in the midst of a severe governance crisis.

Chavismo is now facing a chronic incapacity to eectively deliver social services. This is a terrible handicap
during a recession, because it means that the poor are left with almost no protection. The governance crisis is
particularly visible in the health sector, where hospitals are facing scarcity of even basic products such as
acetaminophen. In September, the scarcity index for medications was estimated at around 60-70 percent.
Diseases long eradicated in Venezuela, such as malaria, dengue fever, and tuberculosis, are making a comeback.
Like previous statist episodes in Latin America, chavista economics has now created a need for exactly what it
hates the most: draconian adjustment policies. Each of the options under consideration is enormously costly:
Reducing spending would undermine the most important electoral tool available to the government. Selling
nationalized rms would generate few revenues because they are in total disrepair and interested buyers are
scarce. Selling CITGO would reduce Venezuelas access the U.S. markets, which continues to be the most reliable
source of foreign reserves. Defaulting on foreign debt would make future borrowing too costly. Increasing the
price of gasoline at home would hurt low-income groups the most.
Because the government knows that any of these policy options are ideologically embarrassing and politically
dangerous, it is choosing stealth adjustment instead. It is gradually devaluing the currency by reducing the
number of transactions eligible for the cheapest exchange rate. It is gradually reducing imports by restricting
access to foreign exchange. And it is refusing to pay its domestic debts to private corporations, an approach
Hausmann and Santos describe as a domestic default.

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The other response of the government has been to become more autocratic. As the price of oil declines,
dependence on the military is increasing. Loyal military gures are being given more cabinet posts, more
benets, and more discretion. One of the perks the military now receives under Maduro is greater latitude to
repress dissidents and to engage in illicit market activities, including drug tracking. Whereas in the 2000s, the
regime came to depend for its survival on the so-called bolibourgeoise business tycoons who have prospered
from state contracts and state protections in the 2010s, the regime now depends on what we might call mili-

narcos: state security forces linked to drug tracking.


When the U.S. government sanctioned several of these mili-narcos in its poorly worded executive order of March
2015, Maduro responded by promoting several of them. Maduro called this an assertion of sovereignty in the face
of imperialism. In reality, it was an armation of the regimes reliance on mili-narcos.
The main paradox of hyperpopulism is that it is the quickest route toward its ideological nemesis. RIDDS is
hampering governance and forcing the government to pursue harsh austerity. Public support for the government
has plummeted, and this decline in support, in turn, is leading to more militarism. Venezuelas lesson for voters is
straightforward. To protect ones country from savage neoliberalism and militarism, start by never electing
radical populists to begin with.
In the photo, people queue outside a state-owned supermarket in Caracas in January 2015.
Photo Credit: FEDERICO PARRA/AFP/Getty Images

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The Price of Mistrust


The U.S.-China relationship is marked by a quiet but destabilizing narrative. That's why it's so
important that the two countries keep talking.
BY KEVIN RUDD

MAY 7, 2015

There is a predisposition in the public debate about the U.S.-China relationship, on both sides of the Pacic, to
believe that the two countries are now locked into some sort of irreversible and increasingly fractious zero-sum
game. Chinas gain by denition means Americas loss or so the thinking goes just as a U.S. advance is seen
as portending a consequential Chinese retreat.

The most recent manifestation of this phenomenon is the heated analysis over Chinas inclusion in or exclusion
from the 2016 Rim of the Pacic military exercise (RIMPAC), which involves units from 21 other Pacic countries
and which the United States leads. The context for this debate is Chinas land reclamation program in the South
China Sea in support of its territorial claims, and whether Chinas inclusion in RIMPAC would be seen as simply
sanctioning such actions.
The truth is, the political machinery of the China-U.S. relationship anchored in regular, working-level
summitry between the two presidents and supported by the framework of the high-level meetings of the Strategic
and Economic Dialogue and its subsidiary policy working groups is functioning reasonably eectively.
Previously, both sides managed the relationship through a series of ad hoc side meetings at the margins of
international forums like the U.N. General Assembly, G20 summits, or Asia-Pacic Economic Cooperation
(APEC) meetings where the issues of the conference, or the particular political dramas of the day, tended to
dominate. The crucial addition to this machinery, which Obama introduced within months of Xi assuming the
presidency in 2013, is working-level summits, which cover both the most dicult and the more routine aspects of
the relationship. This began with Sunnylands in June 2013, when the two leaders met for two days in a relatively
casual setting. And it will continue in September, when Xi arrives in Washington, D.C., for a state visit that will
also be a working summit.

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Whoever becomes the next U.S. president, whatever their views on China may be, should ensure that they can
sustain this machinery, through good seasons and bad. The central strategic signicance of the U.S.-China
relationship should not be held hostage to the topic du jour, or even the crisis of the day.
In great power relations, boring is usually good. We should never forget the Confucian curse of legend: May you
live in interesting times!
Lest I be accused of having a Pollyannaish view of the diculties facing the future of U.S.-China relations, there is
a long list of disagreements capable of derailing the relationship. These include Taiwan in all its contemporary
dimensions, including the future of U.S. arms sales to the self-governing island. They include the future
management of territorial and other political disputes with Japan, one of Americas closest allies. And they
include tensions over the North Korean nuclear weapons program and the possibility of a collision between
Chinese and foreign naval and air assets causing an international incident or crisis. Then there is the
smorgasbord of complexity concerning conicting claims in the South China Sea, including Chinese land
reclamation eorts, at a time of closer U.S. strategic engagement with most of the Southeast Asian claimant
states.
We can recite the profound challenges to the relationship, which are legion, and throw our hands in the air,
predicting gloom, doom, and general despair. Or we can do something about managing them, and even, God
forbid, work toward resolving some of them.
Professional pessimism about the U.S.-China relationship, or indeed about China itself, may be intellectually
satisfying. But it does little to advance the practical diplomacy necessary in managing a relationship so
fundamental to the great issues of our time: how to preserve peace and maintain stability, thereby providing the
foundations for long-term economic prosperity and environmental sustainability for all but in a manner that is
suciently mindful of U.S. and Chinese interests and values. This is far preferable than allowing strategic drift to
set in which may have a long-term trajectory of crisis, conict, or even war.

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And while doubting the strength and longevity of the ruling Chinese Communist Party (CCP) may be
intellectually satisfying for some, a more cautious and evidence-based view is that the CCP is likely to endure for
the long-term, not least because no alternatives are on oer. The Chinese economic model and its
underpinning political economy is sustainable for the foreseeable future: Average annual growth will likely
remain north of 6 percent for the next decade.
I therefore reject the latest fashion statement in American sinology the economic collapse of China preceding
its political implosion as argued in early March by George Washington Universitys David Shambaugh, an
innitely qualied sinologist with publications of the highest quality. But on this occasion, his conclusions defy
the evidence and are just plain wrong. Furthermore, whatever reservations we may have about the Chinese
political system, any policy predicated on an analytical assumption of Chinese collapse is dangerous: a triumph
of aspiration and hope over analytical rigor and hard policy choices.
Many in China already believe that U.S. policy is, in fact, to weaken China from within and to constrain Beijings
options abroad. Xis China has deep reservations about the long-term strategic intentions of the United States
towards their country. Beijing does not believe the United States will happily surrender its current dominant
position in the regional and global order and therefore concludes that Washington is actively pursuing a policy of
containment to deny China international policy space. Chinese hardliners also conclude that this policy of
containment abroad is matched by a parallel U.S. policy of undermining the legitimacy of the CCP at home.
This deeply realist conclusion in Beijing about U.S. policy is matched by Washingtons conclusions about Chinas
operational strategy in the region and the world. The United States concludes that China is actively pursuing a
policy based on Xis statement that the people of Asia should manage Asian security. Washington also concludes
that this, by denition, is designed to exclude the United States and that the objective of Chinese operational
strategy is to push the United States out of the security architecture of the region, to be replaced with a Chinese
sphere of inuence across East Asia.

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But, the prospect of armed conict between China and the United States for the decade ahead remains remote. It
is in neither countrys interests for this to occur. For China it would derail the core mission of realizing the
transformation of its economy, for which it needs sustained strategic stability. Furthermore, Chinese strategic
planners have concluded that U.S. military predominance, both regionally and globally, will continue for the
foreseeable future.
But China will seek to expand its political and diplomatic inuence across Asia, primarily through its formidable
economic presence. There is already evidence of this through the dominance of Chinese trade, and soon
investment ows, across the region which the recently announced Chinese-led institutions, the Asian
Infrastructure Investment Bank and the Silk Road Fund, will likely enhance. Beyond Asia, China will also become
increasingly active in the future reform of the global order. There is no evidence that Beijing has any intentions of
fully revising, let alone replacing, institutions like the United Nations, which have served Chinas interests well.
Instead, China is likely to seek a stronger voice in the various ongoing reform processes of the system, and within
each of the institutions, under the overall Chinese rubric of greater multipolarity and a more democratic
order as opposed to what China sees as an order based on the continuing assumption of the singularity of
unilateral American power.
Xi is signicantly dierent from his predecessors. He wields more power individually than any Chinese leader
since Mao Zedong. He has a clear political vision for the country: his China Dream has as its end point a strong
and powerful Chinese state. He has ended former paramount leader Deng Xiaopings foreign policy orthodoxy
over the past 35 years of hide your strength, bide your time, never take the lead, in favor of a more vigorous,
activist, and assertive international policy to advance Chinese interests both in the region and beyond. He speaks
of a new type of great power relations, a new type of international relations, and great power diplomacy with
Chinese characteristics. Xi identies a period of extended strategic opportunity for Chinas rise, during which
he wants to preserve the peace in order to focus on the completion of Chinas economic transformation. He sees
the strength of the Chinese economy in a growth-challenged world as Chinas principal vehicle for extending its
international inuence.

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Given these signicant emerging divergences in Chinese and American views of the existing regional and global
order, is a common strategic narrative between the two possible? Yes within the framework of what I call
constructive realism, common purpose. Realism refers to those fundamental policy disagreements between the
United States and China like arms sales to Taiwan which cannot be resolved in the foreseeable future but
which should be managed within a general protocol of not allowing any of these disagreements to destroy the
relationship.
Constructive refers to the much longer list of policy areas like the proposed bilateral investment treaty;
expanded cooperation in strengthening the regions thin security architecture to help manage regional tensions;
and expanding the November 2014 agreement on climate change where the two sides can make progress.
These and other bilateral, regional, and global cooperation projects, build step-by-step political capital,
diplomatic ballast, and strategic trust to help resolve some of the more intractable realist challenges.
As for common purpose, that entails building a stronger, sustainable international order that maximizes the
provision of global public goods against the mounting number of global threats to the order itself including
global terrorism, cyberthreats, pandemics, and climate change.
A collective organizing principle, or common strategic narrative, for the overall relationship is now necessary. At
present we dont have one. What we have instead is a silent strategic narrative against each other. A common
strategic narrative that is capable of embracing both fundamental disagreements and substantive cooperation
within the same overall framework rather than having the latter permanently hostage to the resolution of the
former is needed.
These, of course, are only recommendations. The utility of such an approach is a matter for the governments
themselves. Which makes the ongoing utility of regular, working-level summitry all the more important for the
long-term prospects of this relationship. After all, what happens between the United States and China aects the
rest of the world as well.
Feng Li/Getty Images

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