Sunday, July 10, 2005

The incredibly shrinking Venezuelan private sector

I am quite happy to see that my long post on the Venezuelan situation is stirring some serious feedback (1). To the point of receiving this letter from "An Interested Observer". Quoting my post, he developped one of the ideas (calling it intuitive, accurately, but my intuition is good :) to sustain that idea. Namely, the Venezuelan private sector is not doing as good as what some people in the government would like us to beleive. Without further ado, you can read next this good economic explanation of what is in store for Venezuela.

Indeed, the petrodollar windfall is felt and there is an impression of economic growth as commercial activity has restarted and as, without question, the lowest income sectors of the population have benefited from the social programs developed since early 2003. It is possible that eventually this will translate in real solid economic growth but so far the signs are not encouraging. Venezuela seems intent on, again, increase the portion of the public sector, already huge, at the expense of the private sector. This has never worked anywhere.”

The above is part of our bloghost’s summary of the current state of Venezuela. While I gather that it was a rather intuitive assessment, the numbers certainly bear him out.

First, let’s talk about the good news in 2005. GDP (PIB) growth for the first quarter was 7.9% when compared to the first quarter of 2004. This is not nearly as large as the increase last year, but that was compared to a period that contained the end of the general strike. 7.9% is an excellent number, one that most countries would gladly trade for. Another piece of good news is that the price of the Venezuelan oil basket went up from $28.18 to $38.39 in the same period (again just comparing the two quarters), over a 36% jump. More money for oil means more money in Venezuela.

But since oil income is so fundamental in the Venezuelan economy, it raises a significant question: how much of the GDP growth is due to the increase in oil price, and how much would GDP have grown without it?

I’ll spare you the number crunching (if you really want to know, ask me in comments), but if you multiply the amount by which ordinary public spending increased in a year by the public share of GDP (all figures from the BCV, not private estimates), you find that the GDP increase from that alone would have been 6.7%.

This implies that growth from anything other than an increase in government spending (i.e., from extra money available due to price increases) was 1.2%. Unfortunately, the real news isn’t even that good.

In economics, there is something called the multiplier effect. Put simply, it means that each bolivar in the currency – including new ones – gets spent more than once over the course of a year. (Think about little time they spend in your wallet and bank account!) The only economics textbook on my desk to give a numeric value says an ordinary multiplier is around 2. (See also Wikipedia.)

If the multiplier is two, then the total effect of the increase in government spending should have been 13.4% GDP growth in the first quarter! The actual growth would be attributable to only the extra spending if the multiplier were only 1.18. I think two is an overestimate for a number of reasons: it’s the value for the US economy, and the Venezuelan economy is not so efficient and steady; since not all of the new money can be re-spent in the same quarter, the effect from prior quarters – when spending was lower – would be less; inflation may also have a negative effect, since each bolivar injected last year is worth less now; the government is currently importing loads of products, which makes the multiplier for that money exactly one, since it leaves Venezuela.

The real paradox about this is if the multiplier is very low (below 1.18), the private economy is generally in bad shape but is currently growing more. The better off the economy is right now (the higher the multiplier), the worse its prospects for the future. Regardless, without oil money, the private sector would not be driving up growth this year.

I’m not the only one who foresees a doubtful future for the Venezuelan private sector. Banco Mercantil just released a forecast (some of it is here, but the statistics I’m using were only published in a table in the print edition July 4) which implies (I had to calculate) that private sector GDP will grow 21% this year and only 10.6% next year – in nominal terms, i.e., before inflation. Even with the tremendous influx of oil money, private sector GDP growth will be less than the current growth rate – unless inflation ends the year at 12.1% or less. (It was 8% for the first 6 months.) According to Mercantil’s estimate, private GDP will begin shrinking next year if inflation is anywhere above 10.6%. I have a report that consolidates predictions from various analysts, and the average value from seventeen of them for 2006 inflation is 20.9%. With that result, the private sector GDP “growth” in 2006, even WITH new oil money, would be -8.5%!

Indeed, as Daniel says, the signs – especially over the longer term – are NOT encouraging, as it appears that the private sector will begin shrinking, not only relative to the rapidly expanding public sector, but in absolute terms, very soon. If it hasn’t begun already.


Write to AIO

1) Just a reminder. This blog is open to letters on relevant topics, even if they are only half this well presented :-) Even from pro Chavez people if they can sustain arguments this well. Of course I am the sole judge in my own little "ley RESORTE" world. AIO is the fith person to honor this blog with his/her work and I have no problem offering my blog for more good work from other folks.


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