2.1. Inflation rate in Venezuela, causes and consequences.

Venezuela’s annual inflation rate has surpassed 30% after consumer prices surged in

April of 2010. The Central Bank and National Statistics Institute on reported a 5.2%

increase in consumer prices during April, driving up the annual rate to 30.4%. Moreover,

the President Hugo Chavez and his government have been struggling against the highest

inflation rate in Latin America and a weakening economy in general. In 2010, the prices

increased 11.3% from January to April, up from 6.7% inflation in the same period. As we

can see in Figure , The inflation rate of Venezuela has been increasing more from the

year 2008 to 2011. The peak of this inflation rate is 2008 when it reached to 36%. The

lower has been in July of 2011 with 23%. However, eventhought it seems the inflation

rate is decreasing in July 2011, in August of the same year it went up again to 28%.

In addition, Venezuelan has been suffering from high inflation rates for many years. The

figure has been between 25 and 30 % per year. Inflation has continued to rage even

though GDP growth has been negative in 2009 and 2010, and will likely be negative to

neutral in 2011. The high inflation rate led the government to impose price controls.

Controlled prices range from the price of foods to what a parking lot owner can charge

per hour. In some cases, prices have been frozen for years, leading businesses into poor

maintenance, causing the inability to hire more workers, and driving some to near or full

Figure 1 Venezuela Inflation rateSource: Central Bank of Venezuela (2011)

bankrupcy. 

Price controls have also led to spot shortages. Fresh milk, for example, isn't easy to find

beacause its price is controlled. Long duration milk is found easily because its price isn't

controlled. Powdered milk has been difficult. Sometimes the government tries to attack

shortages by importing food. This means Venezuelan people have seen chicken

shortages, but later they saw lots of chicken in the markets, some of it in poor condition.

Hundreds of thousands of tons of food have been found rotting in import containers held

by the state owned company PDVAL (Productora y distribudora de Venezuela en

Alimentos), which in English means a company that produce and distribute Venezuela’s

food. This appears to be caused by a broken supply chain - they bought the food but

didn't figure out how to set up the distribution system to get it to the markets. 

The government continues to insist the problem is caused by "speculation" and by

"monopolies". They seem to ignore a very simple fact: They are printing a lot of money,

and this increase in the money supply isn't matched by an increase in the supply of goods

and services. When people find their pockets full of money, they want to spend it. And

when there aren't enough goods on the shelf to satisfy their demand, then of course prices

rise. This of course prices rise is the key point. The incompetents running the economy

don't get it. If a guy owns a pig, and finds 10 buyers willing to give him around 1000

bolivars for the pig, then he'll sell the pig to the first buyer offering 1001 Bolivars. In

other words, that farmer will sell the pig for the highest price he can get. The same

applies to the guy washing cars, or the maid offering her services, or the importer

bringing in a socket wrench (who also has to account for currency devaluations, paying

off the corrupt customs officials, and actually getting the dollars to buy the socket wrench

abroad). 

As long as the government is tossing around money to buy votes, or printing it to pay its

bills, then there's going to be excess money floating around, and the price of just about

anything they don't control by fiat is going to increase. Their response has been to

increase their controls. They want to control housing rental prices. They of course control

the salaries of government workers (who are now very underpaid and are starting to

complain). Now there's even talk by the Chavez suppporters in the Assembly of

controlling the salaries of workers in the private sector - they don't like to see private

sector labor making more than government sector labor, so they're going to "equalize"

everybody into poverty. The bottom line is inflation continues to rage, they think they can

keep on printing their monopoly money forever, price controls are being extended, and

the country continues to suffer from both inflation and recession.

The price increase has two faces.  A visibly expressed in the figures published measured

and the Central Bank of Venezuela, the other hidden in the shortage. The causes of

inflation in Venezuela are clearly identified, the prevailing fiscal deficits, monetary

financing and exchange rate devaluation. Without the understanding of these elements is

very difficult to design and implement policies to reduce inflation and for that reason it is

observed at the high monetary and fiscal authorities lurching, falling or stepping VAT

price controls and visible change when that such measures can do nothing to stop the

sorrel prices.

Inflation is an enemy of the economy since it affects competitiveness by making

imported goods cheaper and more expensive the products in the international market,

lowers real wages and a negative impact on tax revenues and thus worsens the fiscal

imbalance. Inflation also affects the allocation of resources to more profitable activities

that are socially more appropriate for a country. For these reasons the fight against

inflation is to be taken seriously. But cost of living next to the rising cost of living in

Venezuela is deepening another phenomenon that is related to the dark side of inflation:

the shortage. This is quantified by the BCV (Central Bank of Venezuela) but

unfortunately their data are not published. The scarcity of essential goods is a

phenomenon typical of economies heavily regulated by the State in which the episodes

socialists, Cuban style, are the most notorious examples. In a statist socialist economy

and destroys the incentive to produce since it is the government so centralized, who

decides what and how much is produced. Due to the shortage of milk, meat, eggs and

sugar, among other items, the Venezuelans have seen endless hours in queues to buy a

few goods. This represents an enormous cost in lost man-hours that have either been

miserably to engage in productive activity rather than being consumed in search of food

which are not currently available. A conspiracy From the ranks of government has

claimed that the shortage is due to a conspiracy without the officials take into

consideration the complete failure of an agricultural policy that began encouraging the

use of farms and the destruction of productive capacity and then establish strict price

controls and then install some kind of port economy by encouraging imports, Venezuela

has made a huge deposit of goods coming from all over the world and are strangling the

profitability of agricultural and industrial sectors. These imported goods currently look

cheap but tomorrow will be expensive when you inevitably have to adjust the exchange

rate, as they inevitably will happen in Venezuela. With all the resources that the State

funding has been dedicated to Zamora farms, ranches Florentine, agricultural

cooperatives and social production enterprises endogenous nuclei, Venezuela should have

guaranteed the supply of essential food commodities. But it is because these units have

been a source of corruption and tax authorities and because nobody is going to invest

resources in the farming activity in a context of price controls and risk stifling their goods

seized and confiscated by the action of a government hostile to private enterprise and

instead of seeing those who dare to invest as oligarchs valued as allies, enemies who must

be destroyed. 

In order to understand more about this, we have prepared a history fact from 1951 to

2001:

Period Description

1951-1973

(Price

stability)

During this period, the Venezuelan economy presented one of the lowest

average inflation in the world, 1.6% and a significant rate of GDP

growth, 5.7%. Among the characteristics of this period we can note that

the prosecutor was disciplined management. In effect fiscal deficit as a

percentage of GDP did not exceed 1.5% and there was never a deficit

situation three consecutive years. Consistent with that discipline,

prevailing exchange rate regime the exchange rate was fixed. One can say

that during this period of fiscal management was the anchor of price.

1974-1978

(Low

inflation)

During this period the average inflation increased to 8.4% while the average

growth fell to 4%. Keys features of this period were controls of

massive wage and price policy of direct and indirect subsidies. Both

policies, unsustainable over time due to the accumulation of

produced distortions in the labor market, product and external

sector, enabled the growth of prices that were less than it has to be for the

strong demand of products, fiscal pressures and monetary policy easing.

During this period, there was the attempts to dominate the inflation with

price controls and granted subsides from the treasury. However, there were

abundant resources available.

1979-2001

(High

inflation)

During this period, inflation averaged 32.6%while the pace of economic

activity grew by 1.3% yoy. Between1950 and 2001, the volatility of the

economy, measured by inflation increased, and there was a substantial drop

in economic growth. It is noteworthy that during this period were

implemented within three economic adjustment programs.

We characterize the behavior of the Venezuelan economy in these last two decades as

volatile, mainly associated with the inability of cushion the external shocks from the oil

market and to produce institutional reforms, especially in the tax area.  When there is a

favorable shock of oil the spending increases, when the shock is reversed spending is

maintained or even increased, then resort to borrowing. 

The effect of spending increases the expectations of devaluation. then, comes a

strong exchange rateadjustment causing price corrections. After each episode

of significant price rise, the average rate of inflation is at a higher level, due largely to the

higher level of incorporation of price expectations formation process. On the other hand,

Chavez had explained that devaluation would enable the government to maintain public

spending, which was enough for his critics to claim that all this was linked to the

parliamentary elections scheduled for September this year. At present, the president's

ruling United Socialist Party of Venezuela (PSUV) and its minor allies wield an

unchallengeably massive majority at the one-chamber National Assembly, leaving only a

few seats for dissident voices.

In other words, we attribute the acceleration of inflation in the period 1974-1978 to the

imported inflation. In the presence of a fixed exchange rate in an economy with

Venezuelan importer and bias, increasing prices abroad, due to the increase in oil

prices in the mid-seventies, resulted in an increase in inflation in Venezuela. For its

part, Lovera (1986) emphasizes that the substantial increase in public

spending after 1974, beginning the first oil boom, led to an imbalance between supply

and demand domestic aggregate.  This imbalance, could be mitigated in terms of its effect

on the growth of prices, the ability to import that conferred increasing flows of foreign

currency from oil sales. The vision expressed by these studies is shared by the empirical

study of Rodriguez (1986) who using annual data for the period 1969-1981 found that the

external inflation is a determinant of domestic inflation. Obviously, this estimate is

not robust in the sense that it was made with a series contained little information and

so few degrees of freedom.

2.2. The consumer prices over general goods such as food, clothes, housing. Is Venezuela economy stable in this?

Venezuelan economy is characterized by a shortage of food. The growing problem of

food shortages in Venezuela has become a real point of discussion. If you go to any

supermarket or small shop and people are talking about it, complaining that they can't

buy what they need and sharing anecdotes about how expensive products have become.

The rising discontent over food shortages has become a major challenge for the

government of Venezuela's socialist President Hugo Chavez. More than a few analysts

have pointed to the issue as one of the factors behind the defeat of Chavez's proposed

constitutional reforms that aimed to strengthen popular power and help open the

transition to socialism.

The percentage of people who felt that shortages were a problem increased from 64% in

the third quarter of 2010 to 78% in the last. At the same time consumption has been

dramatically increasing in Venezuela, fuelled by a significant economic boom and the

Chavez government's social policies that have greatly increased the spending capacity of

the poorest. In addition, it has also some historical information since 2004, in which the

consumption has more than doubled from US$24 billion in 2004 to $52 billion in 2007.

The increased consumption, with production falling well short of demand, partly explains

the shortages.

In addition in April, 2011, the government raised the price on cans of powdered milk 48

percent to 23.7 bolivars ($5.50) and on corn oil by 36 percent, according to a resolution

published in the Official Gazette. The costs of sunflower oil and mixed vegetable oil

were also raised. We have to remember that Venezuela is a net importer of food, food is

the principal driver of inflation in Venezuela, according to the central bank, and

consumer prices may climb more than 8 percent in the rest of the year. The trigger is a

devaluation but the reality is that Venezuela has severe inflationary inertia.

Figure 2 CPI November 2011 Source: Central Bank of Venezuela (2011)

In Figure, we can see how in November 2011 the consumer prices index shows how the

food and non-alcoholic beverages represent an increase of more than 34% compared to

the Jannuary accumulated that was 27.70%, this number is skyrocketing. The prices for

food are increasing much more than housing, water, recreation, electricity, gas and

clothing. However, there are prices that are as well increasing like the food, such as the

transportation, furniture, household and restaurants and hotels. In addition, consumer

prices in Venezuela rose 27.4 percent in March from a year earlier, the most among 78

economies tracked by Bloomberg. Prices rose by 5.2 percent, the most in seven years, in

April 2010 from a month earlier after the government raised price caps on dairy products

and cheese.

The International Monetary Fund (IMF) forecast inflation in Venezuela will accelerate

29.8 percent to 31.3 percent in 2011. Moreover, Chavez devalued the bolivar for the

second time in less than a year in January by weakening the exchange rate on so- called

essential goods such as food and medicine by 40 percent to 4.3 bolivars per dollar and

unifying the two fixed foreign- exchange rates. The government, which controls the price

of more than 100 basic food goods, raised price caps on bread and pasta last month by as

much as 33 percent. In other words Venezuelan population cannot buy their dayly food to

survive, they are very expensive and they cannot afford it.

In addition, the food prices rose 33.8% during 2010, a significant increase compared

to 2009 which was 20.2% as inflation data released by the Central Bank of Venezuela.

Foods closed the year with inflation above the general rate, which was 27.2% second

group of goods with high, rises after alcohol (40.3%). Since 2003 the national

government introduced price controls in this sensitive area, which experts

say Venezuelans spend up to 40% of their income. Currently 18 items are

regulated covering some 256 products and presentations. One example of this, is what a

citizen said:

Maria de Abreu, another Caracas resident doing her grocery shopping, complained that

she couldn't find powdered milk. "It's regulated and you can only get a can per person.

And so what people do is that they bring along a friend and another and yet another and

that's how they get enough for their family,"

Figure , show how the markets looks like in Venezuela, they are empty of people, and

the food is getting bad because no one can afford it, prices are skyrocketing, people does

not earn the money for their dayly supplies. There's also a shortage of coffee. As soon as

new supplies arrive, shoppers say, they have to run to the store to get some because it

runs out very quickly. Venezuela has the highest annual inflation in Latin America. In an

effort to curb this inflation, the government set price caps on as many as 15,000 goods in

late November. The price of 18 products, including toothpaste, soap and diapers, which

are considered "basic," was immediately frozen.

The reason for this is pretty obvious. The communist government is going out of its way

to record and regulate all economic activity in their country in order to tax those evil,

sulfur-scented people trying to make money by selling necessities like food to the

proletariat and cap prices to control their profits, all while inflation is up nearly 30% in

Venezuela. As a result, there’s a lot less incentive and a lot less capital to make the

investments necessary to produce enough food for the people.

The fact that the government’s central bank has doubled the money supply over the past

four years has nothing to do with prices going up, according to Chavez. With price

inflation running at an annual rate approaching 30 percent, the President prefers to blame

the consumer and ignore the natural consequences of the government's actions. Karlin

Granadillo, who heads up the price control agency, said, “The law of supply and demand

is a lie. These are not arbitrary measures. They are necessary.”

The price inflation driving up prices has been exacerbated by currency controls that

prevent consumers from converting their depreciating local paper money into dollars or

euros, thus giving them little option but to spend it before prices rise further. But the

impact will hit the poor the hardest.

Food shortages have sporadically plagued Venezuela since 2003, when Chavez started

trying to dictate prices. As he tightens his grip on power, they will only increase. The oil

wealth pouring into Venezuela has been so mismanaged that inflation has hit an

accumulated 78% over the last four years. Consequently even basic food staples are hard

to find except on the black market.

We have to remember that one of the key reasons why it is important to keep inflation in

check is that it inevitably leads to price controls, a cure that is often worse than the

disease. Venezuela is only the latest in a long line of countries that have tried and failed

to cure inflation with such methods. When the government controls the prices, they

become 'fictive' they are no longer controlled by demand and supply, and thus are

meaningless. Meaningless prices cause misallocation of resources and a significant

lowering of productivity.

2.3. Important factors affecting Venezuela’s economy

President Chavez is pushing Venezuela towards an economic system he calls 21st century

socialism. He continued in this direction despite suffering defeat on his proposed

constitutional amendment in December 2007. Government takeover of strategic sectors

of the economy is the top priority in this socialist agenda. The Chavez government

reversed the privatization of the national telecoms company and took over electric,

steelmaking, and cement companies. Next on the agenda is seizing control over the food

production, processing and distribution chains. 

The government pursues a policy of establishing the hegemony of social over private

property. Social property is in essence centralized state property as the farms and firms

the state takes over in order to establish “social property enterprises” are not handed over

to those who work there but managed from the center. As a consequence, Venezuela’s

economic environment is increasingly hostile to private activity, including investment.

This comes at a time when falling oil prices warrant an open door policy of promoting

and welcoming investors. 

To make things worse, the Venezuelan economy’s dependence on oil prices has forced

the government to scale back spending for social policy and direct transfers. Private

consumption is posed to contract, which is likely to trigger social unrest. As protest

actions increase in number and intensity, repression will have to be scaled up. All this

bodes ill for the social peace of Venezuelans in the coming years.

Currency and Price Stability

Venezuela’s inflation rate of over 30% in 2008 was the highest in the hemisphere and one

of the highest in the world, fuelled mainly by inorganic money issuance and government

handouts for consumption. Imports soared to over $50 billion. Plummeting oil prices and

an over-optimistic budget estimation of oil revenues forced the government to announce

tighter fiscal policies. While the announcement was unspecific, it may include the scaling

down of handouts and social policies, smaller salary hikes, higher taxes, and devaluation.

Even the sacred ultra-low price levels for petrol are now under revision. All this spells

trouble as the unions rediscover their temporarily lost goal of fighting in the interest of

workers (even if they are supporters of the Chavez regime), consumers complain about

inflation, and businesses close down due to excessive controls and shrinking margins.

Inflation has increased steadily, from 14% in 2005 to 17% in 2006, 23% in 2007 and 32%

in 2008. Most tellingly, there was no difference in inflation rates between goods subject

to price controls and uncontrolled products. With a rate of 45%, food prices rose faster

than most other items. Only hotel and restaurant prices registered higher inflation. 

The government’s stubborn clinging to the grossly overvalued exchange rate may help to

dampen inflation, but it tends to exacerbate Venezuela’s port economy paradigm by

bringing down import prices while rendering national production uncompetitive. Even if

this was politically welcome because it weakened the entrepreneurial elite, it will be all

the more damaging in the future as a major adjustment will be inevitable in a then much

more fragile national business environment. To make things worse, the government has

removed what was left of the central bank’s battered autonomy has been removed by

forcing the transfer of more than one-quarter of the reserves to its Development Fund, an

institution that is exempt from the parliament’s budgetary control. The operations of the

Development Fund remain opaque.

The government’s economic policy is unsustainable. Serious problems exist with regard

to achieving stability. A case in point is the transfer of $12 billion from the currency

reserve to the Development Fund, an action tantamount to printing money because the

dollars handed over to the central bank by the state petroleum company PDVSA were

converted to bolivars that were then used by the company to pay for royalties and taxes.

In order to fund government programs, the same dollars have been converted again,

probably on the parallel market, where they help to drain liquidity but, at the same time,

provide higher-priced dollars for consequently higher-priced imports. These imports, in

turn, fuel price increases. The country’s hostile business environment does not help to

ease its economic burdens.

Private Property

The constitutional guarantees for private property exist on paper, but they are not

implemented consistently or safeguarded adequately. In practice, the government has

embarked on a campaign of taking over what it claims to be “strategic interests” of the

people. These interests include food production, processing and distribution, construction

materials, utilities, media, telecoms, and even buildings, real estate and hotels. The Law

on the People’s Access to Goods and Services, issued by presidential decree under

special powers in mid-2008, provides for tight controls of complete production chains

and allows state organisms to seize and then distribute goods when they suspect hoarding

(the dividing line between legal stocks and hoarding is ambiguous). The government,

acting “in the people’s interest,” requires no proof in order to seize private goods. The

guarantee of due process and the right to judicial review of administrative decisions are

likewise ignored. The second half of 2008 saw the confiscation of raw materials and

processed food in several private production and distribution facilities

Despite nationalizations and constraints, the private sector still represents about 60% of

the GDP and about 68% of formal employment. Private companies can no longer act

freely, because the state controls everything from cost calculation to output, distribution

and retail prices. This even includes products not subject to price controls. The

government has taken over strategic business sectors and is threatening to seize the rest

unless companies bow to what the government interprets as the people’s interest. Many

Venezuelans remain unconvinced by the government’s actions with regard to

socialization of private enterprise. More than half of the people (55%) think

entrepreneurs are doing a good job and that a market economy is the only way towards

development. Only 41% trust the parliament and a little less than half think the

government is doing a good job (48%) or trust it (47%).

References

Deloitte, J. (2009). Venezuela currency exchange control. Retrieved December

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Financial-Reporting-Alert/us_assur_Financial_Reporting_Alert_10-1.pdf

Rodríguez, M. (1986). Causas y Efectos de la Inflación y de las Políticas

Antiinflacionarias en Venezuela “ Pensamiento Iberoamericano, No. 9

Inflacion en Venezuela. (2010). Retrieved December 14, 2011,

fromhttp://www.guia.com.ve/noti/14692/las-causas-de-la-inflacion-en-venezuela-

estan-claramente-identificadas%E2%80%A6

Central Bank of Venezuela (2010). Retrieved December 15, 2011,

fromhttp://www.bcv.org.ve/Upload/Publicaciones/doc37.pdf