How Venezuela's Economy Became a Disaster

[0:00]Venezuela is the single most mismanaged economy in the world, and while that's a big claim with some stiff competition, there are simply no other countries on earth that have fumbled such a privileged position quite so badly. Venezuela has the largest oil reserves of any country in the world by a significant margin. The runner-up, Saudi Arabia, would have to find an entire USA worth of extra oil just to meet the reserves of this single small South American nation. Now, we've seen many times on this channel before that natural resource wealth does not equal economic prosperity. But at this scale of natural resource wealth, the country could have effectively brute forced its way into the global upper class. Unfortunately, what should have been an easy path of prosperity was squandered, and from its peak, the country has lost more than 80% of its GDP in less than a decade. The collapse was so bad that many international economic agencies just don't collect data on it anymore because the economy was too mismanaged. It would almost be laughable if it wasn't so tragic. The country is now one of the most dangerous and impoverished economies in the world. Venezuela for a variety of reasons that are each worth exploring individually, has become very isolated from the rest of the world, its people are leaving in droves, and governance has become so unstable that it can't even get access to the manpower and investments needed to extract its abundant oil reserves. This is a situation that is not getting any better. Late last year, the country threatened to annex neighboring Guyana, further alienating it in the global community. And now, just late last month, the country held a highly controversial election raising huge question marks about who is really in charge. Venezuela is the national equivalent of a lottery winner that's too incompetent to even claim their winning ticket, let alone manage the money once they get it. But if there's more to learn from failure than success, it's a good place to start. So, how did a country with so much going for it end up so poor? Were these problems coming purely from within, or were their external forces pushing for its demise? And finally, of course, is there any realistic way for the country to turn its economy around? Once we have done all of that, we can put Venezuela, the most mismanaged economy in the world, on the economics explained leaderboard. If you're running a business, you know how challenging it can be to manage complex processes and the huge variety of tools and tech. Switching between different platforms and apps for every small task is far from ideal. That's where our sponsor Odu comes in as an all-in-one business management system. 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So, if you're ready to take your business to the next level, click the link below to start your free trial of Odu and discover how it can transform your business. For most of the country's history, Venezuela has been a petro-dependent territory. Even the indigenous people would regularly use oil tars seeping out of the ground to keep fires blazing throughout the night or waterproof their canoes before the Spanish even made contact. Crippled after its 19th century liberation, the country not only benefited from the discovery of oil, it was the one thing that allowed the government to remain stable via state funding or outright bribery. And for a while, though far from perfect, this worked. Modern Venezuela is one of the better known petro rentier states, receiving a large portion of its revenue from rent paid by businesses, governments, and foreign individuals. Annual production exploded during the 1920s, from just over a million barrels to 137 million, making Venezuela second only to the United States in total output by 1929. By the time Gómez died in 1935, Dutch disease had settled in: the Venezuelan bolívar had ballooned, and oil shoved aside other sectors to account for over 90 percent of total exports, which led to a terrible case of Dutch disease, a trend that would remain common into the 21st century. As a result, the country saw decent growth, although it was based heavily on extracting set oil to fund an otherwise unsustainable economy. This was also dependent on importing most of what it needed in exchange for its oil. As oil continued to be extracted, just three foreign companies controlled 98% of the Venezuelan oil industry: Gulf, Royal Dutch Shell, and Standard Oil. The government tried to reform the oil sector to funnel funds into public coffers. The Hydrocarbons Law of 1943 was first set up in that direction, requiring foreign companies to give half of all oil profits to the state, a move that increased government income six-fold over just five years. And for a while, this worked. In the 1950s, Venezuela took a seat at the table of economic superpowers. At the time, they were the fourth richest country in the world. By the 1960s, Venezuela's petro state status loomed so large that it joined Saudi Arabia, Kuwait, Iran, and Iraq, co-founding the Organization of the Petroleum Exporting Countries, commonly referred to as OPEC. This was a masterful move in the realm of exports because it allowed them and the countries that followed, like the UAE, Qatar, and Libya, to determine pricing by controlling output to keep prices high. This was technically price fixing through monopolistic market power, but neither of these factors really became an issue because they are sovereign entities, unlike a corporation that is at least in theory, beholden to the laws of the countries they operate in. Venezuela, as well as the other countries listed, then nationalized their oil industries. For Venezuela, this nationalized body is Petróleos de Venezuela, S.A., or PDVSA for short. This whole dynamic was put into overdrive when Venezuela continued to discover oil deposits that took it from a modest oil state to the single largest oil state in the world. From the early 2000s, this caused a boom in the economy with gross domestic product peaking at $372 billion US dollars in 2012. This was fueled almost entirely by these priced exports. GDP, after all, is consumption plus investment plus government spending plus net exports. So, how did a country with so much going for it end up so poor? Well, a lot of it can be summed up with a single word, mismanagement. An example of this would be the government's activity preceding and following the surge in oil prices in 2004. The International Energy Agency says that this increase was due to strong demand growth in Asia and North America. It also didn't hurt that an unfolding war in the Middle East disrupted the supply chains of other major global suppliers. Venezuela made moves to put it in a beneficial position to take advantage of this surge. New leadership in 1999 sought to introduce new oil fields, which had become quite stagnant in the 1970s, setting quotas and taking a hard stance against corruption and bureaucracy. They also gutted the PDVSA after an industry strike in 2002, replacing thousands of workers with people who would embrace the new objective. This left Venezuela flush with cash, and the government, at least on the surface, tried to improve living standards with it through very generous welfare systems. Healthcare, food subsidies, and education acting as key representative pillars to show the world and its people signs of strong leadership. With enviable social assistance and rapid decreases in poverty, Venezuela started to look like an economic success story, especially in the eyes of its people, which was a primary goal of Venezuela's government, considering faith in these institutions were shattered over the last 50 years. With a rise in oil prices and massive welfare projects in the early 2000s, the country looked like it was about to become the greatest progressive success story in modern Latin America. But, there was a big problem. It never really worked, or at the very least, it wasn't sustainable. Of course, when done right, strong exports can sometimes insulate an economy from something like the 2008 financial crisis. Oil also typically has low elasticity of both supply and demand with a complex and costly process of initially setting up oil extraction, and the fact that people don't have much choice of what to put in their cars, respectively. Venezuela didn't really suffer from the cost of setting up extraction infrastructure either. Their nation practically floats on petroleum, meaning that they didn't have to invest into offshore or advanced drilling. They could effectively just stick a straw in the ground and crude would shoot out of it. What really tipped the scales was spending, and more specifically, how this money was spent. Corruption is a massive problem at all levels, from small bribes to local law enforcement, all the way up to the national government, and with so much money up for grabs, there was an incentive to line people's pockets. The most desirable jobs in the country became government jobs funded by oil revenues because they had the means to embezzle it with ease. Billions of dollars in official account transfers remained unaccounted for to this day, and that's to say nothing of the more mundane corruption happening in an individual level. A story in 2006 revealed that a select group of Venezuelan bankers profited from the acquisition of Argentinian bonds by the Venezuelan government at the expense of the National Treasury. Then there are these a-mentioned social programs that look great on the surface. The government policies were essentially very populist and involved basically giving oil money away to keep the favor of the people. Of course, this isn't bad by itself, after all those natural resources do belong to the people. But it made the country very dependent on oil prices, especially when it had to adhere to OPEC quotas. This meant that when times were good and oil prices remained high, Venezuela managed to brute force its GDP up until 2014. But, this changed dramatically when a few things started going wrong very quickly. After rising for more than a decade, oil revenues fell by 93% between 2012 and 2020. During the same period, per capita income declined by 72%. By 2014, inflation had reached 69%, the highest in the world at the time, and in 2018, inflation skyrocketed to over 130,000%. As of 2023, it's still at 190%. Relying almost completely on oil was always going to present challenges, but the nation's problems had more to do with how the Venezuelan government handled and continues to handle what should have been a golden opportunity. Of course, this is where we bring up Norway, the gold standard in managing oil wealth. Both countries possess government-owned oil industries, but the key difference is that Norway has used its oil to generate long-lasting wealth, while Venezuela did the macroeconomic equivalent of winning the lottery, only to spend it all on a mansion and fancy cars. Norway still uses its oil revenues to fund generous social programs, but the only difference is that they put it into an investment fund first. Instead of using oil profits to line pockets and give its populace immediate fleeting satisfaction, Norway set up the largest sovereign wealth fund in the entire world. Today, it's worth $1.6 trillion, which translates to $295,000 per Norwegian citizen. Norway also imposed a rule that any spending from the oil fund can only be as high as the expected return, known as Norway's 3% rule. This means that the country isn't technically spending their non-renewable oil revenues, they're actually spending their conservative investment returns. It also has restrictions where the fund can't invest in what the country sees as immoral, which ironically includes fossil fuels. Now, compare that to Venezuela. With no restrictions like the 3% rule, the Venezuelan government might have been able to give a lot of money back to the people in a short amount of time. But the cost of winning public and regional approval created a crippling deficit. Finally, choosing a personal wealth fund that only benefits a few unsavory groups instead of a sovereign wealth fund that benefits everyone, long after the oil revenue dries up, creates an extremely unfair balance of wealth and power. That's really the cause of a lot of Venezuela's struggle: how power is distributed and how power is used. Both countries had similar aims when it came to handling the oil industry. They wanted to use the resources to make the government rich, while doing their best to set up systems that kept the people happy. However, while Norway embraced patient planning and strict protocol, the Venezuelan oil industry, although nationalized, lacked the foresight to create regulatory measures that would result in lasting success. So, this begs the question, were these problems purely coming from within, or were there external forces pushing for its demise? Historically, Venezuela did fall into the trap of giving a bit too much power to Western corporations, instead of seeking collaboration that trained their citizens to work independently. Something that Norway observed all over the world, which encouraged them to keep foreign participants at an arm's length. But this only plays a small role in the economic crisis Venezuela faces today. Since 2005, the United States has imposed targeted sanctions on Venezuelan individuals and entities that have engaged in criminal, anti-democratic, or corrupt actions. In response to increasing human rights abuses and corruption by the government of Nicolás Maduro, in power since 2013. A prevalent and feasible argument is that the USA has pushed these sanctions on Venezuela over other countries because it's a major threat to its domestic oil industry. But, the impact of these sanctions is nearly a cherry on top of the mounting series of domestic failures that fall solely on the lap of Venezuelan governance. And there are a number of examples that paint a better picture. For starters, the country has the worst property rights in the world, with assets often being seized with no compensation. This is terrifying to foreign companies that have mostly since pulled out of the country because even with all of that oil wealth, it's too risky to do business there. It's like getting gold from under Smaug. Sure, there is a lot of money to be made, but there are other safer places to get the same stuff. Now, it could extract its own oil, and it does have a state oil company, but even that kind of sucks because it's run out of smart people to actually run it. Brain drain doesn't even come close to describing the Venezuelan exodus. More than 6.1 million refugees and migrants have left Venezuela as a result of the political turmoil, socio-economic instability and the ongoing humanitarian crisis. Well-educated people have left the country because there are far better opportunities elsewhere that are less dependent on getting a cushy government job, where they could have their assets seized at any time, or be the victim of political or criminal violence. Either way, the government has been fumbling, and since it's lost a lot of its skilled workers and can't get international investment, it's struggling to even drill oil, the one lifeline it had. The country is now top of the misery index, crime is rampant, and inflation is amongst the highest in the world. The government desperately trying to hold on to power is only making things worse by doing things like invading Guyana after they discovered oil and running universally criticized elections. And without major changes, who in their right mind would want to live, work, or invest in such a country? So, is there any realistic way for Venezuela to turn its economy around? Well, in light of recent developments, the future looks bleak, or more accurately, desolate. Recently, the government has made efforts to change the constitution, further stripping the rights of its citizenry from democratic collaboration. This will undoubtedly encourage Western powers to heighten sanctions until the crisis is resolved. With no more oil income to benefit the impoverished people, and no clear game plan to diversify and overcome arguably one of the worst economic collapses in history, Venezuela is a nation without much of a silver lining. The country, without a shadow of a doubt, stands as the most prominent example of what happens when the petro curse takes hold, without anyone empowered capable of channeling it into something more sustainable. Venezuela's leadership literally had every chance to turn this resource into a wellspring of riches. If they'd handled this wealth like Norway or even the US or Canada, it could have properly educated their labor force, invested the wealth into something that appreciates in value, or even created practical infrastructure to support other industries. But they did none of these things, and now it's not only the economy, but the people that will suffer for decades to come. Okay, now it's time to put Venezuela on the Economics Explained leaderboard. Before we get into it, we have to give the patented big disclaimer that the World Bank actually stopped collecting macroeconomic data on Venezuela in 2014, because the country is simply too unstable to monitor effectively. So for this list, we'll be using estimates from the IMF, which realistically should be very similar anyway. Starting as always with size, Venezuela has a GDP of 102.3 billion US dollars, making it the 69th, nice, largest economy in the world, and it gets a 5 out of 10. This is spread out over a rapidly shrinking population of 28.3 million, which means the country has a GDP per capita of $3,867 US dollars. This is approximately a quarter of the global average, and the most resource-rich country on the planet. This puts it in line with nations like Bolivia, Sri Lanka, and Palestine. It gets a 2 out of 10. Stability and confidence is of course tragically bad. Between rampant corruption, squandered resources, the world's worst property rights, a mass population exodus, global sanctions, hostile posturing with its direct neighbor, hyperinflation, food insecurity, extremely high levels of criminal activity, and now one of the most condemned elections in modern history, it's not great. And it gets a 1 out of 10, only because it's not actively fighting a civil war, yet. Growth has been one of the worst of any major economy in the world over the last decade. Since 2012, the country has lost over 80% of its economic output. It went from a middle income global power to a desperately impoverished quarantine tail. It gets a 0 out of 10. Finally, industry. It has the world's largest oil reserves, but it doesn't have the industrial capacity to even pump it out of the ground in exchange for cash. One of the easiest money glitches ever, and it couldn't even enter the cheat code correctly. It also doesn't have other domestic industries, because everything got crushed by the dominance of the oil industry, until it itself got crushed by complete economic ineptitude. 0 out of 10. All together, that gives Venezuela an average score of 1.6 out of 10, putting it into equal last place with Lebanon, a significantly smaller economy that didn't have many of the advantages that Venezuela did. If you're curious to see what's gone wrong over there, we've made an entire video on Lebanon's economic collapse, which you should be able to click to on your screen now.