In Part 2, we explained that Venezuela’s government must change from economic controller to economic regulator in order to facilitate economic freedom to all Venezuelans, whether rich, poor, skilled, or unskilled. This will allow the possibility of removing oppressive controls, the worst of which are price controls. This is because prices are subjective and have psychological roots. High prices for a buyer is higher toil, while high prices for a seller is higher reward or pleasure. Both buyers and sellers are humans, but the difference in their relative positions in economic activity create their opposing interest in prices. If two humans have naturally opposing interests, how can there be a healthy and vibrant economy? This is done by uniting their interests through employment which will be explained next.
Allowing all prices to gradually rise to their market rates will encourage more selling of goods as it directly increases the reward of the seller. Having more goods in the market will prevent shortages and will not lead to excessive prices since supply will be plentiful. Only scarce items have exorbitant prices. The toil from higher prices, from the buyer’s view, is removed by increasing his purchasing power, which is established by employment. Through employment, such buyers become sellers of their own work for a price which is called a wage or salary. Since all prices are allowed to rise, then wages or the price of work can also rise to match the rise of the prices of goods. The basic difference between controlled and uncontrolled price scenarios is the abundance and variety of supply in the latter, caused by the natural incentive for production and work.
Thus, work and useful employment are the most important factors determining national wealth as it directly leads to production which then provides food, medicine, houses, cars, etc. But recall that Venezuela’s employment rate, though not ideal, has risen since 1999 and is not the problem. The quality of the workers is also not a problem since secondary and tertiary enrolment has increased considerably. If human capital is not the problem, then it leaves other fixed capital as the cause of the productivity problem, after price controls.
Smith’s Definition of Capital
Smith defines capital as anything that produces anything with exchangeable value to society. This is different from its current definition which equates capital to assets. This is because Economics was created according to business interests. The main interest of businessmen is their balance sheet and income statements. Thus, capital nowadays only refers to the left side of the balance sheet (cash, equipment, etc), entirely neglecting the human aspect.
To Smith, capitals are divided into fixed and circulating capitals. Fixed capital is divided into:
- Useful machines and tools
- Useful buildings and structures
- Land and land improvements such as irrigation
- Useful Skills or human capital
Circulating capital is divided into:
- Money which circulates goods between people
- Raw materials
- Finished and unfinished goods
Thus to create industry, all factors must work together::
Industry = Human + Fixed Capital (machines, buildings, land, skills) + Circulating Capital + Work
Based on Smith’s formula, we rule out the human factor as the cause of Venezuela’s productivity problem since the population did not decline and skills did not decrease. We initially rule out local Circulating capital as the origin of the problem since money could be printed and raw materials could be grown or mined. We rule out work because employment rose. Thus, we are left with machines, building, and land as the cause.
How Venezuela Lost Its Fixed Capital
Since price controls in 2003 and Currency controls in 2002 were responses to inflation, it means the origin of the low productivity occurred before the end of 2002. As our analysis starts at the end of 1999, we can only look for possible causes from 2000 to 2002. This means a great change must have happened then, which affected fixed capital and caused inflation.
Fortunately, history corresponds with our hypothesis. In November 2001, Chavez enacted 49 reform laws which were not approved by the National Assembly. The most impactful of these laws introduced reforms on land and oil industry which suddenly and forcibly transferred ownership of land and oil interests from private hands to the control of the government. This violates Smith’s rule that any big change should be implemented gradually. The immediate effect was a sudden drop in industrial production from $174b in 2001 to $131b in 2003. Production rose back above its 2001 level in 2005. Had Chavez studied Smith, four years of suffering could have been avoided.
The ownership of fixed capital (land, machines, factories) was transferred from those who had the skills and experience to produce, to those who had less or no skills to produce. This led to low production which led to inflation which in turn was aggravated with controls and more expropriation. In time, those who had no skills to produce can learn to produce and production can rise again. However, with controls in place, production cannot increase to the optimum level. With every expropriation, such as those in 2007 and 2008, production drops again sharply and only goes back up after some time. This is because a single big company or farm has many smaller companies which rely on it through its supply chain. Thus, industrial production dropped sharply from $227b in 2008 to $195b in 2010 and still far from recovery.
3. Stop Expropriations
To prevent the sudden drops in Industry, Venezuela must therefore stop expropriations. Without price controls, business competition itself will check prices and expropriations will be unnecessary. Government’s job is to ensure that competition is fair and no single company or landowner becomes big enough to control prices. In such cases, government must break up such companies and give land ownership to a group instead of to single individuals. Smith explains that since businessmen seek private pleasure from profits, their interests are frequently against those of society. The easiest solution is for government to use the selfish-interest of businessmen against each other through competition. By taking over the company or land, it must assume the role of a businessman or landowner which is not part of its dharma.
- Venezuela’s main problem is inflation which is caused by low production
- Sharp drops in production were caused by nationalizations, the largest took place in 2002 and 2007 and 2008 and is still currently ongoing. Though this problem occurred first, it is only a secondary contributor to current inflation.
- Without local production to supply goods, the shortage must be addressed by foreign goods, which must be bought with US dollars, making them more expensive (the price of the dollar inflates). Thus, currency controls are simply price controls for currency. Though this happened in 2002 after the nationalizations, they are only the third ranked contributor to the current inflation problem. We do not dwell on this because it will be solved naturally by dealing with the primary and secondary contributors.
- General drops in production were caused by price controls from 2003. Though this happened last, it becomes the primary contributor to the current inflation since it affects all.
To solve these causes, the following immediate solutions are proposed:
- Changing government’s mindset from an economic controller to an economic regulator and let the people make economic decisions themselves
- Gradually ending price controls in a phased manner
- Stopping expropriations to prevent further drops in production and instead making sure there is fair competition between businesses
There are other long-term solutions which can contribute to further increase Venezuela’s production of food, goods, and services. These include barter trade of oil for imports to remove the dependence on dollars, re-redistributing companies and land to groups of people who have the proven ability to raise productivity, and diverting some funds from social programs and oil revenue to firmly establish its manufacturing industry to remove its dependence on oil in the same way Qatar has turned to financial services and Dubai into property development.