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Kenya must learn from Venezuela's oil-induced turmoil

Wednesday September 7 2016

By KWAME OWINO
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Thirty years ago, people out shopping in Eastern Europe would walk in the streets and join any queue, before asking what supplies the shops had in stock.  

Today in Venezuela, citizens stand in queues to buy basic food items and household supplies such as soap, diapers and toothpaste. Occasionally, citizens have no choice but to attack supermarket staff and make away with the goods.

Consider that the local manufacturer of the world’s most popular soft drink, Coca-Cola, stopped production in Venezuela because it could not procure sufficient sugar.

And this is happening, not because the country is recovering from a catastrophe of war or environmental hazards, but from a catastrophe of bad economic policy supported by populism.

Outside the Middle Eastern nations and those close to the Persian Gulf, Venezuela has the world’s largest petroleum resource endowment.

The situation in Venezuela challenges the view that Kenya, and indeed the African continent, is automatically primed for prosperity owing to natural resource endowments.

In 2015, the government of Venezuela extracted 2.5 million barrels of crude petroleum daily and marketed virtually all of it in international markets.

This level of extraction meant that in 2015, the total extraction from Venezuela exceeded Kenya’s entire stock of declared crude oil reserves. Yet Kenya recorded GDP growth of 5.6 per cent in that year against a third consecutive year of shrinkage of 10 per cent for Venezuela.

This comparison is not perfect because the average income in Venezuela stands at $13,000 annually, 10 times that in Kenya, though the poverty rates for both are comparable at 32 per cent and 40 per cent, respectively.

So what explains the poor economic performance that condemns citizens to long queues to acquire basic goods in one country and not the other? In short, Venezuela is a classic example of a country whose leadership was overcome by hubris.

BOLIVARIAN REVOLUTION

True, an oil endowment presents a good platform from which to build prosperity. However, an endowment of crude petroleum or another resource requires a far keener understanding about what makes good economic policy.

In Venezuela, an oil endowment met a vindictive national administration that used a national resource to try to prove its political philosophy, while poking its ideological enemies in the eye.

In the middle of the 2000s, the price per barrel of crude petroleum rose aggressively from less than $30 to more than $100.

This situation arose primarily because China and other lower-income countries had started to benefit from reforms implemented in previous years, and therefore needed more fuel.

Venezuela rightly appropriated the resulting cash windfall, but started using it for causes considered essential for its socialist posturing.

When oil prices began to rise in the early 2000s, the country had just elected a new president who was committed to both socialist principles, named the Bolivarian Revolution.

The new party started by bringing in price controls under the guise of stopping the “evil capitalists” from exploiting the masses. The irony is that President Hugo Chavez had won an election and was genuinely popular.

With the exception of a few economists and some maverick entrepreneurs, the hatred for partisan businessmen was palpable and the new administration exploited it well. Add to this a minority population whose rights had been violated by successive regimes and the matter also became about settling identity-based scores.

FREE HOMES

The government nationalised the oil company PDVSA and granted it control over marketing of Venezuela’s petroleum resources. Predictably, its management included supporters of the political party in power.  

As oil prices continued to rise, this corporation earned billions of dollars in revenue annually, providing a credit card for the government to start politically motivated spending.

In addition to price controls, the government subsidised products including petroleum, food, telecommunications and electricity. Nationalisation of companies became a great pillar of economic policy with cement, some basic foods and energy companies taken over by government.

Underlying this broad nationalisation was particular opposition to corporations from the United States and selected European countries, betraying hostility to economic competition.

To President Chavez and his comrades, the Chavistas, economic policy could be used to express political approval with investments allowed from the firms of favoured countries, such as Cuba and China.  

Among the most ridiculous projects that Venezuela undertook was the provision of free homes to the poorest citizens. While it is difficult to argue against the necessity of good housing, it is the policy instrument used to provide it that provides a classic lesson on how it ought not to be done.

Venezuela's version of this populist obsession of socialist governments is known as the Gran Mission Vivienda (Great Housing Mission). In 2013, about half a million citizens received keys to new homes that had been constructed by public funds, but a majority didn’t have electricity or a reliable water supply.

OIL LARGESSE

The overall programme aimed to construct 3 million low-cost houses by 2020, but the target would probably not be met because of the economic and political crisis facing the country today.

The strength and popularity of President Chavez lay in his party’s expanded spending on social programmes in the quest to reduce poverty. With crude petroleum prices reaching above $110 per barrel, this government was flush with cash.

It created small banks and worker-owned cooperatives by loaning out several million dollars, to enable them create jobs and allow poorer people to participate in public sector procurement.

People’s cooperatives and firms had access to public resources while also being exempt from paying tax, thereby ensuring that they were merely conduits for public funds into private hands.

Economic planning sought a high level of control of the economy, with banks required to set aside a specified percentage of their funds for lending to sectors favoured by government.

In this way, they were much akin to large social programmes like the National Youth Service (NYS), Women Enterprise Fund and Uwezo Fund programmes in Kenya.

These are popular but open to corruption, and their economic return is poor. They are a classic case of the throwing-money-at-problems approach that is beloved of bureaucrats.

INEVITABLE FALL

In addition to imposing strict price controls on private firms, the government intervened with production quotas. This was a compulsory requirement for firms to meet targets because the price levels were too low to justify supply of consumer goods in the required quantities.

Such conditions made real profit-making difficult, except for favoured firms that invariably passed to the control of the regime’s political supporters.

As the public choice theory of economics would have predicted, the real investor has no space in this environment.

In every way, each plank of economic policy also had to meet specific political objectives. Underlying all this spending was the income from crude petroleum exports, which the government believed to be inexhaustible.

Venezuela’s government seemed unaware that possession of large oil reserves did not render basic principles of economic management irrelevant. Like every commodity, oil prices couldn’t stay at more than $100 per barrel due to the operation of basic economics.

High prices are an incentive for other firms to provide alternative resources in order to compete for profits. An oil glut and the rise of alternative energy sources were inevitable, which led to a fall in prices back to below $50 per barrel.

The government was unable to pay for basic services and experienced huge budget deficits. It tightened foreign exchange controls further and reduced imports drastically. The result is evident today; socialist principles may be easy to sell to win elections, but are not suitable for managing any economy.

People queue up outside a supermarket in

People queue up outside a supermarket in Caracas on January 13, 2015. Venezuela suffers a shortage of almost a third of commodities, inflation of 64 per cent in 2014 and an economic recession caused in part by drought currency since 2013 is limiting essential imports. AFP PHOTO | FEDERICO PARRA

At peak oil prices, Venezuela depended on oil for more than 90 per cent of import income and more than half of all government spending, and when oil prices inevitably fell, the government went completely broke as debtors came calling.

The irony is that while the initial spurt in spending led to a reduction in poverty, poverty rates went up again as the crisis deepened. And so what the last 17 years teach is that a country that deserved much better overdosed on oil spending and then came crashing back down like a drug addict suffering from withdrawal.

Oil endowments do not make growth consistent and development inevitable. The real lessons for Kenya as we stand at the door of very modest oil exports within the decade will be the subject of a separate piece.

Kwame Owino is the chief executive officer of the Institute of Economic Affairs (IEA-Kenya), a public policy think tank based in Nairobi. Twitter: @IEAKwame