South-Western College Publishing - Economics  
Venezuela's Economy Headed South
Subject Recession
Topic International Finance
Key Words Recession, Inflation, Economic Growth, Investment, Devaluation, Trade Deficit
News Story

Venezuela has one of the most highly regulated economies in the world. It relies on oil exports for more than 70 percent of its export earnings. Venezuela's economy has been contracting. Government estimates were for a 2 percent decrease in real Gross Domestic Product (GDP) for 1999. Venezuela's new Finance Minister, Jose Alejandro Rojas, modified these projections and revealed that the decrease will likely be in the order of 3 to 4 percent. But even this projection may be optimistic since many private analysts are estimating a decline of 5 percent or more.

Inflation in Venezuela is estimated to be 20 percent this year. Although this increase is very large compared to the inflation rate in the U.S., it represents a considerable improvement over the 30 percent increase recorded for 1998. The government deficit for 1999 is estimated to be $8 billion and the current account deficit, a measure of trade and foreign debt repayments could reach $2 billion in 1999. To finance these deficits Venezuela plans to issue $2 to $3 billion in national and international bonds this year. Mr. Rojas also said that the government would not devalue its currency, the bolivar, despite the current account deficit. Analysts estimate that the bolivar is overvalued by as much as 30 percent.

Another source of Venezuela's economic difficulties is the lack of a coherent economic policy. Mr. Rojas blamed the worsening poverty and increased dependence on oil exports on the poor management of the economy.

Mr. Rojas believes that foreign investment is needed to stabilize the economy and produce an economic recovery. To this end, the President of Venezuela, Hugo Chavez, has promised to deregulate and further open the nation's petrochemical, natural gas, mining, electricity, and telecommunications industries to private investment.

(Updated August 1, 1999)

Questions
1. The article mentions that many analysts believe the bolivar is overvalued, by as much as 30 percent. How would a devaluation of the bolivar affect Venezuela's economy?
2. Mr. Rojas believes that foreign investment will stabilize the economy. How would increased foreign investment affect GDP, inflation and unemployment?
3. Draw an aggregate demand/aggregate supply diagram for an economy in recession. What would happen to GDP and the rate of inflation if the government increased aggregate expenditures? What would happen if the government contracted the money supply?
4. How would deregulation of the economy, that is, an improvement in economic efficiency help the economy of Venezuela?
Source Thomas T. Vogel Jr., "New Venezuelan Finance Minister Says Economy May Contract By 4%, Seeks Foreign Investment", The Wall Street Journal, July 7, 1999.

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