It is often difficult to understand how countries that are dealt a pretty good economic hand can end up making a major mess of things. It is as if they were trying to commit suicide by jumping from the basement.
Two of the most extreme cases (but not the only ones) are Argentina and Venezuela, countries that have benefited from high prices for their exports, but have managed to miss the highway to prosperity by turning onto a dead-end street. They will eventually have to make a U-turn and backtrack over the terrain of fictitious progress.
The puzzling thing is that this is not the first time either country has veered into an economic cul-de-sac. It has been said that only barbers learn on other people’s heads, but some countries seem unable to learn even from their own experience. The ultimate reason for such self-destructiveness may be impossible to identify. However, it is certainly possible to describe how the road to hell is paved, whatever the intentions.
It all starts when some imbalance causes overall inflation or some key price — typically the exchange rate, but also power, water and gasoline — to come under upward pressure. The government then uses its coercive power to keep a lid on price growth.
For example, Brazil has wreaked havoc on the financial health of its national oil company, Petrobras, to keep gasoline prices low. Argentina destroyed its natural-gas sector with price controls. Many countries have kept power and water prices too low and have ended up with shortages.
However, things become really nasty when the government opts for foreign-exchange controls. The usual story, nicely summarized by the late Rudiger Dornbusch and Sebastian Edwards, is that lax fiscal and monetary policies cause a flood of freshly printed currency to chase more US dollars than the central bank can provide at the going exchange rate. Rather than let the currency depreciate, or tighten its policies, the government opts for foreign-exchange controls, limiting access to dollars to those who “really” need it and thus preventing “speculators” from hurting “the people.”
Foreign-exchange controls, typically accompanied by price controls, give the government the sense that it can have its cake (lax policies) and eat low inflation. However, controls lead to a parallel exchange rate, which can be either legal, as in Argentina, or illegal and even unpublishable, as in Venezuela.
However, having two prices for an identical dollar creates enormous arbitrage opportunities. A dollar purchased at the official rate can be sold for almost twice as much in the “blue” market in Argentina and a whopping 10 times more in Venezuela. Repeat that game a few times and you will be able to afford a corporate jet. Nothing becomes more profitable than over-invoicing imports and under-invoicing exports. In Venezuela, importing spoiled food and letting it rot is more profitable than any investment anywhere else in the world (disregarding, of course, the bribes needed to make it happen).
The dual-exchange-rate system ends up distorting production incentives and causing the effective supply of imported goods to decline, leading to a combination of inflation and shortages. Here, things turn interesting. Public spending tends to rise with inflation more than government revenues do, because revenues depend on the tax on exports, which is calculated at the pegged official exchange rate.
So, over time, fiscal accounts worsen automatically, creating a vicious circle: Monetized fiscal deficits lead to inflation and a widening gap in the parallel exchange-rate market, which worsens the fiscal deficit. Eventually, a major adjustment of the official rate becomes inevitable.
For example, when late Venezuelan president Hugo Chavez was first elected in 1998, the Venezuelan bolivar could be exchanged for 2,610 Colombian pesos (US$1.35). Today, despite a raft of foreign-exchange controls, a bolivar is worth barely 300 pesos at the official exchange rate (which is soon to be readjusted); one would be lucky to get 30 pesos at the black-market rate. Not surprisingly, prices in Venezuela rise in one month more than they do in two years in neighboring Colombia.
Why do countries opt for such a strategy? Any system creates winners and losers. In Argentina and Venezuela, the winners are those who have preferential access to foreign exchange, those who benefit from the government’s profligacy, those who can borrow at the negative real interest rates that lax policies create and those who do not mind waiting in long lines to buy rationed items.
Such a system can generate a self-reinforcing set of popular beliefs, which may explain why countries like Argentina and Venezuela repeatedly drive down dead-end streets. Because so many businesses make money from the rents created by the rationing of foreign exchange, rather than by creating value, it is easy to believe that markets do not work, that entrepreneurs are speculators and that governments need to control them and impose “fair” prices. All too often, this allows governments to blame the car, and even the passengers, for getting lost.
Ricardo Hausmann is a professor of economics at Harvard University, where he is also director of the Center for International Development.
Copyright: Project Syndicate
Could Asia be on the verge of a new wave of nuclear proliferation? A look back at the early history of the North Atlantic Treaty Organization (NATO), which recently celebrated its 75th anniversary, illuminates some reasons for concern in the Indo-Pacific today. US Secretary of Defense Lloyd Austin recently described NATO as “the most powerful and successful alliance in history,” but the organization’s early years were not without challenges. At its inception, the signing of the North Atlantic Treaty marked a sea change in American strategic thinking. The United States had been intent on withdrawing from Europe in the years following
My wife and I spent the week in the interior of Taiwan where Shuyuan spent her childhood. In that town there is a street that functions as an open farmer’s market. Walk along that street, as Shuyuan did yesterday, and it is next to impossible to come home empty-handed. Some mangoes that looked vaguely like others we had seen around here ended up on our table. Shuyuan told how she had bought them from a little old farmer woman from the countryside who said the mangoes were from a very old tree she had on her property. The big surprise
The issue of China’s overcapacity has drawn greater global attention recently, with US Secretary of the Treasury Janet Yellen urging Beijing to address its excess production in key industries during her visit to China last week. Meanwhile in Brussels, European Commission President Ursula von der Leyen last week said that Europe must have a tough talk with China on its perceived overcapacity and unfair trade practices. The remarks by Yellen and Von der Leyen come as China’s economy is undergoing a painful transition. Beijing is trying to steer the world’s second-largest economy out of a COVID-19 slump, the property crisis and
Ursula K. le Guin in The Ones Who Walked Away from Omelas proposed a thought experiment of a utopian city whose existence depended on one child held captive in a dungeon. When taken to extremes, Le Guin suggests, utilitarian logic violates some of our deepest moral intuitions. Even the greatest social goods — peace, harmony and prosperity — are not worth the sacrifice of an innocent person. Former president Chen Shui-bian (陳水扁), since leaving office, has lived an odyssey that has brought him to lows like Le Guin’s dungeon. From late 2008 to 2015 he was imprisoned, much of this