1 IDEA International, 2 Universidad Central De Venezuela

HeterodoxvsOrthodoxAdjustment inVenezuela:
An Assessmentof the effects oftherestrictionon importsUsing aGeneral Equilibrium Model

Ramón Key1andClaudina Villarroel2

1 IDEA International, 2 Universidad Central de Venezuela

Abstract

The Venezuelan economyis currently indifficultiessummarized ina sharp contractionin economic activityduring the years2013and 2014, aggravated now days by thedrop in oilpricesover 50%.Much ofinternal imbalances present todayare rootedin the mechanism offixed exchange rate sustained in the past, in a contextof increasing public spending.This articleaims tosimulate the effectsof an orthodox adjustment (in place) vs oneunorthodoxadjustment (counterfactual), assessing the external componentto both types ofprograms.In the case of the heterodoxadjustment it refersto adjustmentviaquantitative restriction onimports (setting quantities). For theorthodox adjustment it refers to an adjustmentof the exchange rate(setting prices).

1. Introduction

The Venezuelan economyis currently indifficultiessummarized ina sharp contractionin economic activityduring the years2013and 2014, aggravated now days by thedrop in oilpricesover 50%. Moreoverinflationisalso a problem, having expectations thatthis year it would exceed 100%. Thepublic sector deficithasbeen expandingsincethe global financialcrisis of2008-09, having during the last 5 years in row figures above 10% of GDP.

Much ofinternal imbalancesare rootedin the mechanism offixed exchange rate, controlled(exchange rate anchor) as the main anti-inflationary instrument, in a contextwhere public spendinghas hada rateof continuous expansiondue tothe growing importance ofthesocial agenda(unsustainable).Inthe period2005-2013thecontrolled exchange rateincreases by187% (2.11 Bs/ $ - 6.07Bs/$) while pricesat the consumer level increased by515%. In terms of publicexpenditure(generalgovernment)in 2005it recordeda weight of33% of GDPwhile in2013had anestimatedweight of 40% of GDP (according to figures reported by the IMF).

Theexchange rate anchorin a context ofincreased public spendinghas resulted ina tremendousovervaluedofficial exchange ratewhichcould be between60% - 80%. Thisovervaluationis affectingthe competitivenessof domestic productionon twofronts inexport marketsand thedomestic market.Further,decreasingtax revenuesare50%of external originrelated tothe oil industry.Total importsincreased by104% in volume terms(physicalquantum)and 147% in value terms. It has gone from24to 59 billion dollars.

Theinternal imbalanceis manifested ina deterioration of theexternal position of thecountry, particularlyin reducinginternational reservescurrencyliquidity. Given these resultsin theexternal sector, thegovernment has tendedto adoptunorthodoxmeasuresbeingreluctant totakeorthodoxmeasures like setting price mechanism adjustment.

Heterodoxadjustmentmeasuresincludequantitative importrestrictions, multiple exchangerates, price controlsof the finalconsumer goods,regulation ofcorporate profits. These measures, coupled with fiscal adjustment, werethat characterizedmuch of LatinAmericain theirinitial attempts toaddress the problemsof external debtin the mid-80s. Theorthodox adjustmentthat the governmentwanted to avoid, and which has beenproposed byvarious specialistsincludesamong other recommendationsunificationof the exchange rateand the depreciationof itto correctthe overvaluation, the adjustment offuel prices, and decliningpublic spending.

This articleaims tosimulate the effectsof an orthodox adjustment (in place) vs oneunorthodoxadjustment (counterfactual), assessing the external componentto both types ofprograms.In the case ofthe heterodoxadjustmentit refersto adjustmentviaquantitative restriction onimports (setting quantities). For theorthodoxadjustment it refers to an adjustmentof the exchange rate(setting prices).

1. Heterodox Adjustment in Latin America

MorenoJ.C. (1988) notes that in the second halfof the eightieshas been implementeda number ofstrategiesfor macroeconomic stabilizationin Latin Americaknown as “heterodox” plans.Theyhavebeen describedas "heterodox" because is qualitativelydifferent from thattypicallysuggested by theInternational Monetary Fund.From the perspective ofthe heterodoxplans, conventionalstabilizationpolicies consisted of devaluationand fiscal/monetary contractionare recessiveand ineffectiveto reduce inflationbecause they do not takeinto account theaspect ofinertialinflation.Thisinertial componentis particularly important ineconomieswith persistent highinflation.

Accordingto this literaturethere are differentways of beingheterodox, however, one aspect that highlightsthese authorsin common isthe allegedanti-recessionary bias of policy proposals. Despite these promises, several authors haveanalyzedthe failure of theseheterodoxplans.The sameauthorquotedaboveindicatesthe existence of fourstages:

Initial stage: Uncertainty; strong acceptanceand support.
Stage oferosion: Mismatchesinparticular markets.
Stage ofskepticism: It rethinksandquestions thepossibilitiesofcontrolling inflation.
Final stage: Disenchantmentandresurgent inflation.

Some authorsof this movementargue thatthe lesson fromtheheterodox programsis thatthe objectives ofmaintaining lowinflation ratesandtransfer abroadhigh percentagesof national income(debt payments) appears to be inconsistent.

In thissection we willrescuefor the next sections in the paper the hypothesis ofnon-recessivebiasof heterodox policiesvsorthodox policies. In particular, we will showevidence thatin the caseof heterodoxpolicies they could be morerecessive.

1. TheModel

Themodel used here is a standard CGE model which includes10activities: agriculture,oiland refining, mining, manufacturing, electricity, construction, trade, transport and communications, financial services, and other services.To modelthe effects ofimport restrictions (an important component of heterodox programs), a condition of complementarityis introduced in a standard CGE model astreated in Hosoeetal.(2010). In such treatment, theincome-rent generated bythis restrictionis assignedto the corporate sector.

TheSAM used in this preliminary research corresponds to the year2006 and it is a smaller versionofone constructedbyEcoModin 2010in collaboration with theCentral Bank.

1. Simulations

In order to compare the effects of a “Heterodox” adjustment vs an “Orthodox” adjustment are performed 3 simulations.

Simulation 1:Heterodox Adjustment through a quantitative reduction of 30% in all imports.

Simulation 2:Orthodox Adjustment through depreciation of exchange rate, necessary to increase trade balance in 50%.

Simulation 3:Orthodox Adjustment through depreciation of exchange rate, necessary to reduce imports in 30%.

1. Results

Simulation 1:

A quantitativereduction in importsby 30%(ashas hitherto beengovernment policy), equally toall sectors involved,have the following effects:

-Increasedtrade surplusof 52%.

-Fall inGDP, 4.3%.

-Increased exportsof0.5%.

-Decreasedconsumer utility,10%.

Simulation 2:

The simulation(counterfactual) of the devaluationrequired to achievean increasein the trade surplusof 52% (as above)would be 10% in real terms.Asummary of the effectswould be:

-Decreasedimports, 13%.

-Increased exports, 10%.

-Increasedtax revenue, 0.7%.

-Overalldropin economic activity of2.7%.

-Decreasedconsumer utilityof7%.

Simulation 3:

The simulation(counterfactual) of the devaluationrequired to achieve a30% decreaseinimportswould be 24% in real terms.Asummary of the effectswould be:

-Increasedtrade surplus, 115%.

-Increaseof total exports, 24%.

-Increasedtax revenuesof3%.

-Fall of theglobal economic activity, 7%.

-Fall of theconsumer utility, 17%.

1. Conclusions and policyimplications

1. Ifthe government's goalis to reduce thetrade deficit/increase thetrade surplusorthodoxadjustmentvia pricesproves to be moreefficient than heterodox adjustmentviaquantities.This is in terms of lowerloss of globaleconomic activity andloss ofconsumer utility.

1. Theadjustment viaquantities (restriction on imports) is not sustainable over timebecausehave the following effects: drop intax revenues andstagnating exports.

1. The adjustmentvia prices(exchange rate adjustment) generates the foundationsof the post-recovery over timebecause it produces: increased tax revenuesand boostingexports.

1. Asevere adjustment inthe exchange rateof24%, to achieve a30% reductionin imports (not necessary to improve external balance) maygenerate a short-term severe contractionof GDPand the loss ofutility of the consumers greater thethanin the case of the quantitative restriction.

1. References

-Brooke A., Kendrick D. and Meeraus A. (1992). GAMS: A User´s Guide, Release 2.25. Scientific Press.

-Hosoe N., Gasawa K. and Hashimoto H. (2010). Textbook of Computable General Equilibrium Modeling, Programming and Simulations. Palgrave-Macmillan.

-Key R. and Bayar A. (2011). Impacto Macroeconómico del Plan Siembra Petrolera: Resultados de Modelo de Equilibrio General Computable Dinámico de la Economía Venezolana. Mimeo.

-Lofgren H., Harris R.L. and Robinson S. (2002). A Standard Computable General Equilibrium (CGE) Model in GAMS. International FoodPolicyResearchInstitute (IFPRI).

-Moreno J.C. (1988). Los Programas de Ajuste Heterodoxos en América Latina. Revista Economía Teoría y Práctica No 12; Universidad Autónoma Metropolitana. México.

-Villarroel C. y Key R. (2012). Removal of Energy Subsidies and its effects on the CO2 emissions in Venezuela. EcomodConference 2012. Seville, Spain.

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