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Spectacular underperformance

Nov 23,2014 - Last updated at Nov 23,2014

If it were not such an affront to the freedom of expression, we would almost be amused by Venezuelan President Nicolás Maduro’s recent tantrum over a commentary by economists Ricardo Hausmann and Miguel Angel Santos.

Venezuela has long lashed out at the International Monetary Fund for daring to suggest that its macroeconomic policies might not be working well. Now its president is lashing out at academics.

Maduro, of course, rules over a major oil-exporting economy that is so badly mismanaged that real (inflation-adjusted) per capita GDP today is 2 per cent lower than it was in 1970, despite a ten-fold increase in oil prices.

Hausmann and Santos had the temerity to ask whether, having defaulting on every conceivable kind of domestic debt, Venezuela should invite foreign investors to the party and default on its debt to them as well.

Is it such an unreasonable question?

It is unclear whether Maduro, who called for Venezuela’s authorities to take unspecified “action” against Hausmann and Santos (both Venezuelan citizens), was more offended by the suggestion that his government should default on external debt, or by the authors’ list of all the other ways it has already defaulted.

These include the government’s $3.5 billion unpaid bill for pharmaceutical imports, payment arrears of more than $2 billion for food, and nearly $4 billion owed to airline companies.

Oil production has more than halved since 1997, in no small part because the state-owned oil company has repeatedly defaulted on suppliers and joint-venture partners.

Both the scope and magnitude of domestic default are enormous, with significant de facto “haircuts” (that is, expropriation) for creditors.

During 2013-2014, yields on domestic government debt were around 17 per cent, while inflation oscillated in the 55-75 per cent range.

Negative ex post real interest rates in the vicinity of 30-60 per cent register on the high end of historical haircuts. The toll of this “taxation” is not confined to bondholders: pensioners, depositors and anyone else with claims against the government — or who holds a bolívar — is affected.

So, as Hausmann and Santos ask, should Venezuela’s government default on its foreign debt, given that the historical record shows that nearly all domestic defaults go hand in hand with external default?

Indeed, given that the government is defaulting in numerous ways on its domestic residents already, the historical cross-country probability of an external default is close to one.

Important moral and equity considerations aside, this probability highlights why Hausmann and Santos pose such an obvious question.

In our book “This Time Is Different”, we document how domestic defaults are associated with deeper and longer-lasting recessions and much higher inflation than “purely” external defaults.

Though we proceed to observe that historically there have been many external defaults without domestic defaults, the converse is not true: nearly all domestic defaults are “twin defaults” that also involve external creditors.

Will the Venezuelan case be different?

Hausmann and Santos are right that the huge extent of domestic default suggests a high risk of external default.

They are also probably right that, for most Venezuelans, external default would be a good thing. Default on foreign creditors, as we have noted in the past, is a risky strategy that needs to be compared to other options.

But let’s not pretend that such a step is unprecedented in Venezuela’s history.

Since Venezuela became independent, defaults on its bonded external debt have occurred in 1826, 1848, 1860, 1865, 1892, 1898, 1983, 1990, 1995 and 2004.

“That is why,” as Hausmann and Santos point out, “Venezuelan bonds pay over 11 percentage points more than US Treasuries, which is 12 times more than Mexico, four times more than Nigeria, and double what Bolivia pays”.

To attack them for daring to impugn Venezuela’s credit status in 2014 seems a bit out of touch with past and present realities.

The relevant reality now is the long-term plight and dwindling standard of living of the average Venezuelan citizen.

Over the past 45 years, as Venezuela’s real per capita GDP fell, US per capita GDP roughly doubled and Chile’s per capita GDP nearly tripled.

And neutral observers project that 2014 will be even worse for Venezuela — not surprising, given the chaos of the country’s policy fundamentals.

Maduro’s absurd threat against Hausmann and Santos smacks of a search for a scapegoat.

They were not giving a political speech, but were simply summarising deeply troubling and unpleasant facts.

Given the depth and breadth of the deepening crisis that Venezuela is facing, Maduro’s efforts and attention would be best directed at resolving the country’s problems, rather than at lashing out against scholars stating uncomfortable truths.

Carmen Reinhart, a research associate at the National Bureau of Economic Research, is professor of the international financial system at Harvard University. Kenneth Rogoff, a former chief economist of the IMF, is professor of economics and public policy at Harvard University. ©Project Syndicate, 2014.

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