Explainer: Causes of hyperinflation in Venezuela

Explainer: Causes of Hyperinflation in Venezuela

The hyperinflation in Venezuela is one of the offshoots of a political and socioeconomic crisis that brewed under the presidency of Hugo Chávez and has persisted under the presidency of Nicolás Maduro. Data from the World Bank showed that the country has been experiencing a double-digit inflation rate. For example, in 1989, inflation peaked at 84.463 1989 before it went down the following years and peaked again at 99.877 percent in 1996.

Double-digit inflation rate remained from 1999 to 2012 but it did not go beyond 32 percent and most of the annual figures within the same period played within and around 15 to 22 percent. However, from 2013 to 2015, inflation grew from 40.639 percent to 121.738 percent in 2015. Venezuela spiraled into hyperinflation beginning in 2016 with an inflation of 254.949 percent. It has a record-breaking inflation rate in 2019 at 13060 percent.

A Deep Dive into the Causes of Hyperinflation in Venezuela

The causes of hyperinflation in Venezuela are complex and multifaceted. However, in examining its political economy, three general factors emerged that caused the prices of goods and services in the country to skyrocket and render its local currency valueless. These are economic mismanagement, the decline in the price of oil in the global market, and economic sanctions imposed by foreign countries like the United States.

1. Economic Mismanagement

In an article for Forbes, Garth Friesen, the head of a hedge fund firm, highlighted several specific causes of hyperinflation in Venezuela. These include economic mismanagement through inapt economic reforms and policies, an undiversified nationalized economy dependent on oil exportation, a strong reliance on imports for basic commodities, the absence of central bank independence, and rampant corruption in the national government.

The government under the Chávez administration had engaged in unsound economic policies. These included excessive deficit spending that prompted the central bank to print and introduce new money in circulation, imposition of price controls in a wide range of goods and services that created shortages and encouraged black market activity, and nationalization of large business organizations that resulted in a decline in productivity.

However, despite the fact that its economic management was heading nowhere, the country had a good initial run. It is worth underscoring the fact that Venezuela has the largest oil reserves in the world and it had one of the most promising economies in South America in the 1990s. The arrival of the Chávez administration saw the expansion of government services and government welfare programs using revenues from oil exportation.

The government also pursued a socialist approach to managing the Venezuelan economy. It began nationalizing several sectors and industries in 2006 as part of a vision of redistributing wealth to the public and lessening the influence of multinational corporations. It nationalized telecommunication companies, electric utilities, steel industries and other construction materials producers, and banks or financial institutions, among others.

It also took full control of rice processing plants, coffee manufacturers, and other food producers in several instances. The agriculture sector was under the helm of the government. Price controls were implemented to strengthen economic oversight. The Chávez government explained that these measures were specially intended to protect the consumers from price increases. The same measures were retained under the succeeding Maduro government.

However, despite the supposed good intention of the economic policies and programs, the government was mismanaging the economy. Shortages were rampant because businesses in different sectors and industries became inefficient. Black markets emerged as a response to price controls. These black markets provided opportunities for corruption. Officials were bribed to allow businesses to sell goods and services at higher prices.

2. Oil Revenue Decline

Remember that the Venezuelan economy was reliant on its oil reserves. Government revenues come from oil exportation and most economic activities revolved around the oil industry. Wealth from oil initially allowed the government to finance its various government services and other socialist-oriented government welfare programs and projects like subsidized food and housing, universal education, and free access to the public healthcare system.

However, beginning in 2004, the price of oil in the global market started to decline due to the increased production outputs of other oil-exporting countries like Saudi Arabia, Norway, and Russia. This meant reduced government revenues, a decline in gross domestic product from the declining domestic oil industry, and a brewing budget deficit due to existing government expenditures. The economy contracted by 30 percent from 2013 to 2017.

Government revenues specifically went down along with the decreasing income from oil exports and a shrinking economy. The declining export activity also resulted in the decline in U.S. dollar reserve and other foreign currency reserves. However, despite this emerging crisis, the government did not terminate its services and programs. It resorted to borrowing from the debt market to finance its operations. Venezuela was spending on a deficit.

It is also important to underscore the fact that Venezuela had a weak economy despite its large oil reserves. Economists Ricardo Hausmann and Francisco R. Rodríguez explained that this could be attributed to two factors: the decline in productivity and the decline in the capital stock. The economic reforms that started under the Chávez administration rendered other sectors and industries either undeveloped or inefficient and unproductive.

Other sectors and industries were inefficient because of the absence of free market competition. The country essentially lacked diversification. Non-oil products were costly to produce domestically and other countries find these non-oil Venezuelan products relatively more expensive. The country suffered from a Dutch disease because the government focused on the oil industry and neglected its manufacturing and agriculture sectors.

Nevertheless, for other goods and services, and even for commodities, the country depended on importation because it was more practical. However, with foreign currency reserves running out due to declining oil revenues, Venezuela had trouble importing food and consumer goods. Supplies of essential products were in shortage. The situation marked the acceleration of inflation until the country spiraled down further to hyperinflation.

3. Economic Sanctions

The United States and other countries have imposed economic sanctions in Venezuela on the basis of supposed prevailing human rights abuses perpetrated by the Venezuelan government, widespread corrupt practices across the different levels of the government, allegations of electoral fraud involving the 2018 presidential election that saw the rise of Maduro in power, and accusations of longstanding economic mismanagement.

Venezuela, particularly its government, accused these foreign countries of waging an economic war on its people. The United States defended its decision and stance. The U.S. government specifically explained that economic sanctions are needed to pressure the Venezuelan government to respect and protect human rights, resolve corruption, hold free and fair elections, and reform its economic policies to benefit Venezuelans.

Nevertheless, because of the sanctions, the economic situation in the country worsened. Remember that one of the disadvantages of economic sanctions is that they produce unintended consequences that affect ordinary people. The sanctions specifically led to widespread shortages of food, medicine, and other essential goods. It also increased the prevalence of poverty as it drove more people and their families below the poverty line.

The same sanctions have also become one of the causes of hyperinflation in Venezuela. Shortages in essential goods meant that consumer demands were not being satisfied. These resulted in price hikes. It also became more difficult for the country to participate in international trade and replenish its foreign reserves. Remember that it was dependent on oil exportation for revenues and importation of commodities and essential goods.

Furthermore, because of these economic sanctions, it became riskier for investors to invest in the country or establish businesses. This slowed down economic growth and also worsened the unemployment rate. The reduced government revenue also compelled the printing of more banknotes to finance its spending. Take note that excess money supply in circulation can lead to hyperinflation if it surpasses the productive capacity of the economy.

There is no consensus among economists about the extent to which the sanctions have contributed to hyperinflation. What is more apparent is that these sanctions have had a negative impact on the Venezuelan economy and have made it more difficult for the government to address specific economic problems like hyperinflation, shortages, depressed business activities, unemployment, specific food shortages and insecurity, and poverty.

Discussing and Summarizing the Causes of Hyperinflation in Venezuela

The causes of hyperinflation in Venezuela represent a complex issue. The phenomenon can still be attributed to three general factors. These are economic mismanagement, the decline in the price of oil in the global market, and economic sanctions imposed by foreign countries. Dependence on oil exportation and the socialist economic policies of the government crippled the ability of the country to produce essential goods and made it dependent on importation.

Reliance on oil exportation means exposure to the volatile global oil and gas market. Hence, when the global oil price went down, the revenues of the country declined. Its foreign reserves also declined because it is dependent on importation. An economic crisis emerged not only because of its dependence on the global oil and gas market but also because already had socioeconomic vulnerabilities arising from economic mismanagement.

Take note that one of the theories explaining the causes of inflation is demand-pull inflation. This occurs when demand grows faster than the supply or the productive capacity of producers. Demand from consumption activities in Venezuela was naturally increasing due to population growth. The demand still remained at a reasonable level. However, due to importation issues, the level of demand surpassed the supply. This led to demand-pull inflation.

Another theory that can explain the cause of hyperinflation in Venezuela is cost-push inflation. This occurs when producers and suppliers of goods and services increase the prices of their products to offset the increasing cost of their production or operations. Remember that inefficiencies across different sectors and industries and the emergence of black markets resulted in price increases despite the presence of price controls.

The monetarist theory of inflation is also applicable. This theory explains that excessive growth in the money supply leads to the devaluation of the currency because there is essentially more money chasing the same number of goods and services. The Economist reported that the money supply increased by 60 percent year-on-year at the beginning of 2013 and increased further by 76 percent at the end of January 2014 due to overprinting.

Nevertheless, based on the explanation of factors and causes of hyperinflation in Venezuela, it is still important to highlight that the situation is a product of a complex series of events. It can still be argued that the fundamental root cause of the problem is still traceable back to the inefficiencies and shortcomings of the Venezuelan government under the separate and succeeding administrations of Hugo Chávez and Nicolás Maduro.

FURTHER READINGS AND REFERENCES

  • Friesen, G. “The Path to Hyperinflation: What happened to Venezuela?” Forbes. Available online
  • Hausmann, R. and Rodríguez, F. R. “Why Did Venezuela Growth Collapse?” In eds. R. Hausmann and F. R. Rodríguez, Venezuela Before Chávez: Anatomy of an Economic Collapse. PA: The Pennsylvania State University. ISBN: 978-0-271-05631-9
  • The Economist Intelligence Unit. 2014, February 17. “Monetary Aggregates Rising Sharply.” The Economist Intelligence Unit. Available online
  • The World Bank, International Monetary Fund. 2018. “Inflation, Consumer Prices, Venezuela.” The World Bank Group. Available online