Price controls divorced from reality

Here's what you get when you combine growing demand fueled by growing oil income with tough enforcement of price controls:

The lines formed at dawn and remained long throughout the day - hundreds upon hundreds of _____s queuing up to buy scarce milk, chicken and sugar at state-run outdoor markets staffed by soldiers in fatigues.
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The long lines for basic foods at subsidised prices are paradoxical for an oil-rich nation. Shopping malls are bustling, new car sales are booming and privately owned supermarkets are stocked with American potato chips, French wines and Swiss Gruyere cheese.

Yet other foods covered by price controls - eggs, fresh chicken - periodically are hard to find in supermarkets.

Fresh milk has become a luxury, and even baby formula is scarcer nowadays.

It's not a paradox. Paradoxes don't have explanations. This is Venezeula under Hugo Chavez. Price controls create shortages. Milk has become rare only because the price is artificially low.

It's interesting that the Gulf News is running this AP story. The story concludes,

The government's price controls are also "totally divorced" from reality - in some cases below production costs - making it unprofitable for suppliers to sell their products at official prices, said econ-omist Pedro Palma of consultants MetroEconomica.

Chávez Threatens to Jail Price Control Violators :: NYT

Quote:

Food producers and economists say the measures announced late Thursday night, which include removing three zeroes from the denomination of Venezuela’s currency, are likely to backfire and generate even more acute shortages and higher prices for consumers. Inflation climbed to an annual rate of 18.4 percent a year in January, the highest in Latin America and far above the official target of 10 to 12 percent.
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For now, Venezuela remains far from any nightmarish economic meltdown. The country, which has the largest conventional oil reserves outside the Middle East, is still enjoying a revenue windfall from historically high oil prices, resulting in a surge in consumer spending and lavish government financing for an array of social welfare and infrastructure programs. Dollar reserves at the central bank total more than $35 billion.
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Entering a supermarket here is a bizarre experience. Shelves are fully stocked with Scotch whiskey, Argentine wines and imported cheeses like brie and Camembert, but basic staples like black beans and desirable cuts of beef like sirloin are often absent. Customers, even those in the government’s own Mercal chain of subsidized grocery stores, are left with choices like pork neck bones, rabbit and unusual cuts of lamb.

With shoppers limited to just two large packages of sugar, a black market in sugar has developed among street vendors in parts of Caracas. “This country is going to turn into Cuba, or Chávez will have to give in,” said Cándida de Gómez, 54, a shopper at a private supermarket in Los Palos Grandes, a district in the capital.
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Mr. Chávez also said he would raise subsidies for state-owned grocery stores. Economists say such subsidies, together with hefty loans to farmers, have allowed the price controls to function relatively well until recent weeks.

But recent expropriations of farms and ranches, part of Mr. Chávez’s effort to empower state-financed cooperatives, have also weighed on domestic food production as the new managers retool operations....

“There seems to be a basic misunderstanding in Chávez’s government of what is driving scarcity and inflation,” said Francisco Rodríguez, a former chief economist at Venezuela’s National Assembly who teaches at Wesleyan University.

It is difficult to misunderestimate that basic misunderstanding.

But this is great for the teaching of economics. A government so awash in oil revenue can keep this up for a long time creating plenty of fodder for classroom discussion of shortages, prices ceilings, subsidies, capital flight, yadda yadda yadda.

Venezuela. Chavez and Oil :: The Economist

Quote:

It has been Mr Chávez's extraordinary good fortune that the price of oil increased more than sixfold since he took office in 1999 to its peak last year. That has allowed him to ramp up public spending. With private investors scared off by controls and Mr Chávez's socialist talk, it is this spending binge that helped the economy recover after an opposition-led two-month general strike in 2002-03 and has since fuelled rapid economic growth....

Venezuelan crude, much of which is heavy and sulphurous, sells for about $10 less than lighter benchmark crudes such as Brent and West Texas Intermediate. Last year the average price for the Venezuelan “basket” of crudes was $56 a barrel. Last month, that figure was about $46. Any further fall might start to constrain Mr Chávez's ability to spend freely at home and abroad.

The 2007 budget is conservatively based on an average price for the Venezuelan basket of $29. But it is also based on average oil production of around 3.4m barrels a day (b/d). Neither of these figures bears much relation to reality and nor does the budget itself. Independent analysts, including OPEC and the International Energy Agency, believe the true production figure to be around 2.5m b/d. To complicate matters further, some of the oil is sold at a discount as part of Mr Chávez's strategy to win influence abroad, and 100,000 b/d is more or less donated to Cuba.

In contrast, total government spending last year was a third higher than originally budgeted. That pattern is likely to be repeated this year. “Quasi-fiscal” or off-budget spending, involving the diversion of oil revenues and the central bank's reserves into funds directly controlled by the president, is large and increasing.

Mr Chávez has a large piggy-bank he can draw on. The forthcoming constitutional reform is likely to strip the central bank of its last vestiges of autonomy.

And so on.