By Ricardo Hausmann Mareeg.com-CAMBRIDGE, MA – 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
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. But it
is certainly possible to describe how the road to hell is paved, whatever the
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
For example, Brazil has wreaked havoc on the financial health of its national oil
company, Petrobras, in order 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.
But things become really nasty when the government opts for foreign-exchange
controls. The usual story, nicely summarized by the late Rüdiger Dornbusch and
Sebastian Edwards, is that lax fiscal and monetary policies cause a flood of freshly
printed currency to chase more 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
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.
But controls lead to a parallel exchange rate, which can be either legal, as in
Argentina, or illegal and even unpublishable, as in Venezuela.
But 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 ten 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. But 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 Hugo Chávez was first elected President in 1998, the Venezuelan
bolívar could be exchanged for 2,610 Colombian pesos. Today, despite a raft of
foreign-exchange controls, a bolívar 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.
source : Project Syndicate, 2013.