Venezuela’s Tragic Collapse

 

Venezuela’s catastrophic social and economic collapse, the result of two decades of authoritarian populism, shows the precariousness of development for countries with weak institutions. Similar forces in recent times have brought misery to Zimbabwe and threaten both South Africa and Brazil.

Once Latin America’s richest nation, a thriving middle-income democracy which attracted immigrants and capital investments from around the world, Venezuela fell prey to Hugo Chavez, a charismatic “caudillo,” who promised a “Bolivarian Revolution” to bring social justice and prosperity for all.

Chavez cleverly exploited a serious economic downturn in 1998 in Venezuela caused by a collapse in oil prices, and he also tapped into popular disenchantment with a democratic regime marred by corruption, mismanagement and by a failure to renew its leadership. At year-end 1998, Chavez was elected president on a populist, anti-establishment, “drain-the-swamp” platform.

Chavez faced severe opposition in his early years. His efforts to concentrate power in the presidency and weaken the judiciary were rebuked by an anxious middle class, the media and the business community, and he was almost ousted by a military revolt in 2002.

But then, the winds of fortune changed for Chavez. Just as he was doubling down on his Bolivarian Revolution by purging the military and the national oil company PDVSA of “anti-revolutionaries” and accelerating the nationalization of industry and the socialization of farming, oil prices began to rise because of the China-fueled global commodity boom (2003-2012). At the same time, the global capital markets opened for Venezuela, and the country began a massive credit-binge. Accompanied by price controls, all of this created an enormous temporary illusion of prosperity.

Though the George W. Bush Administration initially took a strong stand against Chavez, once Chavez was able to use the oil bonanza and foreign credit to fund social programs the apologists for the regime started to dominate the discourse. Perhaps swayed by a parade of intellectuals and Hollywood figures who fell for the Chavez charisma and sang the praises of his Cuban-designed social programs, the Obama Administration sought to normalize relations with Venezuela. President Obama also heaped praise on Brazil’s President Lula (“That’s my man right here… Love this guy. He’s the most popular politician on earth.”) whose popularity also increased in line with commodity-boom-fueled economic growth and ample global liquidity. Eminent economists like Joseph Stiglitz, Noam Chomsky and Paul Krugman and institutions like the World Bank also fell in line and lauded Lula and Chavez for improving wealth distribution and giving the poor access to public services. Hollywood director Oliver Stone released a fawning documentary on Chavez in 2009 (South of the Border) acclaiming “a triumph for Venezuelan democracy” and an “alternative to capitalism.”

Washington abdicated its traditional strong influence on Venezuelan affairs in deference to South American sensibilities on non-intervention and in response to a vigorous defense of the Chavez regime led by the leftist governments of Brazil and Argentina. A policy of appeasement was taken as Venezuela pursued its course towards dictatorship and economic collapse.

The plummeting of oil prices in 2014 brought Venezuela’s dream of an alternative capitalism to a brutal end. Chavez had the good luck of dying just before the global capital markets shut down for Venezuela (2013) and oil prices collapsed (2014). He left the country and his successor, Nicolas Maduro, with gargantuan deficits and rampant inflation. Over the past three years, Venezuela has suffered what is perhaps the worst economic collapse of any country in modern history. Harvard Professor Ricardo Haussmann, a Venezuelan who served as planning minister in 1992-93, has documented the extent of the collapse (Venezuelan Tragedy, FT AlphaChat):

  • Output from the productive sector of the economy has fallen by 55% since 2013.
  • The median household wage at the black-market rate is $20/month, and buys 7,000 calories/day compared to 55,000 in 2012.
  • Collapse in public services and health standards are “beyond belief,” and Caracas is the murder capital of the world.
  • Assets of the financial system have fallen by over 90% since 2012 and the banking system has essentially ceased to exist.
  • Public external debt rose from $24 billion in 2004 to $178 billion today, of which $56 billion is owed to China. Haussmann questions the ethics of this lending which served only to prop-up the regime, and he is particularly critical of a recent $850 million “odious” transaction with Goldman Sachs carried out with an expected yield of over 50% annually.
  • To remain current on the servicing of the foreign debt the government has cut imports by over 80%.
  • The productive capacity of PDVSA has been compromised, with oil output falling from 3.7 million barrels/day in 1998 to 2 million today. PDVSA has become the funder and administrator of social programs and the primary locus of corruption.
  • Nationalized firms have been decimated. For example, the steel company, SIDOR, now produces 200,000 tons/year with 22,000 workers, compared to 4.5 million tons with 5,000 employees before.
  • The private sector has been destroyed by expropriations and price and currency controls.

The damage done is irreparable and Venezuela will take decades to recover. The country has become one of the most hostile places to run a business in the world, ranked 187th out of 190 countries in the World Bank’s Ease of Doing Business 2017 survey, surpassed only by Libya, Eritrea and Somalia. An enormous brain-drain of educated Venezuelans working in the oil sector and the private economy and the closure of thousands of businesses can only be reverted over time. Haussmann points to Albania, the former basket case of Eastern Europe that has started a recovery process over the past twenty years, as a source of hope.

Hopefully, the United States and the global community will orchestrate a massive humanitarian and financial effort to help Venezuela recover once the Bolivarian Revolution dies.

Why has Venezuela’s tragic collapse happened?  It took a coincidental combination of a charismatic demagogue and discredited institutions for the process to be triggered and a pliable and easily hijackable political system for it to flourish. Fortunately, in Brazil, at least for the time being, the judiciary, the press and the political establishment have been able to thwart Lula’s project.

Us Fed watch:

China Watch:

China Technology Watch:

  • How Baidu will win the global AI race (Wired)
  • China leads the world in digital economy (McKinsey)

EM Investor Watch:

  • Russia is becoming a food superpower (Bloomberg)
  • Norway’s sovereign fund drops EM bonds (Bloomberg)
  • Emerging Markets look undervalued (Seeking Alpha)
  • No crisis in Venezuela (Al Jazeera)
  • How Western capital colonized Eastern Europe (Bloomberg)
  • From Soviets to oligarchs (NBR Working Papers)
  • Emerging Markets are turning the corner (Seeking Alpha)
  • Understanding the Russian mind-set (Spiegel)

Technology Watch:

  • Pandit says 30% of bank jobs will disappear in next 5 years (Bloomberg)
  • Nike’s Static-Electricity robots (Bloomberg)
  • Government Investment was key to US success (Teasri)

Investor Watch:

The EVP of Johnson and Johnson’s consumer products  did a great job of summarizing the immense challenges facing the industry and features heavily in this week’s post. He argues that historical barriers to entry are crumbling and that data is the new barrier to entry. It’s an interesting thesis, and only time will tell if it’s the right one, but it explains why companies are scrambling to use machine learning to make sense of the data that they have access to. One might wonder though, if old-line companies are leveraging tech companies’ cloud and engineers to unlock insights into their data, who’s data is it anyways? (Avondale)

Consumer:

The head of J&J’s consumer division laid out the problems facing consumer products companies:

Competitive advantages are being dismantled

“the reality is that the pace of change in our industry is truly accelerating…If you look at our last few decades in this industry, there were a series of barriers for entry or sources of competitive advantage that were well established but those are becoming less and less unique.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s hard to have a monopoly on talent

“It used to be that companies like ours would acquire the best talent through our recruiting human resources mechanism, but it’s never been easier for you to source great talent across the world on demand.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s never been easier to build a brand

“Our ability to build and nurture brands, brand building competencies used to be again a source of competitive advantage but the reality is it’s very easy for you to start building a business, building a brand from scratch and you really don’t need a ton of money to get a community of active users that support you.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s not hard to access global manufacturing expertise

“Large scale manufacturing assets used also to be a source of competitive advantage. But the reality is if you want to compete in this industry, you can access high quality contract manufacturing work any place in the world.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Retailer relationships are no longer a moat

“Retailer relationships used to be also a source of advantage and a barrier for entry, but as you all know, new companies can now sell directly to consumers profitably in most markets. And then financial firepower for companies like J&J is not as critical as it used to be because new startup entrants can access capital relatively easy through VCs.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

The disruption is digitally enabled

“So this disruption that is happening is digitally enabled and is changing the face of our industry. You see these new players coming into our category and at the heart of this disruption, there is a new consumer centric paradigm and that’s challenging completely the cost of goods scale and the value scale as we know it and its forcing a change in both the retail and the media landscape.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Small companies are succeeding because they stay close to the consumer and have digital DNA

“small players are the ones that are gaining share and majority of large companies are losing market share…they are really committed to breakthrough innovation by staying really close to consumers and customers and staying on top of consumer trend. They see where the product is going and they are designing to what that emerging consumer need is. They are focused on building digital first brands that have a clear purpose and a reason for being that resonates with millennial consumers. They capitalize on the rise of emerging channels. They don’t just play in the legacy channels but they figure out what are the new shopping behaviors, new emerging channel trends and they disproportionately drive growth in those channels. They are hyper efficient. Normally have very lean cost structures, flat organizations, no bureaucracy and as a result they move very fast. Speed is a great currency for them.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Big companies are becoming value added VCs

“the innovators are launching hundreds of new products every year. But once they’re successful, they all have the same kind of issues, issues like buying, procurement, like selling, distributing, manufacturing and capital. And so, we have a venture group that we started about ten years ago and, basically, it goes out to all the entrepreneurs and says, instead of going to private equity to get money, why don’t we work with you, we’ll invest in you and we’ll help you. And we’ll help you take your idea, solve some of the issues you might have, and we can see how you can be a part of what we’re doing and we can help you achieve your dreams as an entrepreneur…All of that allowing us to kind of source external innovation, so that when you take a healthy core, build strong, new businesses, and then bring all the next businesses in, it gives you a sustainable top line.” —Coca Cola EVP Sandy Douglas (Beverage)

Data is the new barrier to entry

“And what we’re seeing now is there is a new playbook emerging, a new how-to-win playbook that is really characterized by an asset light infrastructure. And the control of the consumer relationship, via the acquisition of the…data that allows for you to have a highly personalized iterative on demand consumer experience. And the ownership of this relationship with consumers and associated ecosystem that comes with it is now the new playbook. It is now the greatest new source of competitive advantage.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)