Written by Ralph T. Niemeyer, Caracas on 20 July 2008
The film with excerpts of an interview with President Chávez is available on youtube.com
A little bit of history.
In order to understand where the interests of the established political and rich class are, a short history lesson may be helpful. PDVSA was nationalised in January 1976 during the government of President Carlos Andres Perez and took over all of Venezuela’s oil policy while the Ministry of Mines & Energy ceded power. By 1980 PDVSA had already minimised fiscal revenues through transfer pricing and acquired refineries in Europe and the United States.
Whereas the fiscal contribution of oil in the years between 1976 and 1993 had been 70% of export revenues it was in 2002 only 40% although the production increased. The state didn’t get it’s share, but why was that so? In the 1980s and much more openly in the 1990s the royalty based system of taxation was replaced by excess profit taxation by this was bringing down tax levels significantly. It could be seen as rather ironic that President Andres Perez who was back in Power for another term in 1989 was reversing almost everything he did in 1976, all his good ideas, so to speak. His Latin American Glasnost, the so called Apertura, with neo-liberal symptoms lead into economic disaster in 1992.
He must have been under tremendous pressure otherwise it is hard to explain why he was literally slaughtering the holy cows he once fed. Has he dreamed of a Great Venezuela in 1976 by using profits from the nationalised oil production for up-grading infrastructure he was all of a sudden applying all typical neo-classical tools. The profits from the state-owned oil company PDVSA mysteriously de-fluxed to some off shore companies.
As PDVSA was allowed to have contracts with private investors it only had the function of an umbrella for these foreign holdings being not affected by national taxation in Venezuela. So how did it come to pass that a state owned company was virtually functioning agreeing to unfavourable terms for the state? In 1989 the government was forced by PDVSA lobbyists to negotiate treaties with the US on double taxation as well as the Investment Promotion and Protection Act, a law which was passed in October 1999 just two months ahead of Chávez’ landslide election victory.
The rich class of course sensed that something was going on in the country and they wanted to be prepared. Not all of them trusted Chávez although at the beginning of his campaign he seemed to be dancing to their tune. They thought that this parachute officer was only talking leftist and by this was pleasing the masses but they had soon gotten disappointed.
One major change, however, PDVSA could not prevent: the new Natural Gas Law which established a royalty rate of 20% as a minimum while the government announced that the same rate would apply to all hydrocarbons. This may be one reason why the old PDVSA management was so angry at Chávez.
The trick of Transfer-Pricing
If one wants to explain how the country was torn apart during the time of the IV. Republic and how it came that the V. Republic emerged with Chávez’ Bolivarian Revolution one has to explain that Chávez founded his movement as early as in 1982.
Revenues from oil were already declining and the PDVSA executives were heading for internationalisation and dreaming of profit maximisation, by allowing foreign – mainly US – companies and their capital buy into their market. On the one hand the Venezuelan oil industry was not able to manage the production themselves and desperately needed the new technology and expertise of those major international companies.
However, on the other hand this enabled the management to use so called “transfer pricing” in order to push the revenues beyond the reach of the government. As Chávez saw this, he made a promise to both himself and his followers that he would “relocate these profits and give it back to the people of Venezuela”.
At the same time when PDVSA managers heard about Chávez’ plans they pushed harder in order to realise their strategy of internationalisation. It has always been as clandestinely clear that either Chávez or the PDVSA management would win as it has always been clear that Chávez and the old PDVSA were enemies but until 2004 it remained unclear who the eventual winner of this shootout would be. By introducing a new hydrocarbon tax and re-negotiating agreements he forced major international oil companies to either accept the new terms or see their vessels with empty tanks home to the US.
The End of the Fourth Republic
In the 1980ies and 1990ies neither side believed in the political system of the time, the so called Fourth Republic. And both sides, the military as well as PDVSA blamed corruption for the crisis. The Military dreamed about saving the country and PDVSA executives dreamed of saving the oil industry from the country.
When Andres Perez was back in power in 1989, PDVSA’s management had already successfully undermined the nationalisation, they merely waited for President Andres Perez to open the Venezuelan markets for foreign investors which he did in defiance of almost all moral principles and even of his own political agenda from his first term. The catastrophic consequences of the “Apertura” under Andres Perez lead to an influx of foreign investment and 25% of Venezuelan oil until 2004 being produced was under foreign contracts. However, these contracts were bearing disastrous consequences for the future of Venezuela as by 2010 more than 40% of the oil would be produced using foreign capital.
Economic decline as direct consequence of mismanagement
In order to understand why nationalisation was so important and had such serious consequences on the state one has to see that the fiscal income rose in the post nationalisation years from 1.4 billion USD (10% of the GDP) to 9 billion USD (40% of the GDP in 1976). The small economy of Venezuela was unable to absorb such an amount of liquidity and the government of Andres Perez sought to invest into rapid industrialisation, something neither the country nor its society was ready for.
Although the state of Venezuela theoretically became rich President Andres Perez had contracted international loans by pledging future oil revenues in order to realise his dream of the “Greater Venezuela”, industrialised and strong.
As this venture turned into an adventure with the foreign companies leaving the field the foreign creditors were eventually able to force the government and state enterprises to adapt policies and make PDVSA incredibly strong after 1983. The state was PDVSA.
This became obvious when the government in 1983 only managed to solve the foreign debt and currency crisis by relying on the investment fund of PDVSA from which the state borrowed 5.5 billion USD. PDVSA had accumulated these funds during the time high prices were paid for crude oil in the early eighties. This manoeuvre, of course, alerted the PDVSA management who in order to avoid further borrowings from the government decided better not to have any profits by spending it abroad, i.e. by buying a share in the West-German refinery VEBA and by selling oil to European partners at discounted transfer prices and by this being out of reach of the Venezuelan government or the tax office.
Legalised Tax Evasion
The government of President Jaime Lusinchi (1984-1989) legalised this method of tax evasion by decreeing that PDVSA determine their own prices and by this encouraged further internationalisation. As a result the state from then on didn’t get much of the direct profits from PDVSA and only a small portion of the cake through indirect taxes and levies.
During the chaotic second term of the Andres Perez government and following the coup attempt of Hugo Chávez in 1992 (which let him end up for two years in prison where he drafted the new constitution he is now revising again) PDVSA pushed through lower taxation as only a weak transitional government took over.
The provisional government accepted a new income tax law with generous allowances for inflation of production costs in the oil sector as well as tax exempts for export levies. As a consequence the fiscal revenue from oil dropped significantly. The state which under President Lusinchi continued with its spending policy had to open the financial market to foreign capital and even negotiated loans with the IMF. All this in a country like Venezuela which could easily be almost as rich as Saudi Arabia and rather an international creditor than being confronted with the IMF demands for “restructuring and privatisation”.
The new constitution made by Chávez
When one reads the new constitution it may appear as if the ownership and sovereignty of the state over the natural resources and PDVSA has been reinforced by the “Bolivarian laws”. However, this is only partly true as even though PDVSA can not be privatised according to the constitution, these laws do not affect PDVSA’s affiliates and foreign subsidies. Since PDVSA itself technically did not produce a single barrel of oil on its own, the “Bolivarian constitution” which seems to promote nationalisation, in fact made it easier for transformation of PDVSA into a liberal licensing agency for a private industry.
In order to investigate PDVSA’s profits properly the Chávez government introduced the new Hydrocarbon Law which obliged PDVSA to open their accounts and explain where profits were made and how the transfer pricing was structured. It should also reveal a lot about the inflated costs of the oil production which evidently ended up in the pockets of a white upper class while more than 80% of the population were living in an incredible poverty.
Focusing on the US – another legal trick to hide profits
In the years before Chávez assumed power in 1999, PDVSA shifted its attention to the US market where it still operates under the name of CITGO. The real reason for the long term supply contracts with favourable discounts for US partners and their own daughter companies is to transfer another large portion of the PDVSA profits out of the country.
Today, PDVSA supplies 14,000 gas stations in the US but also signed contracts with its own subsidiaries. These contracts were used as collateral for loans thus making it absolutely impossible for the Venezuelan government to ever get a share of the real profits.
Since PDVSA acted as an umbrella company for the private foreign subsidiaries or foreign companies, the state, although owning PDVSA did not have much control over it as the contracts which were subject to international arbitration protected the foreign companies by indemnity clauses. Therefore, Chávez changed legislation but still PDVSA had to compensate its international partners even if these were mainly affiliates or daughter companies.
The fact that for the first time in its history PDVSA accepted a place of venue and foreign jurisdiction for these contracts made it an almost impossible task to question the legitimacy and legality of such unfavourable contracts, especially since the courts were in the US. Ignoring these agreements could have led to the confiscation of PDVSA’s assets abroad and therefore would not be in the interest of the state either. Hence, the hands of the Chávez-government were completely tied. The only way to change these unfavourable terms was by paying off PDVSA’s foreign debt which amounted to some 10 billion US-Dollars.
The constant de-flux of profits from oil made Venezuela poor
Statistics prove that the government’s share in the oil revenues continuously shrank. Whereas in 1981 it had a gross income from hydrocarbon production, including refining, of 18.7 billion USD, in 2000 a stunning 29.3 billion USD, PDVSA in 1981 paid 13.9 billion USD in taxes while in 2000 only 11.3 billion USD went to the state, so for every Dollar of gross income in 1981, PDVSA paid 71 cents to the government but only 39 cents in 2000. In order to stop this tax evasion Chávez tried to regain control of PDVSA and by doing this infuriated the rich class of Venezuela as well as the White House, as both the US oil industry and oppositional politicians like Henrique Salas Römer insisted that the Chávez government obeyed the existing agreements.
Since the syncrude tax revenues declined further, it is of course, a battle Chávez had to win if he wanted to be able to continue with the social spending that made him popular with the poor and his missions for the poor majority of the people. The only option that remained was for Venezuela to sell its international holdings as for example PDVSA’s stake in the German Ruhrgas which just before Christmas 2003 the Venezuelan government sold to the Russian Federation when Foreign Minister Ivanov visited President Chávez.
A coup d’état brought back an ever stronger Chávez
Since for some 18 years the foreign affiliates of PDVSA never paid any dividends to the head office which while being more or less legally tolerated by previous governments nevertheless betrayed the Venezuelan people. This came to an abrupt end, when in December 2001 President Chávez forced them to pay dividends for the first time.
It was this and not just the change in the management, that stirred the conflict which later resulted in strike action as well as the coup d’état of 11th April 2002 when President Chávez was briefly ousted from power. Since this time he survived a recall referendum initiated by the country’s opposition in 2004 and in an evenly clear vote got re-elected for another 6 year term in December 2006 by 63%.
Since his re-election, Chavez set forth new terms and conditions and by this increased the share of participation of PDVSA in oil ventures conducted by international companies from 39% to 60-83% depending on the nature of the project, be it exploration for which new technologies are needed or refining. In June of this year (2007) US American oil giants Exxon Mobile and Conoco Phillips refused to accept the new terms and withdrew completely from Venezuela because the Venezuelan state from now on will hold in all production companies a majority stake and also takes the lead in the operations. Exxon and Phillips are negotiating compensation claims with PDVSA. Other international companies such as the French TOTAL, the US American Chevron as well as the Norwegian STATOIL and British Petrol have principally accepted the new terms.
Distribution of income in Venezuela before Chávez
At this stage it should prove useful to take a closer look at the distribution of income in Venezuela as this will indicate what the real problems in such a – theoretically – rich country are based on. The development of the wage share shows the relation between rich and poor within a society but one has to take into account the fact that the salaries of managers and members of the board of directors also form a part of this figure. Therefore it can only be seen as an indicator and not as an absolute figure. One also has to take note of the fact that extreme poverty is always directly related to unemployment.
However, the living conditions of unemployed people should have no influence on the wage share in Venezuela since it lacks any well-developed social system financed by wage dependent contributions. Those who are unemployed are poor and those who have work, thus far don’t have to contribute to the social budget.
The aim of the Chávez government is to change this and introduce a system that we once used in West-Germany.
Also before Chávez, the wage share in theory could have risen because of strong GDP growth and huge profits, but as it stands, it declined while the share of unemployed people and their poverty was rising as well. But in reality such relations are not very likely because an increasing unemployment is normally used to put pressure on wages which forces them to shrink, as a consequence.
Figures released by the Bureau of Statistics show that the path of the aggregated share of all wages in the Venezuelan GDP on one side and the path of the profit share, denoting the share of all exploitation income in total GDP on the other, form a gulf. While wages decreased, profits increased. The figures shown here include the years from 1957 until 1998, so the time before Chávez was elected.
A gulf between Rich and Poor
This development may explain why a man like Chávez could assume power. The poor people of Venezuela were in the clear majority (75%) and have obviously been exploited by the rich minority over the past decades. The upper – middle class who governed the country until December 1998 had obviously not taken care of the people. The conclusion can be drawn that it was their own fault that the Bolivarian Revolution happened with the vast social differences forming a gulf between rich and poor.
Furthermore, a continuous redistribution of income from the bottom to the top of the Venezuelan society created sharp social contrasts and increasing poverty as an inevitable consequence of the exploitation by those who consider themselves today’s opposition.
It is not astonishing to see that the domestic market could not develop within the framework of such conditions. Conditions which pushed up the level of production and importation of luxury items for a small minority, when the basic goods sector was suffering from a lack of demand because of increasing poverty.
The only time wages rose significantly was in the aftermath of the nationalisation of the oil industry in 1975/76. However, soon after this positive development wages stagnated again as did so domestic demand in 1980.
Despite constantly growing GDP Poverty became widespread
We saw that GDP in Venezuela reached in 2002 a real value that corresponds almost 5 times of that produced in 1957. In 1998 wages hadn’t exceeded the value that had previously been reached in1980. This is the real gap between rich and poor. It means that whereas all Venezuelans could have been well off in those years they in fact got relatively poorer while a small upper class became incredibly rich.
The revenues from the oil industry which, at least on paper, in 1976 was completely nationalised, de-fluxed to some off shore holding companies owned by the elite upper class who by method of transfer pricing were selling the country’s natural resources for a lower price to their own off shore companies which then sold petrol and gas to market prices to US and European countries. That’s why the profits from the oil industry although state owned did not contribute as much to the budget of the state as they could.
The Chávez government was getting a grip on the profits from the natural resources by axing the corrupt structures by the management of the nationalised Petroleum de Venezuela S.A. (PDVSA). Chávez demanded the books be laid open and when the managers who were still loyal to the country’s establishment still tried to hide their off shore and transfer pricing system, he fired the complete management. This is were the upper class had understood that he was not the social democrat they had thought he was talking leftist and by this pleasing the masses while not actively posing a threat to their corrupt system.
As a reaction the coup d’état of 11th April 2002 with the active help from the US and Spanish government has been launched by Pedro Carmona, a former oil manager for the Veneco Corporation owned by Isaac Perez Recao who is also a known weapons dealer and shareholder in major banks. Chávez was posing a threat to the dominating power of the establishment.
Chávez infuriated the rich elite by turning against them
This explains why the white, often aristocratic appearing, elite, referred to as Mantuanos (Spanish colonial families) who also owns most of the land and by this controls businesses and banks, are so infuriated about any move the Chávez government is undertaking. Of the 35 million acres of fertile land, 24 million acres are owned by 5 families, while the remaining 11 million acres are shared between 700,000 families. Most of the land is not used for any agricultural production, but just lays bare and unused although Venezuela would be quite fertile and with it’s year-round warm climate would allow for 2 – 3 harvests a year.
The necessity for a land reform becomes obvious when one scrutinises the trade balance of Venezuela. For a considerable amount of the foreign currency the country earns in oil exports costly imports are paid. Venezuela, although being quite fertile, does not produce enough food to supply domestic demand. The land reform is, of course, highly controversial as ownership is a key to economic power. As the land reform progressed and allowed only for 20,000 acres to be owned by a single person, the redistribution threatened the rich land owners, of which some are living overseas. The Financial Times noted that also Spanish and British citizens are loosing out on the land reform of the Chávez government.
That may explain why the relations between those countries are strained with King Juan Carlos de Bourgogne of Spain shouting at Chávez telling him to shut up. In this part of the world, the Mantuanos who were once sent by the Spanish king to conquer South America are not that popular.
The fact that the king’s ambassador had conspired with the US and the country’s opposition to oust Chávez by a military coup is also not forgotten here. All in all the Spanish king’s unusual attack may have amused people in Europe and the US but not in Latin America. It rather has served Chávez’ popularity with his followers whom he never gets tired to tell that Simon Bolivar had once thrown out the Spanish colonialist power from this part of Latin America.
GDP & Inflation before Chávez
A more detailed analysis of the time from 1995 until 2002 reveals that less and less was consumed in respect to production volume but also to the variance of household consumption in regards to concrete products calculated in current and constant prices.
The essential branch of food, drinks and tobacco – time series shows the value of goods consumed shrinking sharply. The real consumption of basic goods declined by 25 percent compared to the level reached in 1991. A horrific fact, especially if we bear in mind that the Venezuelan population grew from less than 20 Million to more than 24 Million during the same time. People were starving. However, excluding the period between 1999 and 2001 real consumption also shrank, although less significantly than the current price path indicates.
Thus, the general inflation was much higher than the price changes concerning food and drinks, which is surprising because usually the situation is reversed. We see such a reversed development exclusively here in the period directly before 1998. Total consumption of goods was actually shrinking by 15 percent (in monetary terms it reaches 30 percent). Of course the real 15 percent also denotes an immense deterioration in the common standard of living, because of rising population levels the effect of the real drop is much more drastic. People were not only consuming 15% less but ever more people had to share less available products.
Oil profits were used to buy luxury goods for the rich
The revenues from the natural resources was not used for producing food and other goods of daily use but were used to pay for expensive imports, increasingly not even for food anymore because the majority could not afford it well anymore due to shrinking wages, but for luxury goods. Cynically enough, the oil profits which had not de-fluxed through the corrupt off shore and transfer pricing system were used for buying German and American cars, yachts, perfume, Swiss chocolate and luxury articles for the rich class while the basic needs of the poor majority weren’t met anymore.
All in all the real consumption level continued to increase due to the neo-liberal reforms that had lead into a disaster in the early nineties provoking the coup attempt of the parachute officer Hugo Chávez in 1992 which failed and bought Mr. Chávez a two years prison term during which he developed ideas for a new economic agenda. He said for him “prison was the baking oven for good ideas”.
Transformation of the Economy by using Oil revenues
The effects of the economic reforms of the first few years of the Chávez government were not felt until recently. Since 3 years, however, GDP grew constantly, in 2007 by something close to 9% and by this one per cent up from 2006.
Investment growth expected in next two years as the National Development Fund (FND) has received some 30.2 billion US Dollars from oil revenues which it uses for investments into 159 development projects, most of these in the infrastructure and energy sector. 17.45 billion USD were stemming from the Central Bank (BCV) and 13.15 billion USD directly from PDV, the national energy company. Said fund initiating economic growth in other sectors as well is part of the new constitution.
The FND fund was established in 2005 to invest part of the oil revenue in development instead of turning the entire income into international reserves. FND is one of the fundamental parts of the new constitution but the international media rather report on the question whether the amount of presidential terms shall be increased or not.
Public and Private investments in the past 4 years hit record levels and here also the new constitution allows for a state-privately owned joint venture structure which shall include the private sector and provides for a mixture of ownership rather than the socialistic or communistic structures many observers feared that Chávez was aiming to introduce.
At present, 60% of the national industry are working at full power while 92% of the manufacturers do so as well.
Unemployment fell from 8.9% in October 2006 to 7.2% (lower than in the EU!) while in October 2007 unemployment dropped again showing the lowest ever unemployment rate in Venezuela.
Note: (23 May 2017): Interestingly, the rich upper class caused the present food crisis by holding back goods while the opposition openly invites the US to invade the country. Given the fact that US Secretary of State, Rex Tillerson, is the former CEO of Exxon Mobil who lost in the international court of justice against the Chávez government, one can assume that Washington is not hesitating to attack the Bolivarian Revolution again.