Venezuela Lives on the Edge

Venezuela’s descent into economic and political chaos has been going on for years. It long predates the death of the country’s charismatic military leader, President Hugo Chavez (1999-2013), who himself rode to power on an economic and social crisis sparked by a two-decade slump in oil prices that started in the mid-1980s.

The slow erosion of Venezuela’s political system caused by that earlier debt crunch, worsened by rampant corruption and poverty, ultimately led Mr. Chavez to victory in the 1998 presidential elections at the head of a populist revolt. Now his brand of deficit-spending redistribution, which he called “socialism in the 21st century,” is itself undergoing a slow-motion collapse.

The unanswerable question, posed by GIS expert Dr. Joseph S. Tulchin in a June 2016 commentary, is how long can you hang on the edge of the abyss before falling in? Judging by Venezuela’s recent history, it could be a very long time.

1. Oil curse

At bottom, Venezuela is an “extreme example of what has become known as ‘Dutch disease’,” Dr. Tulchin wrote in May 2013. The country’s endowment of crude oil reserves (the world’s second-largest) fatally distorted the economy by producing a seemingly endless stream of easy revenue.

The windfall, called “rents” by economists because they are over and above the normal profit on a market exchange, caused the real exchange rate to appreciate and produced powerful disincentives to invest in non-tradeable goods, such as domestic manufacturing and services.

The effect was a near-complete dependence on oil, which accounted for more than 90 percent of the country’s export earnings.

2. ‘The Venezuelan case’

Many of the world’s biggest commodity exporting countries have dealt with such distortions, which make them vulnerable to protracted declines in global prices. The energy-price slump of the 1980s and 1990s wrecked Venezuela’s traditional party system, but also led to the collapse of the Soviet Union and major political disruptions elsewhere.

Wiser from this experience, oil producers came up with coping mechanisms for such cyclical downturns, including stashing assets in sovereign wealth funds or sharp cuts in public spending.

Venezuela is an extreme case because the logic of its political system precludes such adjustments. Back in 1984, Moises Naim and Ramon Pinango, in a classic study entitled El Caso Venezuela, concluded that the country was based on a false sense of social harmony financed by oil revenue. “The country’s extraordinary mineral wealth had encouraged an increasingly corrupt and inefficient political leadership and growing income inequality,” wrote Dr. Tulchin in an April 2016 report.

What Mr. Chavez changed during his 14 years in power was to divert more of the petroleum windfall to welfare spending, which he “used to lift millions of Venezuelans out of poverty and provide them with housing, health care and access to education.” Fiscally, however, this was unsustainable in a socialist economy that squeezed the private sector and let corrupt officials siphon funds from productive investment.

Everything changed when the price of oil collapsed from its historic high of $115 per barrel to just above $20 for the heavy crude that Venezuela produces. In 2014, the last full year of high oil prices, the federal government transferred more than $44 billion from the national oil company, PDVSA, to pay for its social programs.

Now, PDVSA has no more cash to give. The economy began contracting (by 10 percent in 2015 alone), the country could no longer pay for imports and inflation spiked to the highest in the world. Hospitals closed for lack of medicine, one-quarter of the country’s automobiles were inoperable for lack of spare parts, and Coca-Cola stopped bottling soft drinks in the country due to a lack of sugar. Power shortages became the norm and forced public employees into a two-day work week, GIS expert Dr. John Polga-Hecimovich wrote in June 2016.

While this was going on, the government kept nationalized industries in state hands because it would be anathema to go back on Chavismo. Fiscal irresponsibility and runaway inflation made Venezuela a textbook case in failed socialism, GIS expert Lars Christensen wrote in October 2016.

3. Chaos as a steady state

But even in a state of decay, Venezuela’s regime was remarkably sturdy. Some reasons for this peculiar durability were explored by GIS’s Joseph Tulchin in a September 2014 interview with Dr. Matias Bianchi of the University of Arizona.

Of course, oil revenue, while it was still flowing, allowed structural problems to remain unaddressed for decades, as the cash was used to “fix the little pieces of the crisis but not the system.” Even worse, the Venezuelan opposition does not know what it wants and thus cannot provide an alternative. External intervention is unlikely, since the United States has largely lost interest and Venezuela’s Latin American neighbors are not eager for regime change – at least of the nondemocratic kind.

Dr. Bianchi’s forecast was for slow decline reminiscent of the 1980s and 1990s, with periodic outbreaks of social unrest. “The kind of chaos we’ll see is the kind of chaos we’ve seen [then] – the thing that we need to be aware of is that the Caracazo crisis of 1989 happened after a long decade of hyperinflation and scarcity.”

Under President Nicolas Maduro, the regime has become adept at “operating in chaos,” Dr. Bianchi noted. “Each faction controls different parts of the state and they just use it. So there is no centralization as there was with Chavez, there is disorder, chaotic government that will continue.”

4. Wasted opportunity

The endgame after the opposition’s stunning victory in the December 2015 parliamentary elections did not play out as expected. The Democratic Unity Roundtable (known by its Spanish acronym MUD) was unable to capitalize on its majority in the National Assembly, while dithering on the economic crisis. Meanwhile the government and the military closed ranks behind President Maduro, helped by the U.S. decision to renew individual sanctions against government officials accused of human rights abuses and drug trafficking.

Until the 2015 election, Venezuela and Argentina could be considered examples of “competitive authoritarianism,” in which “some competition is allowed, but leaders attempt to govern in an authoritarian manner,” GIS expert Dr. Joseph S. Tulchin said in a Dec. 18, 2015 report. The difference was that President Cristina Fernandez de Kirchner, denied a third term by Argentina’s Congress, was replaced by an opposition candidate, Mauricio Macri, in a fair election. Meanwhile, Venezuela’s opposition could not run the country from the National Assembly – thanks to the 1999 constitution crafted by Mr. Chavez.

One thing that constitution lacks is any mechanism to impeach a sitting president, GIS expert Dr. John Polga-Hecimovich wrote in a June 2016 report. The only possibility was a recall referendum, but after the opposition easily gathered the necessary signatures, President Maduro blocked the petition on increasingly contrived legal pretexts. Meanwhile, he consolidated his police powers under a state of emergency and brought troops onto the streets to quell opposition protests.

By means of these blocking techniques, the ruling Chavistas succeeded in “closing the only constitutional route to a change in government,” Dr. Tulchin wrote in a June 2016 expert view for GIS.

5. Watch the military

By September 2016, the Maduro regime seemed to be hanging on by its fingernails and MUD’s secretary general, Jesus “Chuo” Torrealba, boasted that the president would be out before the end of the year. But as GIS expert Dr. Anthony Maingot accurately predicted, he was not.

The problem with these dire predictions is that they invariably use linear reasoning – things are so demonstrably bad that the Maduro regime cannot possibly survive. However, his ability to remain in power since the death of Hugo Chavez shows that words like “crisis” and “intolerable” are relative.

One thing is clear: there is a drastic asymmetry in the motivations driving the president and his opponents. Mr. Maduro is fundamentally ruthless. He vows that any attempt to overthrow him will provoke a response that will make Turkey’s President Recep Tayyip Erdogan – whose purges and reprisals after July’s failed coup were considered heavy-handed – look like “a suckling baby.” State employees who demonstrate anything less than total fealty are sacked. It is crystal clear that foreign pressure, including from the U.S., the Organization of American States (OAS) or the new governments in Argentina, Brazil and Paraguay, will have little sway over him.

Dr. Maingot predicted two possible outcomes. The first, less likely scenario posits a split in the armed forces as the social and economic situation implodes. Junior officers and members of the National Guard (who do not share in the spoils of the drug trade) would join opposition protests. President Maduro would be forced to resign, and a civil-military junta would be formed to hold elections.

More plausibly, the power struggle would play out inside the military leadership, ending when one faction takes control. Draconian measures would be taken against popular unrest, though the victorious group might negotiate with the opposition, offering concessions in return for the survival of key elements of the regime.

The military’s firepower, drug profits, and fear of possible persecution under a new government argue for the second outcome. So do splits in the opposition coalition, which is divided between those seeking active confrontation (led by Leopoldo Lopez, the former mayor of the Chacao, now a political prisoner) and proponents of a negotiated outcome (including Henrique Capriles, the governor of Miranda state).

All this suggests that political action by civilians will not topple the Maduro government. Only a disintegration of the military leadership could bring about change, whose exact nature is difficult to predict.

In early June 2017, the head of Venezuela’s National Defense Council, General Alexis Lopez Ramirez, quit in protest over President Maduro’s plan to summon a “constituent assembly” to rewrite the constitution. While this measure allows Mr. Maduro to sidestep the National Assembly, General Lopez’s resignation fed speculation – or wishful thinking – that the military is starting to split.

The two figures to watch are General Vladimir Padrino Lopez, defense minister and commander of 120,000 regular troops, and Interior Minister General Nestor Reverol, who controls the 87,000-strong National Guard and (indirectly) 435,000 well-armed reservists, including the feared colectivos motorcycle gangs.

6. Maduro’s game plan

Perhaps the opposition’s key error was to avoid making overtures to the armed forces. Instead, MUD leaders continued to deride the military leadership as “narco-generals.”

Mr. Maduro took precisely the opposite tack, as GIS expert John Polga-Hecimovich noted in a January 2017 report. Thanks to some adroit footwork, he managed to pull through the crisis in the second half of 2016. Over a six-month span, the president neutralized the opposition, pushed forward a bond swap to avoid defaulting on the country’s sovereign debt, and co-opted an important part of the military leadership.

To avert the possibility of a military coup, Mr. Maduro made General Padrino Lopez a virtual co-president in July 2016 – giving him supervision of national food distribution while acting as Mr. Maduro’s coordinating chief of staff. He packed the cabinet with high-ranking officers while shielding and promoting those who have been hit by foreign indictments on drug-trafficking charges.

The opposition, meanwhile, was not winning enough hearts and minds among the general populace. A December 2016 poll showed that while less than 20 percent of voters consider themselves Chavistas, only 38 percent identified with the opposition.

This means that despite an overwhelming rejection of Mr. Maduro and the government, almost two-thirds of Venezuelans are not ready to endorse the MUD. This is a troubling sign for the opposition after 18 years of frequently inept Chavista rule.

7. Financial noose

A big part of Mr. Maduro’s survival plan is staving off a sovereign default, which in practice means preserving the solvency of state-owned oil company Petroleos de Venezuela S.A. (PDVSA). For most of 2016, the company was on the verge of a $10 billion default, until the government pushed through debt swaps secured on PDVSA’s stake in its U.S. refining and retailing subsidiary, Citgo.

That bought time, but only a little. PDVSA’s output is declining and it has no money to invest, which means its rig count is falling. BP stopped four tankers with Texas light crude from going to Venezuela for blending with heavy Orinoco Basin oil while it awaited payment, GIS expert Joseph Tulchin noted in a September 2016 report.

By mid-2017, the PDVSA had technically defaulted on part of its $2.5 billion loan from Russia’s Rosneft, secured on the Citgo shares. The country’s nearly $200 billion in sovereign external debt, including $65 billion in loans from China, would make a Venezuelan default larger than Argentina’s in 2001-2002.

“The conditions for a financial collapse [were] coming together” by the late spring of 2017, Dr. Tulchin noted. Its timing could be determined by outside actors – especially the U.S. Treasury, which can allow international claimants to go after Venezuelan assets, and the OAS, which could invoke the democracy charter (IADC), clearing the way for broader economic sanctions.

Both procedures are significant because they involve timetables for action, either unilateral by the U.S. or multilateral by the OAS. For the Maduro government, they are ticking time bombs.

8. ‘Friendly intervention’

If a bloodbath is to be averted, international mediation may be what’s needed. But neither the U.S. nor the OAS is the right intermediary – especially with the latter organization laboring under a “heavy legacy of domination” by Washington. A better go-between might be the Union of South American Nations (UNASUR), which enhances the concept of regional identity while keeping the U.S. out, GIS expert Dr. Joseph Tulchin wrote in June 2016. Cuban involvement is also crucial, “because its military works side-by-side with their Venezuelan counterparts,” according to Dr. Polga-Hecimovich.

The end of U.S. hegemony in Latin America may allow countries of the region to assert themselves. Paradoxically, it may also help ease out regimes like Venezuela’s – or at least that is the hope.

One possibility is that Colombia, having ended its civil war, could lead a group of nations in a “friendly intervention” to give the Maduro government “a gracious way out of office,” Dr. Tulchin wrote in a February 3, 2017 report. Five months earlier, in his analysis of the drugs-politics nexus in Venezuela, GIS expert Dr. Anthony Maingot said the country’s western neighbor could help unlock a deal:

What could bring the criminal status quo to an end is the situation in Colombia. If the recently signed peace treaty puts the Revolutionary Armed Forces of Colombia (FARC) out of the drug business and cuts supplies to Venezuela, then competition for the decreased supplies could splinter the military.

Only this outcome would give the civilian opposition leverage to make a Mephistophelian deal. In return for legal immunity and control of the narcotics trade, the military will support new elections. Venezuela would not be the first country in Latin America to allow such an arrangement for the sake of ‘democracy.’


The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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