What's wrong with Venezuela?


No, no prizes are won for shouting that Chavez is what's wrong with Venezuela. He's one thing that is but the malaise goes deeper than that. For he's not the first bad economic planner to have power in the country. A new paper tries to discuss what that deeper, underlying , problem is:

They find that the exceptional growth episode was due to a combination of plain old capital accumulation along with total factor productivity growth originating in the booming oil industry and its foreign direct investment transferring know-how to locals. The following collapse shows the undoing of this but with a very different origin. A severe misallocation of resources lead to a drop in total factor productivity, which then triggered capital loss. And how did the government manage to create the mess? First, it steered the economy away from oil, which may be a good idea for diversification. But the second error was to favor heavy industries, a common development mistake.

So there we have it: the sort of disaster that can happen from trying to grow the economy through localisation, infant industry protection and government planning.

For, as you can see, when foreign companies were investing in the country they were bringing with them the new and interesting ways of doing things, those higher productivity ways, which increase the wealth of the country. Note that these new ways only have to be a few percentage points more efficient than the local ways to more than cover the dividends and profits flowing out again.

But then, as so often in Latin America, there comes the idea that a country should be self-sufficient. So local industry is protected: meaning that those new ways discovered elsewhere don't take hold as the foreigners aren't allowed to bring them in. Result? stagnation of the economy.

It is possible to, in theory, suggest a way in which protecting local industries will make a country richer. But given that it's a big wide world out there, with all sorts of people in all sorts of places designing and inventing more efficient ways of doing things, deliberately cutting yourself off from those new ways leads to relative decline, not a growth in relative wealth.