Explainer: Causes of hyperinflation in Venezuela

Explainer: Causes of hyperinflation in Venezuela

The hyperinflation in Venezuela is one of the offshoots of the political and socioeconomic crisis in the country that brewed under the presidency of Hugo Chávez and has persisted under the presidency Nicolás Maduro.

Data from the World Bank have revealed that Venezuela has experienced double-digit inflation. For example, inflation peaked at 84.463 percent in 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 the majority of the annual figures within the same period played at around 15 to 22 percent.

However, inflation substantially grew from 40.639 percent in 2013 to 121.738 percent in 2015. Venezuela spiraled into hyperinflation beginning in 2016 with an inflation rate of 254.949 percent.

Explaining the Causes of Hyperinflation in Venezuela

But what are the reasons behind the hyperinflation in Venezuela? What are the factors that led to the persistent rising prices of essential goods and services? Writing for the Forbes, the head of a hedge fund firm Garth Friesen mentioned that corruption in the government, economic mismanagement, undiversified nationalized economy heavily reliant on oil production, strong dependence on imports for basic commodities, and absence of central bank independence are the specific causes of hyperinflation in Venezuela.

To understand hyperinflation in Venezuela, it is first important to highlight the fact that the country had one of the promising economies in South America primarily because of its oil industry. Take note that the country has the largest proven oil reserves in the world. When Chávez became president in 1998, he used oil revenues to improve government services by subsidizing food, housing, education, and health care, and expanding government welfare programs. The country benefitted from rising prices of oil in the global market. The government also increased not only its spending but also its borrowing to fund other initiatives.

Chávez also pursued a socialist approach in managing the Venezuelan economy. In 2006, his government began nationalizing several sectors and industries as part of its vision of redistributing wealth and lessening the influence of multinational corporations. It nationalized telecommunication companies, electric utilities, steel industries and construction supply producers, and banks, among others. During several instances, the government also took full control of rice processing plants, coffee manufacturers, and other food producers. It also implemented price controls to strengthen its economic oversight.

The price of oil in the global market started to decline in 2004. This substantially decreased the income of the Venezuelan economy simply because oil accounts for more than 90 percent of its exports. The economy contracted by 30 percent from 2013 to 2017. Government revenues also went down along with the decreasing income from oil exports and shrinking economy. The declining export activity also resulted in the decline in foreign currency reserves, especially U.S. dollars.

It is also important to emphasize the fact that the economy of Venezuela suffered from weak economic growth. Economists Ricardo Hausmann and Francisco R. Rodríguez mentioned that the weak economic growth of Venezuela beyond oil production and exportation activities could be attributed to two factors: the decline in productivity and the decline in the capital stock. The country was not a completely specialized country, and it had all the opportunities to diversify its economy by improving other industries and sectors. However, similar with most oil-exporting countries, Venezuela had infrastructures and capabilities that favored oil production and exportation.

Venezuela essentially suffered from Dutch disease because the Chávez administration focused primarily on its oil industry while it neglected its manufacturing and agriculture sectors. During the oil boom, the non-oil products of the country were essentially relatively costly to produce and more expensive for other countries to buy. Importing essential and non-essential commodities were more practical. The nationalization of other sectors and industries, as well as price controls and other government regulations also negatively affected the domestic production capabilities of the country due to lack of free market competition.

Nevertheless, with foreign currency reserves running out due to declining oil export revenues, Venezuela had started to develop problems in importing food and consumer goods until there was a scarcity of different products. The situation marked the acceleration of inflation until the country spiraled down to hyperinflation.

Remember that inflation persisted after the presidency of Chávez in 2013 and during the new presidency of Maduro beginning in 2013. Hence, Maduro inherited the economic problems of Venezuela left by his predecessor. The new leadership aggravated the inflation problem when the government increased the money supply in circulation.

The Economist reported that 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. Its analysis mentioned that this continued increase was one of the primary reasons why inflation was high, especially because there was more local currency than the foreign currency reserves. The Maduro government also increased wages in the public sector and eventually, the minimum wage across the country, thus exasperating inflation further.

Summary: Theorizing Hyperinflation in Venezuela

In summary, the causes of hyperinflation in Venezuela revolve around dependence on oil production and exportation and the socialist and populist economic policies of Chávez that both crippled the ability of the country to produce essential commodities and thereby, resulted in its overdependence on imports. When revenues from oil dried out due to the volatility of the global oil market, the country was affected not only because it was dependent on oil exports but also because it already had socioeconomic vulnerabilities.

One of the primary theories explaining the causes of inflation is called demand-pull inflation. Accordingly, this type of inflation occurs when there is an increase in demand for goods and services or more specifically, if demand is growing faster than supply. In the case of Venezuela, there was no substantial increase in aggregate demand, there was an existing demand, but the supply stock ran out, thus causing demand-pull inflation.

Supplies of essential commodities essentially ran out because the country was unable to import them due to lack of foreign currency reserves and it was not definitely capable of producing such because of its one-dimensional and oil-dependent economic structure.

Of course, another theory and type of inflation called cost-push inflation can also provide an explanation. By definition, cost-push inflation occurs when suppliers of goods and services increase the prices of their products to offset the increasing cost of their production. In Venezuela, the inability to secure imports and the overall economic collapse increased production costs, thus, hindering domestic production capabilities further.

The monetarist explanation of inflation is also partially applicable to understanding the causes of hyperinflation in Venezuela. The 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. This phenomenon was observed during the hyperinflation crisis in Zimbabwe. Remember that the Maduro administration increased the money supply while also increased the minimum wages as part of its attempt to safeguard consumer spending capabilities.

Based on the details above, nonetheless, the causes of hyperinflation in Venezuela involve a complex series of events. Of course, its fundamental root cause can be understood merely as stemming from having an economy severely dependent on a single export and multiple imports that in turn, makes it highly vulnerable to the volatility of the global market. As the Venezuelan economy collapsed, inflation spiraled uncontrollably until it became hyperinflation due to the interactions of different inflation-specific factors such as demand-pull, cost-push, monetary, and essentially, build-in inflations.

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