Topic: International Economics and Development

Venezuela’s House of Cards

The story of the Venezuelan economy and its troubled currency, the bolivar, can be summed up with the following phrase: “From bad to worse”—over and over again. Yes, the ever deteriorating situation in Venezuela has taken yet another turn for the worse.

In a panicked, misguided response to the country’s economic woes, Venezuelan president Nicolas Maduro has requested emergency powers over the economy. And the Maduro government recently announced plans to institute a new exchange rate for tourists in an attempt to quash arbitrage-driven currency smuggling.

These measures will likely prove too little, too late for the Venezuelan economy and its troubled currency, the bolivar. Indeed, the country’s economy has been in decline since Hugo Chavez imposed his unique brand of socialism on Venezuela.

For years, Venezuela has sustained a massive social spending program, combined with costly price and labor controls, as well as an aggressive annual foreign aid strategy. This fiscal house of cards has been kept afloat—barely—by oil revenues.

But as the price tag of the Chavez/Maduro regime has grown, the country has dipped more and more into the coffers of its state-owned oil company, PDVSA, and (increasingly) the country’s central bank.

Since Chavez’s death, this house of cards has begun to collapse, and the black market exchange rate between the bolivar (VEF) and the U.S. dollar (USD) tells the tale. Since Chavez’s death on March 5, 2013, the bolivar has lost 62.36% of its value on the black market, as shown in the chart below the jump.

The Return of the Chimney Sweep

Chimney sweeps are making a comeback in Great Britain. “According to the National Association of Chimney Sweeps,” the Telegraph reports, “Britain is experiencing the largest boom in chimney sweeping since Victorian times. ‘It’s been remarkable,’ said president Martin Glynn. ‘When we started NACS in 1982, there were just 30 members. Today we have 540 members nationally.’” The reason? Gas and electricity prices have risen so high that people prefer to burn wood in their previously unused or underused fireplaces.

Why are the energy prices so high? The British government’s pathological obsession with renewable sources of energy. Converting renewable energy (e.g., wind and solar) is much more expensive than conventional sources of energy (e.g., coal and gas). Since the government mandates that a certain percentage of energy consumption has to consist of renewable sources, energy prices are rising – fast. 

That leads to this amazing paradox: Progressivism started in Victorian England – a time and place of tremendous and unprecedented material and social progress that, nonetheless, also had a darker side. The stories of workers living in freezing and damp dwellings, children chimney sweeps suffocating while on the job, and environmental degradation, were both horrific and true.The evolution of progressivism has come full circle and progressives have turned reactionary: To combat the (highly uncertain) effects of climate change, modern-day progressives have embraced policies that lead to more burning of wood, freezing homes for the poor and vulnerable, and chimney sweeps back at work.

Venezuela Is Spiraling out of Control

As the economic situation rapidly worsens in Venezuela, the government is growing increasingly authoritarian and is now actively undermining the foundations of the country’s already deteriorated social fabric.

On Friday night, President Nicolás Maduro ordered the military to seize the stores of a consumer electronics retail chain and confiscate all the goods in order to sell them at “a fair price.” Soon afterwards large crowds gathered outside appliance stores all over the country, leading in some instances to mass looting. The announcement came one day after the Central Bank reported that the inflation rate in October was 5 percent, leading to an annual rate of 54 percent. However, as our colleague Steve Hanke documents on his Troubled Currencies Project, Venezuela’s implied annual inflation rate is actually 320 percent.

The government claims that runaway inflation and pervasive shortages of basic goods are part of an “economic war” being waged by the United States and the local “parasitic bourgeois class.” Thus, Maduro is now mobilizing his troops against the perceived enemy. The owners of two of the retail chains have been detained under charges of “gouging” and “usury.”

Showing his economic illiteracy, Maduro said that the Central Bank should take note of operations, wondering out loud: “If we are lowering products’ prices by one hundred percent, this should impact the inflation rate, right?” Well, no. As long as the Central Bank continues to print money to finance the government, inflation will continue to rise. However, by actively encouraging outright plunder, the government is deliberately destabilizing Venezuela’s society probably as a means for taking further radical measures.

Last April when Nicolás Maduro officially assumed the presidency after a very questionable victory in the polls, many people speculated that he would be more conciliatory than his predecessor Hugo Chávez. That proved to be wishful thinking. It is clear now that under Maduro the worst has yet to come in Venezuela.

Egypt’s Subsidy Nightmare

If you think that Western welfare states are in a pickle, imagine what they would look like if, instead of transferring money, governments tried to help people by giving all of them free or cheap stuff. One does not need to be an economist to see the inefficiency of in-kind transfers, but many countries use redistribution of stuff – typically in the form of commodity subsidies – as the main tool of redistribution and social assistance.

In Egypt, the government subsidizes the prices of fuels and certain food products at artificially low levels. Obviously, the wealthy – who can afford to consume more of the subsidized commodities – are the largest beneficiaries of the subsidy system. In urban areas of Egypt, for example, the top quintile of the income distribution receives eight times as much in energy subsidies as the bottom quintile.

As I argue in a new Cato Policy Analysis published today, commodity subsidies are behind Egypt’s fiscal meltdown – the country is currently running a deficit of 15 percent of GDP, while being kept afloat only by the inflow of funds from the Gulf countries. To avert a looming fiscal catastrophe, Egyptian policymakers need to act now. The paper, which I also summarize here, provides a list of recommendations about how the reform should be approached:

Nothing New on the Egyptian Front?

Four months after the military takeover in Egypt, the country’s economy is still a train wreck. With growth well below government forecasts, the budget deficit in 2013/2014 may get to 15 percent of GDP, bringing Egypt into truly dangerous territory, unless the inflow of aid from the Gulf countries continues indefinitely. And instead of reforms, there are discussions of a new stimulus plan, worth $3.6 billion.

Nor are there many reasons for optimism in the political arena. Mohamed Morsi appeared in court on Monday, charged with inciting violence and murder. If convicted, he can face the death penalty. Unsurprisingly, the trial, alongside with the ongoing crackdown on the Muslim Brotherhood, has fostered further violent protests in Cairo.

However, if instead of following the news, one listened to U.S. officials, one could not avoid the impression that everything is going swimmingly. Today’s Washington Post has a brilliant editorial describing the state of denial in the administration:

Not surprisingly, a Freedom House report released Monday concludes that “there has been virtually no substantive progress toward democracy … since the July 3 coup,” despite the military regime’s supposed “road map.” But that’s not how Secretary of State John F. Kerry sees it. “The road map is being carried out to the best of our perception,” he pronounced during a quick trip to Cairo on Sunday. A liberal constitution and elections? “All of that is, in fact, moving down the road map in the direction that everybody has been hoping for.”

Iceland, Switzerland, and the Golden Rule of Fiscal Policy

Being a glass-half-full kind of guy, I look for kernels of good news when examining economic policy around the world. I once even managed to find something to praise about French tax policy. And I can assure you that’s not a very easy task.

I particularly try to find something positive to highlight when I’m a visitor. While in the Faroe Islands two days ago, for instance, I wrote about that jurisdiction’s new system of personal retirement accounts.

And now that I’m in Iceland, I want to focus on spending restraint.

As you can see from this chart, lawmakers in this island nation have done a reasonably good job of satisfying the Mitchell Golden Rule over the past couple of years. Nominal economic output has been growing by 6.1 percent annually, while government spending has risen by an average of 2.8 percent per year.

Iceland Spending Restraint

If Iceland continues to enjoy this level of growth and can maintain this modest degree of fiscal discipline, the burden of government spending will soon drop below 40 percent of GDP.

What America Can Learn from the Faroe Islands about Social Security Reform

I’m currently in the Faroe Islands, a relatively unknown and semi-autonomous part of Denmark located in the North Atlantic. Sort of like Greenland, but too small to appear on most maps.Faroe Islands

I’m in this chilly archipelago for a speech to the annual meeting of the Faroese People’s Party. According to Wikipedia, “the party is supportive of the economic liberalism.” But liberal in this context is classical liberal, so they’re my kind of people.

I spoke on the economics of fiscal policy and talked about issues such as my Golden Rule and the Laffer Curve, but today’s post is about what I learned, not what I said.

The current government of the Faroe Islands, which includes the People’s Party, has modernized its Social Security regime with a system of personal retirement accounts. Starting next January, workers will begin setting aside some of their income to finance a comfortable retirement income. When fully implemented, workers will be putting 15 percent of their income in their accounts, creating a system that’s even larger than the private retirement models in Australia and Chile.

So why did Faroese politicians take this step? Well, unlike politicians in most nations, they looked at the long-run data, saw that they had an aging population, realized that a tax-and-transfer scheme no longer could work, and decided to reform now instead of waiting for the old system to collapse.

Here’s a chart put together by the Nordic Council. As you can see, the Faroe Islands were (and other jurisdictions are) heading to an intolerable and unsustainable situation of too few workers and too many retirees.

Faroe Islands Age-Dependency Ratio

By the way, the same situation exists in the United States.

Our population is aging, the Baby Boomers are going into retirement, and birth rates have dropped. Our long-run numbers aren’t as grim as some other nations, but our Social Security system is basically insolvent.

Indeed, Social Security’s long-run deficit is measured in trillions, not billions. According to the most recent Trustee’s Report, deficits over the next 75 years are expected to equal $36 trillion. And that’s after adjusting for inflation!

For what it’s worth, if a private insurance or pension company kept its books in the same was as Social Security, it would be forced into bankruptcy and its managers would be indicted for fraud..

But when politicians operate a Ponzi Scheme, we’re supposed to applaud them for compassion!

This is why it might be worth the cost if we sent the politicians in Washington on a junket (using their taxpayer-financed fleet of luxury jets) to Torshavn, the Faroese capital. They could eat some lamb and fish and learn what it’s like to responsibly address a problem before it becomes a crisis.

Or we could save the money and simply force them to watch my video on personal retirement accounts.

P.S. In you like gallows humor, you can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke, though it’s not overly funny when you realize it’s a depiction of reality.

P.P.S. You probably don’t want to know how Obama would like to “fix” the Social Security shortfall.

P.P.P.S. On Monday, I continue my tour of the North Atlantic with a speech in Iceland on the Laffer Curve. I don’t know if I’ll say anything memorable, but I’ll use the opportunity to learn more about some of that nation’s policies, including their very successful privatized fishery system. Iceland has some bad policies, of course, but it’s also worth noting that they wisely have rejected membership in the European Union, they’ve reduced the burden of government spending in recent years, and they also made the right decision when they decided (with help from an outraged electorate) to limit bailouts when their banks went bust. You won’t be surprised to learn, though, that the Paris-based OECD has been using American tax dollars to advocate bad fiscal policy in Iceland.