miércoles, 14 de enero de 2015

Venezuela, Where do we go?


The following is an analysis that was made ex-post facto to the crisis in Chili (Allende) and Perou (Allan Garcia), perfectly extrapolable to the current situation in our country. To read, understand and assimilate that this is not over, and that it would take long time to return to the level from where we started in 1998. Things are going to be worst, and worst, and recovery will be slow and painful. The nigthmare is here. We are in Phase III of the Dornbusch & Eduards analysis.

But how does everything go so badly wrong?

Dornbusch & Edwards explain that the problem is a combination of factors:

The combination of external influences (debt crises,economic blockades etc.), domestic policies (socialization of firms, bank nationalization, etc.) and macroeconomic policies bring about an unsustainable economy where inflation is out of control, and the foreign exchange constraints force realism on policy makers.

And they go on to list the four stages of the unfolding disaster.

Phase I: In the first phase, the policy makers are fully vindicated in their diagnosis and prescription: growth of output, real wages and employment are high, and the macroeconomic policies are nothing short of successful. Controls assure that inflation is not a problem, and shortages are alleviated by imports. The run-down of inventories and the availability of imports (financed by reserve decumulation or suspension of external payments) accommodates the demand expansion with little impact on inflation.

Phase II: The economy runs into bottlenecks, partly as a result of a strong expansion in demand for domestic goods, and partly because of a growing lack of foreign exchange. Whereas inventory decumulation was an essential feature of the first phase, the low levels of inventories and inventory building are now a source of problems. Price realignments and devaluation, exchange control, or protection become necessary. Inflation increases significantly, but wages keep up. The budget deficit worsens tremendously as a result of pervasive subsidies on wage goods and foreign exchange.

Phase III: Pervasive shortages, extreme acceleration of inflation, and an obvious foreign exchange gap lead to capital flight and demonetization of the economy. The budget deficit deteriorates violently because of a steep decline in tax collection and increasing subsidy costs.The government attempts to stabilize by cutting subsidies and by a real depreciation. Real wages fall massively, and politics become unstable. It becomes clear that the government has lost.

Phase IV: Orthodox stabilization takes over under a new government. An IMF program will be enacted; and, when everything is said and done, the real wage will have declined massively, to a level significantly lower than when the whole episode began! Moreover, that decline will be very persistent, because the politics and economics of the experience will have depressed investment and promoted capital flight. The extremity of real wage declines is due to a simple fact: capital is mobile across borders, but labor is not.

To make their point, Dornbusch & Edwards provide the following charts of real wages for, respectively, Chile under Allende and Peru under Garcia.

Remember that at the time they wrote, Peru's collapse was in progress. The pattern is clear. When the economy collapses under the triple burden of supply-side dysfunction, unsustainable fiscal finances and capital flight, the real wage falls to below its previous level. The inevitable IMF program restores stability, but at the price of stagnation, inequality and poverty for much of the population. And as Dornbusch & Edwards explain, therein lie the seeds of the next crisis:
Initial conditions: The country has experienced slow growth, stagnation or outright depression as a result of previous stabilization attempts. The experience, typically under an IMF program, has reduced growth and living standards. Serious economic inequality provides economic and political appeal for a radically different economic program.The receding stabilization will have improved the budget and the external balance sufficiently to provide the room for, though perhaps not the wisdom of, a highly expansionary program.
Policymakers explicitly reject conservative economic policies and implement highly expansionary policies designed to reduce inequality and eliminate poverty quickly, usually by means of large real wage rises.  I was struck by the beliefs that justify such dramatic reversal in policy, in particular the rejection of conventional economics: Chavez, Allende and their kind simply don't think that the rules of economics apply to them. And when it all goes horribly wrong, they blame external factors while exonerating the domestic policies that have enabled external factors to exert such a destabilising influence on the country. It is hardly surprising if investors do not wish to invest in countries where their investments are at risk of expropriation, or where their profits could be wiped out by large government-mandated wage rises or sudden tax increases, or where rising inflation erodes not only their returns but their capital. The loss of capital investment arising from these policies is probably the most damaging aspect, since it erodes supply-side capacity and directly causes precipitous real wage falls when the collapse eventually comes.

Having said that, it is not reasonable to blame expansionary "populist" policies for economic collapses without taking account of the role of the preceding harshness in setting them up. IMF programmes may stabilise the economy, but too often at the cost of real suffering among the population: the desire to improve their lot is entirely understandable. Austerity breeds profligacy, which in its turn is forced to give way to even more austerity. Rinse, repeat. This has been the story of Latin America for a very long time.