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Crisis in Venezuela

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Economics

The crisis in Venezuela is an ongoing economic and political crisis that began in 2010. It is marked by hyperinflation, crime, mass emigration, and starvation. How did this crisis begin and just how bad is it? Can Venezuela ever go back to the once prosperous state it was? Let’s answer these questions.

Summary and facts of the crisis in Venezuela

The crisis in Venezuela began with the presidency of Hugo Chávez in 1999. Venezuela is an oil-rich country and the high oil prices in the early 2000s brought in a lot of money for the government. Chávez used this money to fund missions that were aimed to improve economic and social conditions.

Between 2002 and 2008, poverty decreased by more than 20% and the standard of living improved for many Venezuelans.1

However, Venezuela’s overdependence on oil led the economy to suffer from the Dutch disease.

The Dutch disease occurs when the exploitation of natural resources like oil and gas leads to a rise in exchange rates and a loss of competitiveness for other industries in the country.

The effects of the Dutch disease can be seen in the short and the long term.

In the short term, foreign direct investment (FDI) increases due to the high demand for that natural resource. In this case, oil. The Venezuelan Bolívar strengthens. As the oil sector in Venezuela grows, real wages also rise, and this results in higher tax revenues for the Venezuelan government.

In the long term, the prices of exports in other sectors are no longer price competitive (due to the strengthening of the Venezuelan Bolívar). There will be a reduction in output in these sectors and it could lead to job cuts.

When the oil runs out, or in Venezuela’s case, when oil prices drop, the government experiences a fall in revenue because of its dependency on oil-financed government spending. The government is left with large current account deficits and the economy is left with a small export industry.

By the early 2010s, it was no longer sustainable to fund the social works from the revenue generated by oil and this caused the Venezuelan economy to shake. Poverty, inflation, and shortages started to increase. At the end of Chávez’s presidency, inflation was at 38.5%.

Nicolás Maduro became the next president, following Chávez's death. He continued the same economic policies Chávez left. High inflation rates and large shortages of goods continued into Maduro’s presidency.

In 2014, Venezuela entered into a recession. In 2016, inflation reached its highest point in history: 800%.2

Low oil prices and a reduction in Venezuela’s oil production caused the Venezuelan government to experience a fall in oil revenue. This resulted in a cut in government spending, fueling the crisis even more.

Maduro’s policies have sparked protests in Venezuela and the attention of many human rights organisations. Venezuela has been driven into an economic and political crisis because of corruption and mismanagement.

Economic Crisis in Venezuela A picture of Caracas at night StudySmarterA picture of Caracas, the Venezuelan capital, at night, Wikimedia Commons.

Economic impacts of the crisis in Venezuela

The economic impacts of the crisis in Venezuela are numerous, but in this explanation, we will look at the impacts on Venezuela’s GDP, inflation rate, and poverty.

GDP

In the 2000s, oil prices were increasing and so too did Venezuela’s GDP per capita. The GDP peaked in 2008 where GDP per capita was $18,190.

In 2016, the Venezuelan economy contracted by 18.6%. This was the last economic datum the Venezuelan government produced. By 2019, the International Monetary Fund (IMF) estimated that Venezuela’s GDP contracted by 22.5%.

Crisis in Venezuela Summary of the GDP from 1985 to 2018 StudySmarterFigure 1. Venezuela's GDP per capita between 1985–2018.Source: Bloomberg, bloomberg.com - StudySmarter.

As you can see in figure 1 above, it is clear that the crisis in Venezuela has severely impacted the country’s GDP and has reduced the size of its economy.

To learn more about GDP, check out our 'Gross Domestic Product' explanation.

Inflation

At the start of the crisis, inflation in Venezuela was at 28.19%. By the end of 2018 when the Venezuelan government stopped producing data, the inflation rate was at 929%.

Economic Crisis in Venezuela Graph of the inflation rate in the country StudySmarterFigure 2. Venezuela's inflation rate between 1985 to 2018. Source: Bloomberg, bloomberg.com - StudySmarter

In figure 2, you can see that inflation in Venezuela was relatively low compared to today. From 2015, the inflation rate rapidly increased from 111.8% to 929% at the end of 2018. It was estimated that in 2019, Venezuela's inflation rate hit 10,000,000%!

Hyperinflation has caused the Venezuelan Bolívar to lose its value. Thus, the government has introduced a new cryptocurrency called the Petro that is backed by the country’s oil and mineral reserves.

Hyperinflation refers to the rapid increase in general price levels. Hyperinflation is defined by the IASB as when the 3-year cumulative inflation rate goes above 100%.3

Causes and effects of hyperinflation in Venezuela

Hyperinflation in Venezuela took off because of the excess printing of the Venezuelan Bolívar.

Printing money is quicker than borrowing money or getting money from tax revenue, thus the Venezuelan government decided to print money in urgent times.

The excess circulation of the Venezuelan Bolívar caused its value to decrease. When the value shrank, the government needed more to fund their spending, so they printed more money. This again led to a decrease in the value of the Venezuelan Bolívar. This cycle caused the currency to eventually become worthless.

This, combined with the continually increasing inflation, severely impacted the Venezuelan economy:

  • Decreased value of savings: as the value of the Venezuelan Bolívar is worthless, so too are savings. Any money consumers have saved is now worthless. Additionally, with fewer savings, there is a large savings gap in the economy. According to the Harrod - Domar model, fewer savings will ultimately lead to lower economic growth.

  • Menu costs: as prices change frequently, firms have to calculate new prices and change their menus, labelling, etc. and this increases their costs.

  • Confidence fall: consumers have no or little confidence in their economy and will not spend their money. Consumption falls and the aggregate demand (AD) curve shifts inwards causing economic growth to fall.

  • Lack of investment: as businesses have low confidence in the Venezuelan economy, firms will not invest in their businesses and foreign investors will not invest in this economy. A lack of investment will result in low and slow economic growth.

You can learn more about inflation and its impacts in our 'Inflation and Deflation' explanation.

Poverty

Nearly all Venezuelans live in poverty. The last data set available in 2017 shows that 87% of Venezuela’s population live under the poverty line.4

In 2019, the average daily income in Venezuela was $0.72 US cents. 97% of Venezuelans are uncertain as to where and when their next meal will come. This has led to Venezuela receiving humanitarian aid to help relieve some from poverty.

Economic Crisis in Venezuela A group of people with Venezuelan flags in the streets StudySmarterProtest in Venezuela in 2014 due to the food shortages, Wikimedia Commons.

Foreign involvement in the Crisis in Venezuela

The crisis in Venezuela has sparked the interest of many foreign countries.

Many organisations like the Red Cross, have provided humanitarian aid to ease hunger and illness. Some of the aid has been received but most of it has been blocked or denied by the Venezuelan government and their security forces.

The European Union, the Lima Group, and the United States have taken a different approach, and have imposed economic sanctions against government officials and certain sectors in Venezuela.

Economic sanctions

The United States is the country with the most sanctions on Venezuela. The US started to impose sanctions on Venezuela in 2009, but under the presidency of Donald Trump, the number of sanctions imposed significantly increased.

Most of the US sanctions are on Venezuela’s gold, oil, finance, and defence and security sectors. This has impacted Venezuela’s revenue in the gold and oil sectors.

Other countries like Colombia, Panama, Italy, Iran, Mexico, and Greece have also imposed sanctions on Venezuela.

These sanctions on Venezuela have almost left the country isolated from the rest of the world. The aim of these sanctions is to encourage Maduro to end his harmful policies and encourage the Venezuelan government to put an end to the extreme conditions many Venezuelans experience.

Although sanctions are imposed with good intentions, they often lead to unintended consequences.

The US sanctions on Venezuelan oil increased business costs in this industry, which caused them to produce less. Many firms also tried to protect their profit margins and cut jobs.

Increased unemployment and higher prices for consumers affect the many Venezuelans who already live in poverty. Ultimately, sanctions, more often than not, hurt those they are trying to protect, and not the government.

Is there any solution to the crisis in Venezuela?

The crisis in Venezuela runs deep and impacts many. The impacts of the pandemic haven’t made this crisis any easier for most Venezuelans.

With the continuous mismanagement of the country’s oil and mineral resources, underinvestment, and large sanctions from the rest of the world, Venezuela continues to plummet further into this economic and political crisis.

This has resulted in many Venezuelans being left in despair. More than 5.6 million Venezuelans have fled the country in search of a better future, which has caused a refugee crisis in the neighbouring countries.

Crisis in Venezuela Facts: millions have left the country since the beginning of the crisis. Some are depicted in this picture StudySmarterHundreds of Venezuelans waiting to enter Ecuador. Source: UNICEF, CC-BY-2.0, Wikimedia Commons.

While it is uncertain whether the crisis in Venezuela will improve or deteriorate, it is sure that there is much work to be done if Venezuela is to get back to its prior economic fortunes.

Crisis in Venezuela - Key takeaways

  • The crisis in Venezuela began with the presidency of Hugo Chávez when he used the revenue from the oil to fund government spending.
  • It was no longer sustainable to fund government spending from the revenue generated by oil and this caused the Venezuelan economy to shake.
  • This led to poverty, inflation, and shortages.
  • Following Chávez’s death, Nicolás Maduro became the next president and continued the same economic policies which led to hyperinflation, extreme poverty, and massive food and oil shortages.
  • Venezuela’s GDP continued to contract, inflation levels continued to climb and nearly all Venezuelans live in poverty today.
  • This has led to many organisations getting involved to provide humanitarian aid and many countries have imposed economic sanctions.

Sources

1. Javier Corrales and Michael Penfold, Dragon in the Tropics: The Legacy of Hugo Chávez, 2015.

2. Leslie Wroughton and Corina Pons, ‘IMF denies pressuring Venezuela to release economic data’, Reuters, 2019.

3. IASB, IAS 29 Financial Reporting in Hyperinflationary Economies, https://www.ifrs.org/issued-standards/list-of-standards/ias-29-financial-reporting-in-hyperinflationary-economies/

4. BBC, ‘Venezuela crisis: Three in four in extreme poverty, study says’, 2021, https://www.bbc.co.uk/news/world-latin-america-58743253

Crisis in Venezuela

The main causes of the crisis in Venezuela are the mismanagement of government funds, the overdependence on oil, and the policies imposed by the government.

It began in 2010, during Chávez’s presidency when it was no longer sustainable to fund the social works from the revenue generated by oil causing the Venezuelan economy to shake.

The excess printing of money caused the currency crisis in Venezuela, rendering the Venezuelan Bolívar to become worthless.

The effects of the crisis in Venezuela are extreme poverty, hyperinflation, low economic growth, and mass emigration.

Some facts of the crisis in Venezuela are:

  • 87% of Venezuela's population live under the poverty line.
  • The average daily income in Venezuela was $0.72 US cents.
  • in 2018, inflation reached 929%.
  • in 2016, Venezuela's economy contracted by 18.6%.

Final Crisis in Venezuela Quiz

Question

What did President Hugo Chávez use the oil revenue for?

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Answer

He used the money to fund government spending which included missions that were aimed to improve economic and social conditions.

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Question

Explain what is the Dutch disease.

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Answer

The Dutch disease occurs when exploitation of natural resources like oil and gas lead to a rise in exchange rates and a loss of competitiveness for other industries in the country.

Show question

Question

What happens in the short term when a country has an over-dependence on the natural resources they possess? 

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Answer

In the short term, foreign direct investment (FDI) increases because of the high demand for that natural resource. Their currency strengthens. As the natural resource sector grows, real wages will also rise and this results in higher tax revenues for the government.

Show question

Question

What happens in the long term when a country has an over-dependence on the natural resources they possess?

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Answer

In the long term, the prices of exports in other sectors are no longer price competitive. There will be a reduction in output in these sectors and it could lead to job cuts.

Show question

Question

What was the inflation rate in Venezuela at the end of Chávez’s government?

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Answer

40.64%

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Question

Who became the next president of Venezuela after Chávez?

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Answer

Nicolás Maduro

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Question

Define hyperinflation.

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Answer

Hyperinflation refers to the rapid increase in general price levels. It is defined when rates increase by 100% annually.

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Question

What caused hyperinflation in Venezuela?

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Answer

The excess printing of the Venezuelan Bolívar.

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Question

How does hyperinflation impact an economy?

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Answer

The value of savings decrease causing savings to become worthless and the economy faces a large savings gap.

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Question

What was the average daily income in Venezuela in 2019?

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Answer

$0.72

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Question

What percentage of Venezuelans live in poverty?

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Answer

97%

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Question

Which country has imposed the most sanctions on Venezuela?

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Answer

The United States 

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Question

What negative impacts can sanctions result in?

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Answer

They can result in worsening economic conditions.

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Question

What was Venezuela's inflation rate at the end of 2018?

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Answer

65,000%

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Question

What has happened to the Venezuelan Bolívar?

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Answer

It has become worthless so the government has scrapped its usage.

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Question

What is the new cryptocurrency the Venezuelan government has introduced?

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Answer

The Petro

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