Tag Archives: Capital Controls

Venezuela’s first step

Venezuela is a nation is turmoil.  The media, as well as our class blog, have highlighted the on going violence and shortages. Many feel that this is a result of the capital controls put in by the socialist regime of Hugo Chavez. By loosening the capital controls on Monday, the Venezuelan government is taking a step in the right direction.  However Venezuela has a long way to go, and further progress requires further action.

Venezuela is one of the largest petroleum exporters in the world.  It seems absurd to think that there is a food shortage.  Yet the country depends heavily on the imports for its food, and the balance of trade is misleading due the heavy influence of oil exports.  In the past, in order to curb capital flight, the regime of Hugo Chavez put in place strict capital controls to keep money in the country.  The ramifications of these actions are being witnessed today.   Many importers lack the currency to secure imports due to capital controls.

The government of Venezuela has taken action.  As reported in the Wall Street Journal, the currency controls are being removed, allowing the currency to float on the open market.  Lifting the currency controls is hoped to have the effect of clearing up the shortages, alleviating the social unrest.  However it could also devalue the currency, causing inflation.

This can be seen in the short-run international finance diagrams. Upon the removal of the controls, the devaluation would come as a result of a shift in the Net Capital Outflows curve to the right, which has the effect of decreasing the value of the currency relative to the other countries (in this case the US dollar), shown in the currency diagram.

The most obvious way to fight inflation is to raise interest rates.  But raising interest rates enough to counter the inflation may be unfeasible and/or undesirable given the current economic situation.  A similar effect could be achieved if Venezuela had increased foreign investment.  To this, the country should remove laws that limit foreign investment and property rights that where implemented by Chavez.  In addition, Venezuela should consider leasing some of its oil and natural gas resources to foreign companies, as it did before the industry was nationalized in 1973.  By increasing foreign investment, Venezuela can shift the NCO curve back without messing with interest rates, as well as generating some badly needed revenue for a cash-strapped country.

Considering the natural resources that Venezuela has, it is surprising to see the situation as bad as it is.  The situation seems to be largely due to bad economic policy.  Capital controls, nationalization, and weak property rights have not proven to be sustainable economic policies.  Venezuela’s decision to lift its capital controls should be followed by further “free market” policies rectifying the above problems.