VENEZUELA - Historical Background & The Oil Curse.

Venezuela's petroleum wealth was known from the pre-Colombian era, when the indigenous peoples made use of oil and asphalt seeping to the surface. It was then used mainly for medicinal purposes and some of the oil was used for limited home heating in areas where it surfaced. In 1912 the first oil well was drilled. Shortly thereafter, first Shell and then Rockefeller's Standard Oil, became major oil producers in Venezuela. By 1929, Venezuela had become the world's second largest oil producer, after the US, and the world's largest oil exporter.

Between 1920 and 1935 oil's share of exports went from 1.9% to 91.2%. This had an immediate and dramatic impact on the economy, known as "The Dutch Disease" or "The Oil Curse", the most important consequence of which was that agricultural production declined to almost nil and Venezuela fell behind in industrialising, relative to other Latin American countries. In 1943 Caracas came up with the Hydrocarbons Act, which made the state's income heavily dependent on oil. While previously oil income was mostly based on concessions and customs, the new act tied oil revenues to taxes based on income from mining. The law established that the foreign companies could not make greater profits from oil than what they paid to the state.

Steadily rising oil income led to the state's ever increasing reliance on this source of revenue in lieu of income taxes. From the 1950s, however, the world had an oil glut after increased output in the Middle East and imposition of import quotas in the US. The result was a chronically low oil price. In 1960 the world's main oil exporting states, largely due to prodding from Venezuela, decided to form the Organisation of Petroleum Exporting Countries (OPEC). Also in 1960, Caracas created the Venezuelan Oil Corp., which later formed the basis for the nationalisation of the oil industry.

By 1974, when the Arabs imposed an oil embargo, world oil prices - and, along with them Venezuelan state income - had quadrupled from 1972. This sudden rise in state income was historically unique in Venezuela and to the other OPEC states. It made a newly elected president, Carlos Andres Perez, promise the Venezuelans they will become a developed country within a few years - Shah Mohammad Reza Pahlavi vowed to make Iran the world's fifth power. Perez' "La Gran Venezuela" was to "sow the oil" through a combination of fighting poverty, via price controls and higher income, and import substitution. Part of his plan was the nationalisation of the oil industry, which took effect in 1976 with the creation of PDVSA.

While the oil boom seemed to be a huge blessing, it had negative effects on Venezuela and other big oil exporters, such as chronic inflation and, paradoxically for Caracas and other OPEC capitals, rising indebtedness. These problems were exacerbated when, in the mid-1980s, the price of oil began to plummet due to OPEC over-production. By 1998, the price of oil had fallen to $3.19/b (in real 1973 cash terms for the US dollar). This had a devastating effect on Venezuela's economy, particularly on per capita income - in steady decline since the mid-1980s. Even after world oil prices rose in 2000-03, thanks to an OPEC price defence pact reached in March 1999, Venezuela's economy by mid-2003 had reached the point of collapse.

When Chavez was first elected in December 1998, it did not look like he had any particular plans for PDVSA. He did, however, have very clear plans for OPEC which, under the leadership of Ali Rodriguez (who then served as energy minister and later headed OPEC), was to be turned into a strong bloc once again. Until Chavez came to power, OPEC had become a shadow of its former self, with member-states regularly ignoring their output quotas. Venezuela, especially, had turned into one of the members' most unreliable partners. Production over allotted quotas, combined with the expanding of oil production in non-OPEC countries, such as Russia and Mexico, led to a steep decline in the price of oil. Chavez promised to put an end to this by organising OPEC's second summit in Caracas in September 2000. Also, Chavez spent the first years of his presidency visiting the leaders of OPEC and non-OPEC states to convince them to adhere to production quotas in the case of the former and output cuts by the latter, so as to maintain an oil price band of $22-28/b.

Chavez' efforts bore nearly immediate results as the price of oil rose for the first time since 1985 to over $27/b (in nominal prices). Soon, however, Chaavez ran into conflict with the management of PDVSA which, for the past fifteen years, had been producing as much oil as possible, regardless of OPEC quotas. The result was a steady rotation of PDVSA presidents and, later, an all-out confrontation between Chavez and the oil industry. Chavez then argued that the industry needed re-nationalisation because it had become a "state within a state".

The Dutch Disease, or what APS Energy Group President Pierre Shammas called "The Oil Curse" when Saddam's Iraq invaded Iran in 1980, is caught whenever a commodity brings a sudden rise in income in one sector of the economy which is not matched by increased income in the other sectors. The sudden sectoral surge causes severe problems in the other sectors, distorting growth in services and other non-tradables which cannot be imported, while discouraging production of tradables that are imported. The reason for this disparity is that the greater income rapidly raises the demand for imports, since domestic output cannot meet demand quickly enough, and raises the demand for services which the local market has to supply because services cannot be imported as easily as tradables can. Higher demand for imported goods and local services, in turn, causes a rise in prices - which ought to cause domestic output to rise but does not as the flow of foreign exchange into the economy has caused an inflation of wages and prices.

One can clearly observe the oil curse in the Venezuelan economy - even now that high oil prices have pushed its GDP up - or in the economy of Algeria, once a breadbasket for the French empire. It is seen when one looks at the extent to which the rise in oil income was followed by a corresponding fall in agricultural output, delaying industrialisation. While agricultural output made up about one third of Venezuela's GDP in the 1920s, it shrank to less than one tenth by the 1950s and to less than 6% now. Industrial output fell from 1990 to 1999, from 50% of GDP to 24% in 2003 (compared to the whole of Latin America, which declined from 36% to 29% in the same period). Constant devaluations of the national currency, the bolivar, and subsequent rises in inflation have hit Venezuela's economy since the oil boom of 1979-81.

The sudden rise of oil income caused a serious problem in the government's fiscal policies. New revenues caused the illusion that the oil income could be used to industrialise the country through massive infrastructural projects, to "sow the oil", as Perez used to say. The quadrupled income caused government spending to even surpass the newfound revenues. When the oil income began to decline again, it was not as easy to reduce state spending. As a result, the state went deeper and deeper into debt. Between 1970-94, foreign debt rose from 9% to 53% of GNP. While oil prices and revenues fell, so did per capita income and the Venezuelan economy as a whole, and poverty increased. In 1996 Venezuela was one of the very few countries in the world where per capita income was lower than it was in 1960.

Reliance on oil has fostered a rentier and clientelistic mentality among Venezuelans. The idea was that one could do well in Venezuela as long as one had access to its oil wealth. So rather than engaging in creative activity, Venezuelans were encouraged to ally themselves with the state, seeking either employment or contracts, with PDVSA being a monopoly on Venezuela's oil income.

Political analyst Terry Lynn Karl describes the consequences of oil as follows: "In the manner of a petro-state, rent seeking had become the central organizing principle of the [country's] political and economic life, and the ossified political institutions in existence operated primarily to perpetuate an entrenched spoils system. Both state agencies and political parties had given up their programmatic roles to become machines for extracting rents from the public arena".

Venezuela's oil wealth has caused the state to appear to have magical powers, to be able to accomplish just about any feat at no cost to the population. Thus transformed into a petro-state, the Venezuelan state came to hold the monopoly not only of violence, but of the nation's natural wealth. By manufacturing dazzling development projects that engender collective fantasies of progress, it casts its spell over audiences and performers alike. The government seizes its subjects by inducing a condition of being receptive to its illusions. The result of the clientelistic and magical nature of the state was that the government would become very bureaucratic. Of the people employed in the public sector (about 50% of the total working population), about 45% are employed through the government.