Krueger (1990) defines the two dimensions of government failure in a broad and narrow sense. The generalized government failure refers to the sum of all government actions that lead to the deviation from Pareto-optimality, which means that all uncorrected market failures and deviations caused by government intervention are considered government failures. A narrow definition government failure refers to a government act that leads to a worse situation than in a laissez-faire situation. Further, Krueger classifies government failure as failure of either omission or commission. The former refers to the government’s failure to properly perform what it should do, such as the lack of investment in infrastructure and wrong economic policies.
The latter refers to what the government has done wrong, such as the vigorous efforts in public-owned enterprises, retail, manufacturing, banks, insurances, etc. These business activities are not necessarily related to the public sector. The by-product of government failure is the breeding of large scale corruption, and the policy of improving the welfare of the poor turns out to be more beneficial to the rich eventually. Using the case of Venezuela, this essay analyzes the causes of the economic crisis in the country based on the government failure theory by Krueger, as well as the limitations of Krueger’s theory.
Venezuela’s economy is in deep recession. Since 2014, the country’s economy has experienced negative growth for four consecutive years. The GDP growth rate in 2017 was -12.5%, which is the bottom of the 33 countries in Latin America (Halff, et al., 2017). The decline in crude oil production capacity is the direct cause of the deterioration of the country’s economic situation. Due to insufficient long-term investment, Venezuela’s crude oil production continued to shrink, falling to 1.6 million barrels per day by the end of 2017, only about half of the 1998 production (Halff, et al., 2017). The country’s average export price of crude oil plummeted from $95/barrel in early 2014 to $21/barrel, and then slowly rose back to $59.14/barrel in January 2018. This price recovery is not nearly enough to completely reverse the passive situation facing the economy. As of the end of December 2017, the country’s foreign exchange reserve was less than 10 billion US dollars. As the economic situation worsens, the shortage of commodity supply has become increasingly prominent. At present, most food and daily commodities are sold at government-restricted prices. The prices are low, but supply is insufficient. Buying food consumes most of the income of ordinary people, and their lives are getting more and more difficult.
In 2012, Venezuela’s economic growth rate reached a high of 5.6%, and has since continued to decline. In 2014, Venezuela’s per capita GDP reached US$16,530, surpassing Brazil, Argentina and Mexico, and is in the forefront of Latin America. But since this year, the Venezuelan economy has contracted. Its total economic reduction was more than 50% since 2013 (Bahar, Piccone, & Trinkunas, 2018). In 2013-2017, the CPI growth rate in Venezuela was as high as 41%, 63%, 121%, 254% and 626% respectively. In the nearly 20 years of the administration of the PSUV in Venezuela, the Venezuelan economy has become increasingly distorted.
The dependence of the national economy on the oil industry has intensified, and the process of economic diversification has not progressed. On the other hand, both crude oil production and export volume have declined, and oil export revenues have faltered. Domestic manufacturing has lost its vitality and the economy has become increasingly dependent on imports. At the same time, foreign exchange shortages have led to insufficient imports. Food, medicines and consumer goods have been in short supply. Under this circumstance, the most fundamental task facing Venezuela is to build a truly productive economy. However, international political pressure is making the task increasingly difficult for Venezuela.
The rent-seeking behavior is an important concept in Krueger’s government failure theory to make sense of what happened in Venezuela. According to the theory of public choice, officials, like ordinary people, have a code of conduct that maximizes personal interests. Their maximization of interests includes maximizing their budget for their own departments, re-election, and so on. Government officials and elected legislators are full economic individuals who have selfish motives in participating in public decision-making. Under the guidance of this behavioral motive, the behavior of officials and elected legislators may not represent the public interest, but only their interests: “it may be more realistic to assume that individual actors within the public sector are as concerned with their self-interest as those in the private sector (Krueger, 1990).” In addition, politicians and officials also have weaknesses shared by humans, and their knowledge may not be complete. The information they possess may be inadequate, and their rational ability is thus limited. Even if their motives are for public interests, the outcome of their actions may still go to the opposite side. In a stable society, rent-seeking turns resources into cartel and lobbying activities, and deviates from production. The result is the increasingly slower the economic growth. (Rosser, 2007). Although the government is elected by the people, it cannot spontaneously ensure that all government actions always represent the public interest.
In Venezuela, the rent-seeking behavior and associated corruption is maximized with the nationalization of critical economic sectors, especially the oil industry. As early as the 1970s, the Venezuelan government implemented the nationalization policy of the oil industry. After 1999, the nationalization process was significantly accelerated. The nationalization policy has significantly reduced the production efficiency of the oil industry, resulting in a sluggish oil production. In addition, the social policy of the Venezuelan government since 1999 has also caused social divisions, large-scale emigration of elites, and the withdrawal of international capital, which has greatly damped social productivity.
With nationalization and reduction in productivity, corruption, money laundering, and drug trafficking have become prominent issues in Venezuela (Bahar, Piccone, & Trinkunas, 2018). For a long time, Venezuela has always been considered one of the most corrupt countries in Latin America and the world. In addition to nationalization, another source of corruption lies in the country’s fixed exchange rate mechanism. Due to extreme inflation, there is a remarkable gap between the official exchange rate and the black-market exchange rate. If importers want to get the opportunity to convert Bolivar into US dollars at the government’s very low official exchange rate, they have to bribe the monetary authority’s officials. Meanwhile, the importers can often madly overstate the value of imported goods to earn more dollars, forming a vicious cycle of bribery and exploitation.
In terms of solving the problem of government failure, Krueger (2009) argues that the primary task of poverty reduction in developing countries is to promote growth, because economic growth is a prerequisite for poverty reduction. Open trade policies are thus conducive to economic growth. Policies to reduce trade barriers are clearly a policy of reducing poverty. On the other hand, she is not optimistic about developing countries to reduce poverty through income redistribution policies. These policies have little effect in low-income countries. It is not so much the redistribution of income, but rather the redistribution of poverty.
Importantly, these redistributive policies can undermine incentives and thus inhibit economic growth (Berg & Krueger, 2003). From this perspective, Venezuela’s high welfare policy is the cause of government failure and economic crisis. Since Chavez was in power in 1999, Venezuela has implemented a series of reforms aimed at expanding the role of the public sector, enhancing social welfare and improving the lives of poor people. These measures have significantly improved the situation of the people at the bottom of the society, but they also brought major drawbacks. First, the fiscal expenditures have become larger and larger, and the expenditure rigidity has been greatly strengthened. Second, the national enthusiasm for work has declined, and production efficiency has been greatly reduced.
While Krueger’s government failure theory highlights the defects in government behavior, it does not include considerations of institutional defects. Institutional deficiencies in Venezuela are manifested in the following two aspects. First, the state is the tool of the ruling class. Therefore, whether it is the monarchy autocratic political system or the democratic political system, the ruling class always uses the state machine to maintain its class rule (Myers, 2014). The government’s implementation behavior always favors the interests of the class it represents. In this way, government behavior is very likely to be dominated by interest groups that are politically or economically dominant. Since the PSUV came to power in Venezuela in 1999, there have been sharp differences in public opinion and contradictions between the ruling and the opposition parties.
The development path of “21st century socialism” advocated by the ruling party has been strongly questioned by the opposition party. This major disagreement has created sharp political contradictions between the two sides (Halff, et al., 2017). The whole society has divided itself into two opposing groups. Every election in Venezuela has become a confrontation between the two major groups. The struggles between the two parties have become the central focus of the government, distracting it from the pressing economic and public issues. Second, in Venezuela, the government organization system lacks supervision. The government organization emphasizes a vertical information transmission mechanism. This characteristic of the government organization system leads to the excessive length of the administrative chain and the distortion of information transmission, which makes it difficult for the superior to effectively supervise the lower-level behavior. Such an ineffective institutional system is also the reason for the surging corruption and government official irresponsibility in Venezuela.
Another limitation of the government failure theory is the underestimation of the external forces in national economic development. The poor economic situation and continued political instability in Venezuela have exposed the Maduro administration to increasing external pressure. Some Latin American countries accuse it of undermining democratic institutions and human rights violations, and advocate sanctions against them. Latin America’s three major countries – Brazil, Mexico and Argentina – are all supporters of this claim (Halff, et al., 2017). In 2017, 12 countries jointly issued the Lima Declaration, condemning the Maduro government.
They have held foreign minister meetings several times and exerted pressure on the Maduro government (Government of Canada, 2017). The United States under Trump administration is also constantly strengthening its pressure on Venezuela. In 2017, the Trump administration launched seven sanctions against Venezuela, the objects include Maduro and more than 30 senior officials of the Venezuelan government. Some Venezuelan citizens were banned or restricted from entering the country. US financial institutions were banned from participating in Venezuela bond trading and equity trading (Halff, et al., 2017). In March 2018, the Trump administration re-implemented sanctions against Venezuela, prohibiting US citizens and entities from engaging in any transactions related to the “Petro” with the Venezuelan government or its agents. During Krueger’s time, globalization and international trade was not a determining factor in national economic development. Therefore, her government failure theory did not include much discussions about the international environment and economic sanctions. Right now, these sanctions are becoming the major obstacles for Venezuela to carry out political and economic reforms.
In conclusion, Krueger’s theory of government failure has its drawbacks, which overlooks the importance of government institution and fails to recognize the impact of globalization and international trade. However, Krueger’s idea economic policy dynamics successfully grasps the dynamic evolution of government policies in developing countries such as Venezuela. Non-neutral policies are becoming more and more complex, distorted, and difficult to reverse due to the rent-seeking behaviors of government officials. Her theories remind people that the initially policy or reform measures are very important.
When designing these policies and reform measures, not only their initial effects, but also their dynamic evolution and dynamic effects should be considered. Facing the economic crisis, the Venezuelan government needs to isolate the domestic economy from the international community, truly implement price control and foreign exchange control, and then gradually restore the economy. Then, it should completely abandon the national currency and allow international currencies such as the US dollar to enter and freely circulate in the country. Finally, Venezuela should be more actively seeking international financial assistance to help stabilize exchange rates and prices. Judging from the current domestic and international situations, the Venezuelan government has not yet found an effective way to implement these solutions.