“The small library that accompanied Bolivar on his military campaigns included Adam Smith’s The Wealth of Nations”
In Part 1, we pinpointed the root cause of Venezuela’s economic problems to low productivity (Industry), aggravated by high inflation (nominal Trade). This low productivity in turn is caused by price controls and forced change of capital ownership while this high inflation is aggravated by currency controls and printing too much currency. Our solutions will therefore focus on these issues in a systematic and deep way, meaning that they will be implemented from inside going out, with each implementation’s success depending on the previous one, similar to a relay race or a military campaign.
1. Change in Government Paradigm
The underlying cause of the controls and nationalizations implemented by Chavez is the South American concept of the “caudillo” which best translates into “benevolent dictator” when viewed from a historical perspective. Smith’s Theory of Moral Sentiments explains that societies which have low levels of ‘fellow-feeling’* have high levels of injustice. This explains why such societies naturally clamour for stability and strong leadership instead of progress and individual freedom. A manifestation of this lack of fellow-feeling in South America is the prevalence of corruption and violence. The solution to corruption therefore is to build this fellow-feeling, explained in depth in The Theory of Moral Sentiments, and is beyond the aim of this analysis.
Although the benevolent dictator approach has its benefits in the short term, in the long term it must lead to a mature democracy otherwise the society’s natural progress will be hindered. A father must be strict while his children are young but must gradually allow more freedom as they grow up to realize their full potential. Likewise, a chieftain must command his society in the beginning but gradually he must delegate authority to other chiefs or to the people themselves as his society grows and develops. The leadership system gradually changes from a single warlord, to a king with ministers, to a modern president with a cabinet, agencies, and staff. This delegation and increased division of labour allows people to make decisions themselves with the leader merely giving basic directions and regulations, allowing him to concentrate on the big picture. Since our analysis deals with economic issues, we emphasize the people’s freedom to make economic decisions themselves.
The first step in solving Venezuela’s economic problems therefore is for the government to gradually transition itself from being an economic controller to an economic regulator. This means letting Venezuelans control their own economic destiny and follow their dharma, with the government being in the background enforcing security, justice, and maintaining essential plans, works, and services.
2. Phased Elimination of Price Controls
After the government’s role switches from oppressive micromanager into a wise regulator, the elimination of the most burdensome controls can be implemented. The first burden is price controls which must be removed gradually as to protect the people from price shocks. Smith advises that wrong policies should be mended gradually, as any big, sudden change can do more damage in the short run:
- “It may be deliberated how to properly restore the free importation after it has been interrupted, especially when its local monopoly already employs so many people. Humanity in this case may require that this freedom be restored only by slow gradations and with much reserve and circumspection. Were those prohibitions taken away all at once, cheaper foreign goods might enter so fast as to deprive our people of their employment.” (Simplified WN, Book 4, Chap. 2)
Economic controls, whether for prices, currencies, or imports should be added and removed gradually. For example, the government can set a date, such as June 2015, when most price controls will be 100% eliminated. This can be phased out by letting prices rise 16% each month until it has risen to the market price.
For example, if the market price of bread is $1 but controlled to $0.50, its price will be allowed to rise per month as follows:
- January $0.58
- February $0.66
- March $0.74
- April $0.82
- May $0.90
- June $0.98
Only the weakest in society, such as senior citizens and the disabled, will enjoy controlled prices, significantly reducing the enforcement burden on the government. A phased approach will prevent hoarding especially if the price increases are done in a weekly or even daily basis, as the changes will be very small. Of course, the government can choose how long this phase out process should be so as not to create unrest. The number of producers will increase each month as prices rise and the competition of the producers will prevent prices from going beyond the estimated market price. The main duty of government in this phase is to ensure that no single company is large enough to control prices, otherwise, the oppressive control will merely transfer from the government to that single company or cartel.
The gradual elimination of price controls will cause previously hoarded goods to be gradually released back to the market. This is because those hoarded goods will provide no profit after goods start to become more abundant, as explained by Smith:
- “The corn merchant, from excessive avarice, might raise corn prices higher than needed. He is likely to suffer the most by this excess of avarice because he must sell his leftover corn at a loss if the next season proves abundant.” (Simplified WN, Book 4, Chap. 5)
The ultimate goal of removing price controls is to encourage production across the board. If a producer knows that he can set proper prices after six months, then he will use the six months to prepare to rebuild his capital, hire workers, and re-start production whether it be agricultural, industrial, or service in nature, because demand is very high (recall that Chavez’ social programs increased the demand of the poor). If a consumer knows that prices will be higher in six months, then he will reduce his expenses and focus only on essentials. If the consumer is rich, then he must convert his cash into investments to avoid it from being eaten up by the perceived inflation.
The government can use people’s investments to add to national productivity by funnelling it into cooperatives or profitable long-term government projects such as its oil and mining ventures.
But removal of the price controls of 2003 will only remove inflation gradually in the long term. Sudden inflation, like the one in 2002 which led to the price controls, will still happen unless expropriations are stopped. Part 3 explains why such expropriations cause sudden inflation.