Venezuela and Egypt

Foreign Policy’s Javier Corrales wrote a great piece about the economy of Venezuela under the reign of recently deceased Hugo Chavez. Some of the economic turbulence in Venezuela has striking resemblance to those in Egypt. I quoted what Corrales argued are the three main problems the Venezuelan government has handled the country’s has handled it’s economy. It’s a great piece and I encourage everyone to read the whole thing, but if you don’t have the time. Read the quoted part. If you replace “Venezuela” with “Egypt,” it would still make perfect sense

“Venezuelan Disease involves more than just fiscal profligacy. It also involves misguided responses to inflation. Populist governments tend to make their worst mistakes in dealing with inflation. Governments today, unlike in the 1960s, have learned to worry about inflation because it is one of the quickest ways to expand poverty. Inflation acts as a form of consumption tax that falls heavily on low-income, salaried groups, lowering their purchasing power dramatically. Populist governments in particular panic about inflation precisely because it hurts the very same group they want to court — namely, low-income workers. But rather than cutting back on spending and introducing productivity-boosting reforms (in order to increase the number of goods that currency units are chasing), populist governments respond to inflation by imposing microeconomic controls.

They tend to favor three types. Foreign exchange controls try to lower the demand for dollars by restricting access to them. Retail price controls make raising prices illegal. And labor market controls, which aim to protect low-income salaried workers, can range from raising the minimum wage to making it harder for employees to fire employees. Venezuela under Chávez saw all three forms of controls.

The problem is that these controls end up exacerbating the very same problems they are meant to address. For instance, exchange rate controls accentuate rather than alleviate the demand for dollars; those who hold increasingly undervalued bolívars, the Venezuelan currency, become desperate to get rid of them.

Price controls, in turn, precipitate a supply crisis. Producers facing price controls for their products, in a country with galloping inflation, soon discover that their costs exceed their allowable retail prices. At this point, production is no longer profitable. Producers must either discontinue that product (which yields scarcity) or switch to importing (which stimulates the demand for dollars, offsetting the government’s effort).

And labor controls produce more inflation and labor scarcity. By imposing an excessive increase in minimum wages, the government is actually increasing rather than decreasing the inflationary pressures on the private sector. And by creating restrictions on firing labor, the government creates labor scarcity. “


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