By John Weeks

[for longer treatment, see my new book, The Economics of the 1%: How mainstream economics serves the rich, obscures reality and distorts policy, Anthem Press, print and ebook versions]

The Problem

In a video currently on The Real News along with Greg Wilpert I discuss causes of inflation in Venezuela.  In this 99%’er I elaborate my thoughts.

Recent events in Venezuela, civil unrest and economic instability, indicate the dilemma governments encounter when implementing progressive policies in the interests of the poor, working class and lower middle classes.  Eighteen months ago in Argentina I observed a similar process unfolding, though less extreme in its manifestation.  Just last month I witnessed what may be the early stage of the same phenomenon emerging in a central African country, Zambia.

The problem is easily stated.  With alarming frequency attempts by left and center-left governments to implement progressive policies result in macroeconomic instability that proves the undoing of the progressive project.  What is going on?  Why do the governments we applaud for their commitment to poverty reduction and equitable growth so often seem to screw up the economy?

A frequent explanation by progressives for the troubles in Venezuela is what might be called the External Forces argument.  The idea is simple – the global capitalist elites, most notably in the United States, set about systematically and relentlessly to undermine any attempt anywhere to implement policies contrary to the interests of that elite.  The techniques to undermine progressive change range from use of economic power to direct military intervention and everything in between.

In the case of Venezuela the government of the United States directly and covertly supports domestic reactionary forces with the clear intent to effect “regime change”.  Inflation, capital flight and shortages are all the result of the nefarious manipulations of financial and commodity markets by agents and agencies of the US government.  The political unrest itself and the street demonstrations result from an unholy alliance of domestic reactionaries and US security agencies.

The role of the US government in Venezuela and elsewhere is real and we should never underestimate it.  However, if that is the entire explanation, and the policies of progressive governments bear no responsibility for the economic and political instability, then we have a very depressing story, indeed.  Simply stated the depressing story is that progressive governments seek to implement fundamental changes and the domestic and global forces of reaction prevent that happening.  To reverse the famous line Cassius makes to Brutus, “the fault is in our stars, not in ourselves”.

However, like Cassius I think the fate of progressive governments does not turn on things beyond our control (Julius Caesar Act 1, scene ii, where the actual line is “the fault, dear Brutus, is not in our stars, but in ourselves”).  Greater optimism is justified, because by identifying and understanding the cause of mistakes governments can more successfully implement fundamental change.

The chart below shows the inflation rates since 2000 in three Latin American countries, all with progressive governments for at least a majority of the years covered.  Two of the three, Argentina and Venezuela, experienced high inflation, with the government reported rate in Argentina well below the actual rate.  The Bolivia numbers show that all progressive governments do not suffer from severe inflation, whatever its cause.

Solving the Problem

Why are Argentina and Venezuela experiencing high inflation and not Bolivia?  Inflation results from total expenditure in an economy exceeding the total supply of goods and services.  The demand in excess of total supply represents an imbalance or disequilibrium.  This imbalance is eliminated in one of two ways:  1) imports increase by an amount equal to the extra demand, and/or 2) prices rise and real purchasing power falls to eliminate the excess demand.

How do we know that Argentina and Venezuela have excess demand?  Evidence of this is shown by the fiscal deficits of the two countries.  In 2013 the Bolivian government had a budget surplus of about two percent of GDP, while Argentina had a deficit of about three percent of GDP and Venezuela in excess of eight percent (the Argentine figure is probably an under-estimate).  The chart below shows the steady increase in the Venezuelan deficit from 2009 onwards.

I have written in several columns that a fiscal deficit is not necessarily a problem.  If the economy is suffering from underutilization of its resources, most importantly labor, increasing pubic expenditure is the appropriate policy.  However, if an economy is close to its potential output, a rising deficit results in excess demand, which generates imports or, if imports are restricted, inflation.

Why should Venezuela have a large public sector deficit when it is a major petroleum exporter and oil prices are strong (though below their peak in the 2000s)?  I think the answer lies in what might be called the political economy of progressive governments.  Such governments are defined by a commitment to reducing unemployment poverty.  Those that elect them expect this commitment to be realized.

Reduction of unemployment and poverty requires public expenditure targeted at those goals.  By definition success implies that the economy approaches maximum capacity when inflationary pressures increase.  As J M Keynes wrote in his seminal work The General Theory of Employment, Interest and Money, with an economy close to full capacity “a further increase in the quantity of effective demand produces no further increase in output and entirely spends itself on an increase in [prices] fully proportional to the increase in effective demand”.

At this point the Latin phrase festina lente should guide fiscal policy (“make haste slowly”).  In its urgency to reduce poverty and serve the interests of the 99%, a government must take care not to attempt to achieve too much too soon.  Legitimate pressures from an electorate long denied economic justice will create  a strong temptation for inflation-generating expenditure.

The necessary outcome, as in Venezuela, will be inflation itself and an unsustainable level of imports.  In response to the latter governments often introduce import controls which intensify inflationary pressures and lead to shortages of goods.  At this point what is essentially a class conflict over the distribution of national production can be mis-represented by reactionary forces as an allegedly broadly based rebellion against economic mismanagement.

Reactionary governments enjoy considerable margin of error in economic policy because the international forces of reaction will never seek to destabilize them for their commitment to the service of the 1%.  In contrast, progressive governments continually tread a narrow path and must implement their commitment to the 99% in a manner than minimizes the destabilizing tactics of reactionaries both domestic and foreign.  Part of that minimization strategy is careful management of expenditure.  To use the mainstream term, “fiscal discipline”.

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John Weeks is Professor Emeritus and Senior Researcher at the Centre for Development Policy and Research, and Research on Money and Finance Group at the School of Oriental & African Studies at the University of London.