Venezuela in Chaos

Venezuela has enormous oil reserves, it has been selling oil for nearly a hundred years, and its people are impoverished. So what went wrong? Some say it is a fine example of the failings of socialism, but in fact it was plutocratic capitalism that set the rot in place.

Venezuela was possibly the richest country in South America before it struck oil. Because there was so much of it, foreign oil companies poured in, as did their money. This caused the local currency to increase wildly. The oil companies paid locals huge salaries or wages, and the growth was so pronounced that any reasonable contractor worked in the oil industry. That meant that people left agriculture and manufacturing by locals was squeezed for capital.

Worse, when the politicians become corrupt, which is easily done when law and order is weak and there is money flowing like water, the average person was overlooked and they slid into poverty. At first the plutocrats simply walked off with the profits but by 1950 the government reformed the industry and required half the profits to go to the state. This had the effect of making the government essentially totally dependent on oil money. For Venezuela the effect has been so dramatic that oil now accounts for about 98% of its exports, and up to 50% of its GDP. In the 1970s, the Venezuelan government received huge incomes, which led to rampant mismanagement and embezzlement. In the 1980s oil prices plummeted and Venezuela sustained rampant inflation and massive debts, in part due to government investments offshore that were not exactly wise. The IMF gave its usual recipe: austerity, and there were major riots. Austerity hurts the poor, while the rich remain unscathed, which may be why the bankers of the IMF favour it.

In 1998, Hugo Chavez was elected President on a socialist pledge, and while he did significantly improve the lot of the average Venezuelan, he also badly mismanaged the oil industry and the economy in general. Chavez also bailed out Cuba by supplying it with oil, and also managed to greatly increase national debt. His government was authoritarian, and when he was replaced by Maduro, the latter has probably become more authoritarian.

Maduro inherited a mess, and he was not gifted with luck. Between 2014 – 2016, oil prices slumped by a factor of three. The government gets out of its debt problems by inflating the currency, which may be running at a million per cent now. The effect of this is the impoverishment of the middle classes. The very rich get richer by picking up assets at a huge discount in forced sales. Currently, 90% live in poverty.

There are various opinions on what should have been done. The most obvious one is to have strong law and order and fiscal responsibility. The second is to ensure the wealth is controlled. A good example of this is Norway, where oil contributes 80% of its exports, but only 22% of its GDP, and huge reserves are being held for the future. Another good example where I have lived was Calgary. The state government poured money into health care, which was extremely cheap when I was there, and they had excellent roads and general infrastructure. My opinion is that such resource-rich economies must invest a large amount of the income in broadening the economy. In Venezuela’s case, there has been economic broadening, although agriculture contributes only 3% of GDP. It is largely a food importer, for no good reason. Nevertheless, while exports total $32 billion, imports only total $17.75 billion. The problem is with government finance. It has income of almost $93 billion, and expenses roughly twice that.

Maduro replaced Chávez in 2013 and narrowly won an election. There was a recent election that Maduro also won, but which the opposition boycotted. There are accusations that the elections would be rigged, and since then there are accusations that they were, but if there were no opposition candidates that seems somewhat moot. It is one thing to complain that elections were rigged; an entirely different matter to assert they were going to be rigged. Two weeks later, Juan Guaidó, leader of the legislature, declared himself acting President. The US government has declared support for Guaidó and refuses to recognize Maduro, and threatens that if he does not step down, they will make him. They declare the election was illegitimate, but do not cite any grounds. Exactly how Guaidó declaring himself President is more legal eludes me. If the opposition did not stand, it is hard to see how Maduro could not win, and if simply boycotting an election was sufficient to overturn an election, why Mr Trump could consider what would happen if Hillary had boycotted their election. The US claims the majority prefer Guaidó, but arguably the majority voted for Hillary, and I don’t see Trump stepping down. Nor should he, at least on that ground. The rules are the rules. Trump has even hinted at military intervention. Other countries have backed Guaidó. Macron has argued he should note the protests on the street. So should Macron. Hypocrisy runs strong when politicians have a deep problem and they can divert attention from their own failings.

The Venezuelan military is at this moment behind Maduro, and while that is the case, short of a massive US invasion, he is likely to stay there, and the Venezuelans are likely to stay poor. US sanctions are not helping, but US sanctions have been there for quite a long time and are not recent, although the recent freezing of oil money will hurt the poor even more. The history of US intervention is not good, the worst example being, in my opinion, the removal of Allende in Chile, which occurred because (a) he was a socialist, and (b) US corporations could control the copper. The fact that Pinochet murdered a large number of Allende supporters bothers not the US conscience. I heard one speech where it was stated that control of the oil industry would make things better for Venezuela and the US. So at least someone in Washington thinks US corporations should have the Venezuelan oil.

So how do they get out of this mess? Who knows? The economists say Venezuela must diversify its economy and do a number of other things, but the problem is with most of the population impoverished, they cannot start much. One thing I have learned while running my own business is that if you have no money, you are screwed. So what will happen, other than the poor becoming poorer? Who knows?

Trump on Taxation

President Trump has announced the intention to make sweeping tax reform, and a significant tax reduction for companies, at present reducing from 35% to 16%. His argument is that by doing this, he will encourage multinational companies to stop hoarding money in offshore tax shelters and bring it back to invest in the US. So what to make of this? The tax reform is an extremely good idea. The simpler and more transparent the tax law is, the less time everybody wastes on minimizing tax and the more they devote to actually earning money. Everybody accepts tax reduction is good for them, but the problem then is, does the government earn enough money to pay for what it wants done? That is a detail that has to be left because it depends on what is available to tax, and how much the government wants to spend.

Company tax is an odd animal because one argument is that you collect more or less the same tax irrespective of the rate. It goes like this. A company earns money, but those earnings are spent in four basic ways: investing in new plant; buying goods/services from other companies; paying staff; paying dividends. Looking at these in inverse order, money transferred to dividends becomes personal income, and that is taxed, so what we are avoiding is double tax. Many countries avoid such double taxation by giving company tax credits with the dividends, and while I am unaware of US tax policy on this, as a general rule as long as there is no double taxation, lowering the company tax rate has no adverse effect on dividends because those on the low tax rates in general cannot afford the stock. The important thing is that unlike people, companies do not spend on themselves, leaving aside “perks” such as company jets. My view is such “luxury expense” for senior staff should be taxed as a personal benefit to them.

Paying staff means the staff pay tax on their earnings. Now, if the staff are low paid, lowering company tax does reduce the tax collected, because most staff do not pay the 35% rate, although some may be on a higher rate. Similarly, buying goods and services from other companies simply transfers the taxable profits, although if the goods are imported, the profits go elsewhere. The question here is, then, will the US increase local production? The reason many multinationals manufacture offshore is that wages there are seriously lower, and they do not have to pay benefits and compliance is less strict. There is rationality in thinking that such goods manufactured offshore should be taxed as if the company met home compliance and had paid home benefits and wages because that levels the playing field from the “own country” point of view, but of course it hurts developing countries.

The virtuous part, according to Trump, is that by lowering company tax, multinationals will bring back more of the offshore funds accreted, and all companies will have more money to invest and create new jobs, or pay dividends. The next question is, is this valid reasoning? I am not so sure. The problem with investing to create new jobs is you have to have something to invest in. That is not so easy to find. There is no real evidence that company tax is inhibiting investment because there is no real evidence that, leaving aside small individual companies in trouble, there is a widespread shortage of money. What I see is more a general shortage of ideas. Thus we see the new product is another mobile phone that is only a little bit different from the last one. Ask yourself this: what would you really want that is not currently available if you had the money to buy it?

What that suggests is the economic slowdown is not caused by higher corporate tax, but more through inequality. Those with money already have most of what they want, and those without money cannot afford much of what is there. If we really want to promote growth, then I am afraid the poorer have to have more purchasing power, because they are the only ones at the moment who could power acceleration in sales. Of course the rich will keep on buying, but only at their current rate, and that will not power the growth President Trump wants. So my question is, will President Trump do anything to reduce inequality?

Inequality by country

In the previous post, I produced an oversimplified model that showed why inequality in income is inevitable, and that raises the question, can something be done to modify that, and if so, is it desirable to do so? To answer that sort of question, first we should look at where the inequality is, because different countries have different economic policies. First, there has to be a measure of inequality, and economists have created something called a Gini index to measure this. This registers a country using values between 0 (everyone has exactly the same wealth) to 1 (one person has the lot). The journal Science produced maps to compare countries. The US had a Gini index of 0.4 in 2010. What does that mean? Apparently, the top 1% controlled nearly 20% of US income, but the 99% is also unevenly spread, as my crude model would have predicted. In 2012, the top 20% of Americans enjoyed over 50% of the US income, up from 43% in 1967, and this is presumably due to very many more higher incomes for the tech-savvy graduates of Silicon Valley and similar places. Thus this increase is in part due to more investment in education, and that does not seem wrong, at least to me. The middle 20% received about 14% of all income, and the bottom 20% about 3% of the income. That should not be a total surprise to those who followed the logic of my crude model.

Now, if we look at other countries, we see some odd results. One of the more common results in the Science article was “no data”. However, the countries with most equality tended to be Scandinavian countries, parts of the old Soviet Union (some “Stans”, Belorus and Ukraine) and some of the old “Iron Curtain” countries, such as what was Czechoslovakia, Hungary, and one or two others. The most uneven country was South Africa, with some African and South American countries running fairly close behind.

What can we conclude from that? The extreme value for South Africa probably lies in the historical tying up of the mineral resources such as gold and diamonds by a few hands. The second point is that for historical reasons there is more than one society there, and while efforts are being made to integrate these and give more opportunities to those previously deprived, in fairness there is only a limit to what can be done in a short time. Whether that limit has been reached is another matter. Equality does not depend on wealth, but probably more on social policy, thus Scandinavia has plenty of wealth, particularly Norway, but the money has been mainly put aside by the government, thanks to royalties on oil production and very progressive taxation. Similarly, many of the countries in South and Central America have been plagued by right wing governments, including dictatorships, and these are centres for much greater inequality.

This suggests at least two points. The first is that inequality is the greatest the further the society is away from general near equality. In other words, as my model suggests, the more time there is to develop free of external influences, the greater the inequality. The second is that the more progressive the taxation, the more equal the society. Unfortunately, that is not a free ride, as it often leads to a transference of wealth, when the rich simply pack up their bags and go to somewhere with a more friendly taxation policy. What to do about inequality, if anything, is quite a difficult question to answer.

Inequality in Society

By now, just about everyone will have heard about Thomas Piketty, who has claimed that the world inequality is getting worse and inevitably it will get much worse, on the grounds that wealth generates wealth. He has been attacked from various quarters, usually on relatively irrelevant details, for example that some of the data in his statistics are not quite right, but so far nobody has provided a knockout blow. Now, in

a recent edition of Science, where a number of articles addressed this issue of inequality of income in the world, one particular item took my attention: it arose from some physicists who argued such inequality is natural and arises from considerations similar to those of the second law of thermodynamics. Very specifically, they consider the statistical origin of entropy, and argue that a distribution of wealth where everyone has the same is just one of very many distributions, so it is extremely improbable when one considers how wealth evolves. 

One way to illustrate the concept is to construct a simple model, and this is instructive (in my opinion, anyway) because it also shows something about models. Consider a game with these rules. There are 128 participants, and they play in rounds, and every round the players earn one credit. At the end of the round they may spend any of what they have, or they can save. If they get four credits, on the next round they get a bonus credit (return on investment) and they also have the choice of borrowing a further four credits. To further simplify, assume there is a fifty per cent chance of taking a specific option from the choice of two, and if the option is to spend, the choices of how much is evenly divided amongst the options. Now, watch how this game evolves.

At the end of round 1, each player has 1 credit, and half elect to spend it, which gives 64 with 1 credit and 64 on zero. Following round two, half of the first 64 continue to save, and half of those who choose to spend use one credit and the other half both credits. So we now have 32 with two credits, 48 with 1 credit and 48 with none. The reader can keep this going for himself, but it soon becomes apparent that 8 soon reach the 4 credit mark, at which point they get their bonus, then two will further invest, and of these, 1 will take the option of borrowing, and that one gains two each round, even though by borrowing he effectively has to repay at some stage. So, after five rounds, out of 128 originals, 1 has got ahead of everyone else, and only one other is close behind.

 

The analogy with entropy is as follows. In statistical thermodynamics, the entropy of a state is proportional to the logarithm of the number of ways of forming it, and the more ways, the higher the entropy. The second law says a system tries to maximize entropy. There is only one way to get to maximum wealth, while there are many ways to get a low wealth.

You may protest that this game is too crude, and you would be right, but it shows something about models. The first point about models is you have to get all the equations (a numerical statement of the rules) down and you have to accurately fix all the constants and functions. In this example, all earnings are in units of 1 (a constant) but in practice, it will be a distribution. Similarly with investment returns, and there are a number of other problems. Nevertheless, this simple model gives a qualitative result that matches reality: the distribution of wealth will always be unequal because different people make different decisions on what to do with what they earn, and the effects become very pronounced quite quickly. What this model has really done is not to predict social behavior, but rather to show the effects of a proposition, and that is where models are strong.