Hugo Chavez against the Backdrop of Venezuelan Economic and Political History

Hugo J. Faria

Instituto de Estudios Superiores de Administración and Universidad Monteavila

Address in the U.S.

IESA POBA International 646

PO Box 02-5255

Miami FL 33102-5255

Address in Venezuela:

IESA, Centro de Finanzas

Calle IESA, San Bernardino

Caracas, Venezuela

Telephone #

58 212 555 4327 (Office)

58 416 6244019 (Mobile)

58 212 992 6103 (Home)

hugo.faria@iesa.edu.ve

This is a revised version of the paper “From Riches to Rags: A Venezuelan Tale of
Ethical Decay that Explains Hugo Chavez” presented at the 2007 APEE Conference.

1
 Political Economy Determinants of Hugo Chavez

President of Venezuela Hugo Chavez is a source of irritation for the leaders of free

countries. Financed by high oil prices Mr. Chavez has meddled in the internal electoral

processes, sometimes successfully, of Bolivia, Ecuador, El Salvador, Mexico and Peru

among others. He has established alliances with Iran and other rogue states of the Middle

East. “An avowed Marxist, Mr. Chávez is in the process of destroying his country. Of

this there is no doubt. But he is also an international menace, and a rich one at that. He

has been using his oil wealth to sow revolution, à la Fidel Castro, in South and Central

America. Did we mention that he's a dear friend of the Iranian government?” (O’Grady

2007).

In short, Chavez has been a destabilizing force around the world attempting to subvert

democratic rule and capitalism and to instate the so-called Socialism of the XXI Century

in Venezuela and elsewhere. In Venezuela, the so-called Bolivarian Revolution in 2007

has nationalized utility companies in the electric sector, renationalized the largest fixed

telephone company and shut down a TV station with the broadest audience.

The aim of this paper is to cast light on the political economy determinants behind the

advent and popularity of Hugo Chavez. This research shows that the Venezuelan

economy was a growth miracle from 1920 to 1957 in particular during the decades of the

forties and fifties. However, starting in 1958 and with the dawn of democracy in 1959,

political leaders acting in complicity with some members of the private sector, started to

undermine the institutions that protected private property. This erosion of economic

2
freedoms continued unabated and was conducive for the free election of Hugo Chavez.

Under Chavez, economic freedom has continued to decline and not surprisingly, political

and civil liberties are seriously in jeopardy. Thus the Venezuelan economy from a

growth miracle became a growth disaster. This is a story of an economy that went from

riches to rags provoked by a governmentally owned oil wealth that engendered perverse

incentives coupled with a lack of political and entrepreneurial leadership.

This paper has the following structure. The sections Growth Miracle and Growth

Disaster provide objective information on the performance of the Venezuelan economy

for the periods 1920-1957 and 1958-2006 respectively. Section What Happened? offers a

brief historical account that allows a comparison of the institutions that prevailed in both

periods, 1920-57 and 1958-2006. Based on the institutional environment evidence that

prevailed over the 1958-2006, the Poverty Trap section characterizes today’s Venezuelan

economy as socialist and mercantilist and suggests some factors that account for its time

persistence. The following section entitled Collective Action Problems brings a Public

Choice perspective of why is so difficult to extricate the Venezuelan economy, and for

that matter most Latin American economies, from the poverty trap of socialism and

mercantilism. The next section The Foundation of Freedoms highlights that property is

the foundation of freedom and patrimonial governments like Venezuela’s lack this pillar

of freedom contributing to explain the precarious political, civil and economic liberties in

Venezuela. The section Other Obstacles to Freedom, based on historical and

contemporaneous evidence suggests the importance of entrepreneurial leadership for the

promotion of economic freedom. This section also brings examples that point to the

3
absence of this leadership in Venezuela. The following section Probable Scenarios offers

potential future outcomes describing causes for the demise of Chavez. The perception is

that there is more optimism about the prospects of ousting Chavez than about the

implantation of capitalism. The final section Conclusions summarizes the paper.

Growth Miracle

According to (Jones 2002, 216-219) who uses data from the Penn World Tables Mark 5.6

that updates (Summers and Heston 1991), Venezuela’s GDP per worker relative to the

U.S. in 1960 was 0.837. That is Venezuelan workers on average earned almost 84 cents

for every dollar made by average American workers. To put this indicator in perspective

in 1960 Canadian workers earned 79.7%, Swiss 82.5% and Australian 78.8% of

American workers.

To reach such a high plateau necessarily the Venezuelan economy had to grow at very

high rates during the preceding decades and the best available evidence is consistent with

this hypothesis. Official and reliable data from the Venezuelan Central Bank commenced

in 19501. According to central bank data during the 1950-57 period the Venezuelan

economy exhibited an average real per capita growth rate of 5.4% similar to the growth

rates experienced by the Asian Tigers during the 1960-2000 period. Moreover, the

accumulated growth rate of the Venezuelan economy for the 1950-57 period was 87%,

not only higher than of any Latin American country but surpassing the accumulated

growth rate of West Germany which was of 76%. Thus the German Miracle paled in

comparison to the Venezuelan Miracle.

1
The Venezuelan Central Bank was established in 1939.

4
Moreover, the best available evidence provided by (Baptista 2006) and (Sanchez-Coviza

and Olcoz 1966) suggests that Venezuela’s GDP expanded during the forties at rates in

excess of 10% annually. These same scholars estimate high growth rates for the decades

of the twenties and even the thirties.

Growth Disaster

Jones (2002, 4) using data from the Penn World Table classifies Venezuela as a growth

disaster because between 1960 and 1997 real income per capita experienced a growth rate

of minus 0.13 percent. According to (Barro and Sala-i-Martin 2004, 4), out of 112

countries with known data from 1960 to the year 2000, sixteen countries endured average

negative growth rates. Fourteen out of sixteen countries belonged to the Sub-Saharan

region, two were Latin American, one, Nicaragua suffered a civil war and a socialist

government, the second one was Venezuela rich in oil, gas, carbon and iron and with no

major internal turmoil.

Using data from the World Development Indicators published by the World Bank and

based on the author’s calculation and fellow researcher’s Hugo Montesinos, Venezuela’s

growth rate of its real income per capita during the sixties averaged 1.46%, seventies

minus 0.76%, eighties minus 1.88%, nineties minus 0.08% and during the presidency,

thus far, of Hugo Chavez from 1999 to 2006 minus 0.06%. However, the growth rates

from 2004 until the present have exceeded 10% annually due to high oil prices.

5
 What Happened?

The discovery of oil in 1918 provided substantial impetus to the Venezuelan economy.

However, private international companies handled all aspects of the oil business. That is,

the Venezuelan government did not commit the mistake of attempting to manage the oil

business. The Central Bank acted as a Currency Board defending an irrevocable fixed

exchange rate to the dollar. The marginal tax rate on individual income was 12% in 1957

and consolidated public sector absorbed 22% of GDP. Moreover, government

consumption represented 12% of GDP and the rest was spent building the country’s basic

infrastructure. The overall fiscal budget was generally in surplus. Tariffs on imported

goods were relatively high, 20%, nonetheless other impediments to trade like quotas,

antidumping or safeguard laws did not exist. There were very few state owned

companies. Virtually no price, interest rates or exchange rate controls existed. Although

political and civil liberties were very restricted, the judicial system administered justice

impartially, particularly in the area of business and economics. The cities of the country

were safe and corruption was centralized, located at the highest level of government.

Thus, the damage of corruption to growth was not as severe when it is widespread across

governmental bureaucrats.

According to Escovar and Faria (2005) the index of economic freedom for Venezuela, on

a scale from 1 to 5 where one is the freest, was 1.5 in 1950 and 1.6 in 1955 2. This

suggests that the Venezuelan miracle was not just driven by oil. A set of economic

2
Escovar and Faria (2005) using criteria of the Heritage Foundation and the Wall Street Journal estimated
Venezuela’s economic freedom for the years of 1950, 1955, 1960 and 1965.

6
institutions were in place that guarded private property and contributed to channel the oil

wealth efficiently through out. To the extent, that the manufacturing, construction and

service sectors were expanding at rates greater than overall GDP.

Even though during the fifties Venezuela enjoyed high levels of economic freedom,

several governmental decisions started to erode them. In 1950 de dictatorial government

of Perez Jimenez nationalized CANTV, the telephone company. A few years later

founded SIDOR, a state owned steel company, built dams to generate electricity and also

established various hotels across the country with the intent of developing a tourist

industry. In addition, founded a state owned petrochemical company called Instituto

Venezolano de Petroquimica and set up numerous regional “development” banks. This

tendency towards state owned companies was implicitly justified on the apparent success

of centrally planned economies like the Soviet Union.

Perez Jimenez government was overthrown in 1958 and a democracy with universal

suffrage and freedom of the press was established in 1959. These events are consistent

with the notion of economic freedom, growth and wealth destabilizing dictatorial

regimes, (Barro 1999 and Glaeser et al. 2004). That is, citizens after savoring economic

freedom also want to enjoy political and civil liberties.

Democratic leaders, however, accelerated the downfall of Venezuela towards socialism

and mercantilism. Romulo Betancourt was elected in December 1958 and assumed the

presidency in 1959. One of Betancourt’s first decisions as president was a Land Reform

7
aimed against the existence of large extensions of land, latifundium. New “owners” of the

redistributed land were given titles of use but not full ownership titles. Betancourt’s

government established a central planning governmental office called CORDIPLAN

adapted to a mix economy. During his tenure OPEC, a cartel, was founded by one of his

cabinet members, an oil state owned company was created called CVP and international

oil companies were barred from new concessions. That is, if these companies discovered

new oil they were not allowed to extract it.

Betancourt devalued, (confiscated average Venezuelans labor fruits), the currency from

bolivares 3.30 to 4.50 to the dollar and implemented exchange controls. In addition, he

increased overall government expenditures, in particular consumption outlays. Tripled

income tax rates from 12% to 36% and exacerbated its complexity and gradualness

creating numerous brackets. Years of successive fiscal deficits made their first

appearance and have become a staple of Venezuela’s public finance

Price controls were generalized. A notable example was rent controls which wiped out

the rental dwelling market and contributed to foster today’s slums. Lastly, limited

European immigration, which was major source of innovation and transformation of the

Venezuelan economy.

Not withstanding the fatal wounds to the Venezuelan economy inflicted by Betancourt,

the following government of Raul Leoni cemented the import substitution policy that

ended up increasing the cost of living to Venezuelans and misallocated resources. Leoni

8
also fortified and augmented the syndicated labor force. Rafael Caldera succeeded Leoni

and not only did not reverse the socialist and mercantilist policies of his predecessors, but

made the Venezuelan economy more inward looking forcing all private companies to be

owned in its majority by Venezuelans.

In 1974 Carlos Andres Perez was elected president of Venezuela. His government like

Betancourt’s provided a big push to socialism. The central bank, founded in 1939, was

51% owned by the government and 49% by the private sector. The government of Perez

bought the stake owned by the private sector and placed several of its cabinet members

on the board of the central bank wiping out in practice its independence.

Perez, in addition, nationalized the oil and iron industry and established new state owned

companies financed with high oil prices induced by the Arab oil embargo and by a very

lax U.S. monetary policy. These nationalizations ended the precarious balance that

existed between the civil society and the political society and marked the commencement

of a patrimonial government.

In spite of tripling fiscal revenues due to oil boom, the government started a debt

rampage also used to finance governmental enterprises. Finally, clear signs of corruption

surfaced in the judicial system.

The following government of Luis Herrera at least doubled external debt and in 1983

devalued the bolivar to more than 7 bolivares per dollar. Devaluation has remained a

9
common place policy and today the official exchange rate is Bs 2,150.00 per dollar and in

the so-called parallel market hovers around Bs 4,000.00. Herrera established exchange

rate controls that were a source of substantial amount of corruption, not surprisingly, that

mostly surfaced in the following government of Lusinchi who basically continued the

socialist and mercantilist economic policies of his predecessors.

In the late eighties Venezuelans elected for the second time Carlos Andres Perez. The

government signed an agreement with the International Monetary Fund and under the

banner of market reforms continued to devalue; inflation never broke the floor of 30%

and implemented new taxes like the VAT in spite of poorly provided government

services and that government owned the commanding heights of the economy.

Unfortunately, IMF bureaucrats would have never recommended the better approach of

adopting the VAT with reduction or elimination of income taxes, making the tax reform

income neutral.

The Perez government liberated most prices, rent controls remained in place, but in an

inflationary environment the positive impact of eliminating price controls is to a certain

extent lost. Price increases in a no inflationary environment serve as signals of relative

scarcity. When there is inflation is difficult to disentangle the signal effect from the

overall tendency of prices to increase.

The Perez administration liberated international trade, reducing tariffs unilaterally.

However, in an environment of great uncertainties, high inflation and high cost of doing

10
business, perhaps is not a good time for trade liberation given the clout of inefficient

entrepreneurs through their influence in the media and rival politicians who typically are

not friends of market solutions. In other words, a timing issue, a desirable sequence of

reforms perhaps needs to be addressed whereby inflation is tamed and measures towards

reducing the cost of business and igniting growth are adopted. In a stabilized growing

economy, which goes a long way in winning popular support for reforms, unilateral trade

liberalization is pursued.

The Perez government also sponsored gasoline price increases in an attempt to bring the

price more in line with the cost of production, phasing out the governmental subsidy.

Like trade liberalization this is also a good policy. Nonetheless, a timing issue under

democratic rule is perhaps also warranted. For average Venezuelans is difficult to accept

to pay higher prices for gasoline where part of the implicit contract with government is

that oil is owned by the state and impoverished citizens in exchange get subsidized gas

prices. Again, maybe a better moment to increase gas prices is under a sustainable growth

environment whereby people perceive better prospects ahead.

Apparently it is quite important that reforms induce high and sustainable growth rates to

secure approval by the populace of new economic policies. The reelections of Fujimori in

Peru, Menem in Argentina and Cardozo in Brasil were driven by high growth

accompanied by disinflation. During the Perez government the economy grew at a

healthy pace, however, this growth was fueled by high oil prices that financed greater

government expenditures.3 When oil prices fell growth subsided. Moreover, the
3
High oil prices which were generated by the Gulf War conflict.

11
beneficial effects of growth in terms of increasing real wages and welfare were

substantially offset by high inflation. Thus, growth under Perez was not led by greater

private investment and in general enhanced economic activity in the private sector

induced by brighter economic prospects.4

The Perez government privatized the telephone company, CANTV, and sold half of the

airline company VIASA to the government of Spain. However, to exact a high price for

the telephone company it extended a 10 year monopoly to the new owners which

precluded consumers from enjoying the benefits of greater competition in the short run.

Notwithstanding the monopoly issue, service quality improved substantially. VIASA

eventually went bankrupt and was liquidated, its demise a least spared Venezuelans from

financing 50% of the losses.

While Mr. Perez was under house arrest, for relatively speaking minor corruption

charges, I visited him with a group of students who knew him. During the interview I

asked his opinion about a possible privatization of PDVSA, the state owned oil

monopoly. He answered that such a privatization would be equivalent to him selling his

home. This personal anecdote illustrates the mindset of his economic policies:

government control and ownership of the commanding heights of the economy. Not

growth engendered by the private sector, neither national nor foreign.

4
Higher governmental expenditures should not increase output substantially since to finance it is necessary
to take away resources from the private sector and to transfer those resources to the government. Not to
mention the distortion of incentives if it is financed by greater taxes. Higher oil prices, however, amount to
more taxes paid by U.S. consumers. Thus if there is a place where the Keynesian view might work is in
Venezuela. However, there are no signs of a multiplier effect since the ratio government spending to GDP
actually increases in the wake of high oil prices.

12
Needless to say, the ill-conceived policies of the IMF, some due to content others to

timing, were very unpopular and contributed to disillusion people with market reforms

engendering a constituency for price and interest controls and no more privatizations.

These sentiments played a major role on the election for the second time of Rafael

Caldera who went back to all sort of controls. The economy was on an unsustainable path

and Caldera ended up signing another agreement with the IMF characterized by inflation,

devaluation and a new tax to bank related financial transactions.

A simple way of summarizing the problems afflicting the Venezuelan economy is that

peoples’ right to the pursuit of property is severely limited. The following rights, all

related to the protection of private property, are denied to Venezuelans. a) The right to

earn on a hard currency. b) The right to pay low taxes. c) The right to spend your income

on the cheapest good produced on any part of the world. d) The right to convert the fruit

of your labor into any currency of the world. d) The right to pursue work and ownership

in any activity deemed legal. e) The right of entrepreneurs to charge whatever price they

consider suitable. f) The right of bankers to charge the interest of their liking and to

extend or deny credit to anyone the feel it is appropriate. g) The right to contract freely in

the labor market. h) The right to a well functioning judicial system that protects property

rights and punishes violators of these rights.

Given the systematic violations of these property rights it should be unsurprising

Venezuela’s condition as a growth disaster. The lack of performance of the Venezuelan

economy, the attendant increase of poverty coupled with the idea that IMF recipe is

13
equivalent to capitalism, fostered propitious conditions for the advent of the populist

government with autocratic tendencies of Hugo Chavez5.

Chavez wins easily the elections in 1998 campaigning against the so-called Punto Fijo

Pact that generated the “corrupt policies of the last forty years”. Chavez projecting an

image of an outsider banked politically on the growth disaster and impoverishment

engendered by the perverse economic policies implemented systematically and most

prominently since 1958. Chavez promised to put an end to these policies under his

government.

Ironically, however, Chavez has not only implemented the perverse policies of his

predecessors but in some instances has exacerbated past policy mistakes. Inflation,

devaluation, price, interest rate and exchange controls, reduced independence of the

central bank and of the judiciary, rampant corruption, impunity, state owned companies,

land reform, complex tax and labor legislation are all policies not invented by Chavez.

Nonetheless, these policies are ubiquitous under the Chavez government. In some cases

past mistakes have been exacerbated. For example, recently the Chavez administration

has nationalized the telephone company, CANTV, and Electricidad de Caracas, an

electric-utility company.6 Viasa, the airline company, was liquidated as previously

mentioned, but the Chavez government revived the company founding a new airline

called “Conviasa”.

5
Another well-known example of poor economic performance driving non democratic outcomes is the
Great Depression which fostered militarism in Japan, Nazism in Germany, Fascism in Italy and central
planning practices in many Western economies.
6
This is the second nationalization of the CANTV; the first one took place in 1950 under the dictatorship of
Perez Jimenez.

14
Chavez has encountered a fertile ground to promote class-warfare given the rise in

poverty levels and rational ignorance of the population on economic issues. Basically,

Chavez attributes the existence of poverty to the capitalist policies of the past, also called

by him savage neoliberal economic policies. He is extremely charismatic with the low

income population and has the tale wind of high oil prices that have allowed him to

pursue more redistributionist policies and to ignite growth7 by virtue of greater

government expenditures.

A Poverty Trap

Clearly what ails Venezuela is socialism and mercantilism. An unmistakable

manifestation of socialism is that the commanding heights of the economy, oil, steel, gas,

coal, electricity, water, are owned by the government and the numerous interferences of

the government with the workings of free markets. Obvious expressions of mercantilism

are prohibitions that common citizens face to import sugar, milk, rice, sorghum and used

cars, among others, from most countries such as the U.S. New cars, clothes and shoes for

example face a stiff tariff of 35%. The existence antidumping and safeguard laws that are

typically abused by inefficient entrepreneurs in connivance with government officials.

Finally, import quotas that are granted to domestic producers after the internal production

has been sold.

7
High oil prices also temporarily ignited growth under both of Perez’s administrations.

15
Socialism and mercantilism mutually reinforce each other because both have in common

the destruction of free markets. The philosophical pillars of socialism reject free markets

as an efficient mechanism to allocate scarce resources. Mercantilism negates free markets

for utilitarian reasons. That is, entrepreneurs seek shelter from competition manipulating

government and the latter grants impediment to trade in exchange for private benefits,

and power. Alternatively, the government extends protection to entrepreneurs to enhance

politicians control and/or they see themselves presiding over an industrial empire. The

initial impetus of protectionism, government or entrepreneurs, is not totally clear but the

consequences are transparent: to increase the cost of living to ordinary citizens8.

There are numerous events where the interaction of socialism and mercantilism

contribute to induce inertial forces that maintain a perverse status quo. For example,

Chavez coming from a socialist perspective frequently disparages the Bush government

initiative of free trade. Many entrepreneurs in the country take solace from Chavez’s

criticism because trade barriers will not fall precluding competition. Similarly, when

Chavez vilifies capitalism, inefficient entrepreneurs take comfort because capitalism will

not come to Venezuelan shores and therefore they will not have to reckon with

competition.

Another case of this unholy alliance between socialism and mercantilism is the alleged

tendency for the local currency to become overvalued. Numerous economists indicate
8
Since access to wealth by privileged entrepreneurs under mercantilism is based on “know who” and not
on “know how” riches accumulated is a source of irritation because it is associated, rightly so, with a
corrupt practice. Moreover, the ubiquitous problem of envy linked to inequality is exacerbated under
mercantilist practices engendering undesirable social stress whereby wealth is stigmatized. Further, this
mercantilist root of wealth accumulation typically does not translate into prosperity and welfare for the
people creating a fertile ground for Chavez rhetoric against riches and capitalism.

16
that the bolivar is overvalued, which is a code word for devaluation, that is, for the need

to rob the people of their hard earned work. The government benefits from devaluing the

currency because dollars obtained through exports of oil can be exchanged for more

bolivares, and non competitive entrepreneurs also benefit because of the destruction

competition due to the higher price of imported goods.

Complex taxation, regulation and labor laws also promote socialistic and mercantilist

objectives. Socialists thrive in complexity under the conviction that complex rules

achieve cosmic justice, (Sowell 1999). Well established, most likely big companies love

complexity because it serves as access barriers, eliminating potential competition from

smaller companies that cannot survive under convoluted rules. It is revealing that leaders

of CONINDUSTRIA, a guild of managers and owners from the Venezuelan industrial

sector, typically do not advocate for the need to reduce the cost of doing business in

Venezuela. Usually, they plea for a “competitive currency” and for the reduction of

imports, “justified” on the grounds of employment creation.

Direct beneficiaries of socialism and mercantilism are conspicuous Venezuelans with

substantial influence in the media and in the political decision making process.

Consequently, it is very difficult to extricate the economy from such an impoverishing

self perpetuating equilibrium. This I would suggest is a condition that plagues most Latin

American countries explaining why most economies south of the Rio Grande remain

stagnant or show pyrrhic growth rates.

17
 Collective Action Problems

It is well known that public institutions are non rival, that is, are subject of joint

consumption, that is, the good can be consumed simultaneously and totally by many

consumers. For example the benefits of a good judiciary system is a public good, not only

non rival but also non excludable. In other words, it is very difficult to impede access of

consumers once the good is produced. By the same token, the benefits of free trade, the

benefits of monetary freedom, and the benefits of simple and low tax laws, among others,

are public goods9.

The Neo Classical explanation for underproduction of these goods is market failure and

therefore the need for government intervention. That is, the free market mechanism fails

to produce an “optimal” amount the good, hence the need for a governmental solution.

The market fails due to consumers’ inability to display collective action in spite of being

consumers the ultimate beneficiaries of the public good, (Olson 1977) provides a seminal

explanation along this lines10. Consumers are beset by problems of a) group size, b) free

riding and c) rational ignorance.

a) Group Size. Basically the number of consumers is too large to be able to organize

them efficiently. Consumers are beleaguered by the same problems that afflict

participants in the prisoners’ dilemma game. It is difficult to communicate and to

establish binding agreements.

9
The classical example of a public good is national defense. Another example is ideas like calculus.
10
(Cowen and Crampton 2002, 3) assert that “a consensus developed that governments should provide at
least a few public goods, such as national defense, but markets do the best job of providing most goods and
services”. They stress convincingly that much of the new market failure theories based on asymmetric
information, efficiency wages and lock-in are bogus.

18
 b) Free Riding. Once the public good is produced everybody benefits whether one

contributes or not to its production. Since contribution is costly consumers expect

others to contribute. If most consumers react in the same way no one contributes,

consumers attempt to free ride, and no collective action is undertaken.

c) Rational Ignorance. It is costly to become informed about good economic

policies. If the benefits from becoming informed do not outweigh the costs,

people remain ignorant about policies that will benefit them hindering collective

action.

In short, consumers remain indifferent, in spite of policies inimical to their best interest,

and will not exert lobbying efforts or pressures before public officials. On the contrary,

beneficiaries of perverse policies will do whatever is possible to preserve the status

enjoying the benefits of protection, also a public good but dispersed to a much smaller

group. In this fashion public goods such as the benefits of free trade or of a stable

currency are under produced.

An alternative interpretation is that under production of the aforementioned public goods

is rooted not in market failure, but in the government’s inability to fulfill its most

important mandate: to protect peoples’ natural rights among them the right to pursue

property. In other words, the Venezuelan government has failed to produce the benefits

of free trade, stable currency, low taxes; transparent justice among others because of an

ill advised interference on the economy.

19
The Venezuelan government is the ultimate responsible for the erection of trade barriers,

currency devaluation and forcing Venezuelans to use exclusively the bolivar. Ironically,

government intervention is the root cause of failure to produce optimally public goods.

Likewise, one of the major duties of government is to provide a sound justice system.

Corruption and lack of independence of Venezuela’s judicial system is another example

of ultimately government failing its people. The same goes for complex regulation, rigid

labor laws and lack of personal security.

The Foundation of Freedoms

Parliamentary Democracy was born in England as a result of a Coasean bargain between

the crown on one side and nobles and the people on the other, whereby funds were

provided to the King in exchange for protection of basic freedoms (Pipes 1999, Glaeser

and Shleifer 2002, 1208)11. That is, the crown needed the people to survive because the

most important owners of land and creators of wealth were the people who consented to

be taxed for a price: protection of property with the ensuing freedom.

The Venezuelan institutional arrangements, and of OPEC countries, are not conducive for

the dawn of stable democracies because governments are patrimonial. That is, the

sovereign is also the owner; hence there is no binding check on the Leviathan. It is

revealing that most OPEC countries are secular or religious autocracies and perhaps not
11
“In fact, one can view the Magna Carta as a remarkable example of an early Coasean bargain, in which
the community and the crown agree on a cash transfer needed to support the efficient outcome”, Glaeser
and Shleifer (2002). Djanko, Glaeser, La Porta, Lopez-de-Silanes and Shleifer (2003, 613) also conceive
the adoption of the U.S. Constitution as a Coasean bargain.

20
coincidentally, oil is owned by government. The light of democracy in Venezuela,

another OPEC country, is also waning. This is a manifestation of the “natural resource

curse”, (Sala-i-Martin and Subramanian 2003, 5). A revealing illustration, of perverse

outcomes rooted in Venezuela’s patrimonial government that bypasses the will of the

people, is provided by (Alvaro Vargas-Llosa 2006):

Chávez buys influence through oil. It is a form of blackmail: At OPEC, Chávez fights for
increasing prices, making life hard for poor countries that import oil, and then offers
those very nations oil subsidies they have no choice but to accept. That is what happened
with the 14 Caribbean countries that make up the Caricom group. He also sends 100,000
barrels of oil to Cuba daily; and 200,000 barrels to Bolivia every month in exchange for
soy, poultry and political subservience. And he has bought $3 billion worth of Argentine
bonds to entice President Kirchner's loyalty. Chávez is denying his nation its wealth from
oil, somewhere between $40 billion and $50 billion a year. His annual "aid" budget totals
more than $2 billion. He sponsors 30 countries, including some in Africa, in order to buy
their vote for a seat at the U.N. Security Council.

Chavez is capable of denying his nation its wealth from oil, as Vargas-Llosa notes, in

essence because the government and not the people is the oil wealth owner12. This

ownership allows the government to require oil companies to pay taxes directly to the

government. Perhaps this “bypassing the people effect” would be substantially

diminished if oil taxes were equally divided among all Venezuelans eighteen years and

older. In this fashion to obtain revenues the government would have to tax the people,

ideally through consumption taxes, and in exchange the people most likely would

demand protection of basic rights and governmental quality13.

12
Needless to say Chavez predecessors also misused oil wealth not just because they embarked in all sorts
of wasteful programs but for the basic fact that governments typically do not spend money as wisely as
citizens.
13
It is advisable that all the people experience the burden of government. Consumption taxes are better
suited for this purpose than income taxes. In addition, the existence of a unique tax rate, more commonly
found among taxes on expenditures, minimizes social conflicts of the sorts induced by gradual income
taxes. Finally, consumption taxes are less costly to administer.

21
As Vernon Smith puts it in relation to another OPEC country: “A central issue in Iraq—

as well as the U.S. and other countries---remains whether the people control government

thorough through voting and taxes or the government controls the people through a

monopoly on natural resources,” (Smith, 2003). Looking at the problem in this light

apparently the curse is not the existence or not of oil but who owns the oil, politicians or

the people.

A perverse consequence of socialist institutions and patrimonial governments is that

people live off the state. Peoples´ energies are channeled to penetrate the state through

political entrepreneurship seeking wealth transfers from government and not procuring

wealth creation. The addiction of the people to governmental largess induced by socialist

institutions is exacerbated by mercantilist institutions. The most influential entrepreneurs

in Venezuela have accumulated wealth by virtue of various impediments to trade

implemented by government. When entrepreneurs supplicate for governmental protection

because their farm or industry has been invaded by outsiders or workers, it falls on deaf

ears because public officials know that those businesses exist thanks to governmental

favors. Moreover, the plea is not legitimate because business owners want protection of

their property, which is very reasonable. However, the barriers to competition enacted at

the behest of these same business owners-rent seekers constitutes a confiscation of

property of common citizens by forcing consumers to buy more expensive domestically

produced goods. Interestingly, in patrimonial governments, businesses are captured by

government.

22
 Other Obstacles to Freedom

All stable and flourishing liberal democracies not only are financed by the people but a

competition among economic groups and entrepreneurs lobbying government for

different policies is observed14. This competition among pressure groups lobbying

government has important historical roots, (De Long and Shleifer 1993) document

important historical evidence on the role of entrepreneurs in promoting conditions

propitious for growth:

European history also presents cases where cities grew rapidly and commerce flourished
in the absence of strong princes in regions where political power was held by merchant
oligarchies or checked by constitutional limitations and representative assemblies. The
city-states of northern Italy, of the Low Countries, and of Burgundy prospered and grew
in the later Middle Ages and the Renaissance before they came under autocratic
Habsburg control in the sixteenth century. (672)

By contrast, limited governments are more concerned with private economic prosperity:
either they are led by merchant oligarchs who have a stronger interest in maintaining and
expanding the flow of commerce than in the power of the state and the splendor of the
court, or they give a veto parliaments or estates-general that feel the weight of heavy
taxes. (674)

Corn Laws and their repeal in Britain is a better known more recent case. In 1804 under

pressure from landowners was introduced in Parliament a Corn Law that sought to

protect farmers’ profits imposing a duty on imported corn. On May 15, 1846 the repeal of

the Corn Laws was passed at the request of Prime Minister Sir Robert Peel whose wealth

came from his family’s textile mills. Manufacturers’ fearing higher wages wanted to

eliminate tariffs on imported corn. In other words, manufacturers’ defending their own

interest were also furthering the welfare of Britain’s people. Hence, not necessarily
14
This competition among pressure groups has been theoretically modeled by (Becker 1983 and 1985)

23
altruistic motives were behind Robert Peel’s political action. Peel was defending his

personal interest, and those of industrialists, and it happened to be aligned with the

interest of consumers. This account is consistent with the view of Buchanan and Tullock

that people are people and as such we are always pursuing our self-good and not

necessarily the common-good, (Buchanan 1999 and Tullock, Seldon and Brady 2002).

A present day example worth looking into is President George W. Bush’s initiative of a

Free Trade Area of the Americas (FTAA). Is this initiative driven by American

consumers that want to buy less expensive goods or by entrepreneurs that to export more

would like to see the U.S. government lowering its trade barriers to induce other

countries to do the same? Moreover, is President Bush backing this initiative out of

concern for American consumers’ pocket or political supporters’ wallet width? The point

is that this is a situation where efficient entrepreneurs lobby government, in competition

against other entrepreneurs and the AFL-CIO, for policies that better their lot but also

American and Latin Americans consumers’ welfare15.

This line of reasoning leads to another obstacle to freedom and growth in Venezuela,

namely the absence of leadership, in particular of well-organized pressure group by

efficient entrepreneurs. Consider the recent political events of April 2002 where for 36

15
Needless to say, the best antidote for less lobbying activity, which detracts entrepreneurs’ valuable time
from truly wealth creating endeavors, is a small government with little intrusions in the economy.
However, given the current size and intrusions of government a way to reduce government is implementing
policies that increase competition, partly induced by the collective action of efficient entrepreneurs. I would
hypothesize that the size of the U.S. government today would be much larger if it were not for the backing
of efficient entrepreneurs that support the view of limited government.

24
hours Chavez was deposed by popular and peaceful demonstrations with the help of the

military. The opposition leader was Mr. Pedro Carmona a high ranking entrepreneur who

came from a heavily protected corporation. In spite of his background many libertarians

in Venezuela supported Mr. Carmona and were signatories of a document purported to

legitimize Mr. Carmona’s presidency.

In last year’s election the opposition leader, Mr. Manuel Rosales, was a professional

politician. However, his policy promises were mostly redistributionist with no plans to

move back the frontiers of socialism and mercantilism in Venezuela. Of course part of his

campaign financing came from traditional inefficient economic groups.

RCTV was an open signal TV station whose license to operate was arbitrarily, in

violation of freedom of speech, revoked by the Chavez government on May of 2007. In

spite of the fact that RCTV was watched mainly by low income people, where Chavez

draws much of its political support, the editorial line of this station did not produce

programs commercially attractive but at the same time educational showing for example

during its numerous and widely viewed soap operas the negative welfare consequences of

inflation, devaluation, trade barriers and price controls just to mention a few 16. It chose,

however, a political line of opposition attacking the government for its numerous

violations of political and civil rights, which in itself is not bad except for the fact that

most Venezuelans saw their personal economic situation deteriorate under democratic

rule with free elections and freedom of the press. Hence, the freedom of the press
16
Is there a Venezuelan that would have refused to receive shares of PDVSA, tax dollars from oil
corporations or to pay less for imported goods as a result of eliminating trade barriers? Thus in spite of
numerous policies with wide appeal that empower people, the opposition leaders to Chavez have been so
far incapable of articulating such a popular media campaign.

25
discourse and the political liberty speech does not necessarily touch a sensitive chord

among low income Venezuelans because it lacks credibility, particularly when it is

articulated by leaders mostly associated, rightfully or not, with past corrupt policies.

The reaction of the owners of RCTV was substantially better than rival VeneVision,

owned by Mr. Gustavo Cisneros one of the wealthiest persons of Latin America with well

diversified investments across the globe. After a meeting with President Chavez and

former U.S. President Jimmy Carter in Caracas, VeneVision in the year of 2004 ceased to

make any comment that could damage the reputation of the Chavez government, i.e., auto

censorship.

In contrast, in the U.S. for example there is intense competition, with quite different

political and economic orientations, between Fox News and CNN. Likewise the editorial

lines of the Wall Street Journal and the New York Times are very dissimilar. Not to

mention the existence of Think Tanks with markedly distinct orientation. Part of the

explanation for the existence of these diverse views of the world of different

organizations is the economic support provided by entrepreneurs of different stripes.

Apparently entrepreneurs are less afflicted by the problems of collective action that on

average stifles consumers. The group numbers are smaller and the profits to be reaped

provide the necessary incentives to be well-informed and to spend time in organizing and

coordinating an effective lobbying effort.

26
 Probable Scenarios

Given the problems of collective action faced by consumers, the ability of a patrimonial

government to capture managers and business owners, the lack of entrepreneurial

leadership of Venezuela’s most prominent business person, and the inertial forces of a

perverse status quo whereby socialism and mercantilism are mutually reinforced, it is

very unlikely that opposition leaders will be able garner the support of most Venezuelans

to oust Chavez based on a future capitalist economy. It is more likely a Chavez crash due

to all his policy mistakes which now do not surface with sufficient force because of high

oil prices.

Moreover, it is probable that the ousting of Chavez will be prompted by the same leaders,

some of them from the military, which today support him. This scenario, however, does

not necessarily augur good economic prospects. Venezuela’s men in military uniform

come from a socialist persuasion. Further, dictatorships in general are no panacea for

growth17. Examples abound of dictatorships in Latin America and other parts of the world

that have failed to bring about reforms capable of igniting high and sustained growth18.

Finally, oil revenues serve as a floor that prevents a crisis of major proportions capable of

inflicting enough pain to disenchant Venezuelans with socialism and mercantilism.

17
(Glaeser et al. 2004, 287) report that dictatorships on average grow less than democracies for the period
1960-2000.
18
Democracy, on the other hand, is not critical for growth either, (Snowdon, 2006, 15). There are many
democracies around the world that are rich and poor suggesting that the correlation between growth and
democracy is zero. This view is expressed by Xavier Sala-i-Martin in an interview to Snowdon cited above.

27
Another probable and more optimistic scenario is that Venezuela experiences the Eastern

European Countries Syndrome whereby suffering at the hand of communism was so

acute that now these economies are more capitalist and their leaders more pro-American

than their Western European counterparts. It is conceivable that suffering inflicted by

Chavez policies induces Venezuelans and its leaders to look for refuge in capitalism as an

antidote for our chronic stagnation and concomitant high levels of critical poverty19.

Conclusions

This paper has shown that up to the fifties the Venezuelan economy exhibited high levels

of economic freedom which is consistent with the miracle growth rates that Venezuela

experienced between 1920 and 1957. Not surprisingly, these high levels of economic

freedom served as a catalyst for the introduction of democratic rule increasing

Venezuelans’ levels of political and civil liberties. This is another example of a positive

correlation between economic and political freedoms, (La Porta, Lopez-de-Silanes, Pop-

Eleches and Shleifer 2004, 452-453) and consistent with the Lipset-Barro hypothesis that

prosperity tends to inspire democracy, (Lipset, 1959 and Barro 1996, 1997 and 1999).

The inception of democracy brought more redistributionist policies and greater influence

of rent-seeking pressure groups that had the effect of undermining economic freedoms to

the extent of instigating on average negative growth over the period 1960-2006. This is

19
Outside intervention, namely a U.S. invasion is now days unlikely. As the Wall Street Journal
editorialized on July 3, 2007, “Regime change against dictators who let their people starve is now
considered to be unacceptable. That's the policy of Tony Blair, who just stepped down, and President Bush,
who's a short-timer. Nowadays the habit is to cajole, bribe or beg despots to stop their depredations --
whether in Sudan, North Korea, Zimbabwe”

28
an example of growth-retarding features of democracy, (Barro 1996, 2). As expected,

lower levels of prosperity have induced social unrest and created an environment

conducive for the emergence of a populist leader who blames “capitalism” for peoples’

impoverishment.

This paper singles out several factors that militate against the prospects of destroying

socialist and mercantilist institutions and replacing them with market economy

institutions. Among them are problems of collective action, a patrimonial government

that bribes its people, lack of entrepreneurial and political leadership, and the inertial

forces of socialism and mercantilism given that both practices mutually reinforce each

other across time. These same factors preclude the scenario of opposition leaders credibly

convincing the populace that without Chavez their living standards will improve.

Thus myopic and self-serving political and entrepreneurial elites are responsible for this

flagrant case of government failure. Even more worrisome is that judging by the

discourse of political leaders and opinions to media outlets of most pundits we have not

learnt our lesson. That is, there is no consensus among leaders of the opposition that we

urgently need to dismantle socialist and mercantilist institutions.

Given these considerations the most likely scenario, barring outside intervention, is that

Chavez will discredit himself and today friends in government may become tomorrow his

political foes and oust him. This scenario does not necessarily bode well for the economy

because our military are formed in the socialist school of thought. There is, however, the

29
possibility that given all the wounds inflicted to the economy by Chavez we learn our

lesson and end up embracing capitalism.

In sum, the problems that plague the Venezuelan economy transcend Chavez. Moreover,

Chavez is a consequence of the unsurprisingly failure of socialism and mercantilism

implanted gradually in Venezuela and commencing with the first nationalization of the

telephone company in 1950. Further, getting rid of Chavez may be a necessary condition

to overcome our problems though not sufficient. Consequently, most analyses about

Venezuela that mainly center their attention on Chavez are simplistic. A more fruitful line

of inquiry is to uncover mechanisms capable of dismantling, under democratic rule which

is prevalent in Latin America, socialism and mercantilism.

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