The Impact of Oil

Written by: Matt K. 

Oil prices impact the global economy on both sides of the market — supply and demand. Probably the most current example of the effect on oil prices in an economy is Venezuelan stagflation which is an economic phenomenon that occurs when the inflation rate is high, the rate of economic growth is slow, and unemployment is high. It’s an issue that is oftentimes incredibly difficult for fiscal policy to address because a government will worsen unemployment by trying to fix inflation and worsen inflation by trying to fix unemployment. One example of this is the Venezuelan hyperinflation spawned by Venezuela's former president Hugo Chavez and heavily exacerbated by its current president Nicolás Maduro. To understand the stagflation, the oil and export-based economy of Venezuela must first be understood. 

Venezuela is the single most oil-based economy in the world however its exports aren’t diversified. Not all oil is sold at the same price. You have different types of crude such as Brent Crude and WTI (West Texas Intermediate) and WCS (Western Canadian select) as the main North Amero/British examples. Perhaps, more importantly, are the crudes exported from overseas such as Russia, China, and the developing oil-based nations with their different crudes like Saudi Arabia, Iran, Iraq, and Venezuela. Each crude affects the economy differently. For example, the WTI intermediate set the bar price for common heavy crudes in the US and its exports of the products made out of those crudes is the backbone of petrol dollar investment and trade flow inside the domestic US economy but it doesn’t affect any trade values across NAFTA or the global economy. 

A sharp rise in oil prices can cause inflation to increase as it’s typically a consequence of the decrease in aggregate supply, caused by the increase in input prices, which creates a shift to the left of the SAS curve because the SAS curve is drawn under the assumption that input prices remain constant; so if the short-run aggregate supply is decreased, then there would be a disparity in the relationship between the price levels and the real GDP in the economy, and a sharp fall in oil prices will begin to the exact opposite. Of course, a more rapid decrease in oil prices is more difficult for an exporting country to deal with.

 This is exactly what happened to Venezuela. During the presidency of Hugo Chavez, the prices of petrol were super high and as a consequence, the GDP of Venezuela was super high because most of its exports were just crude petrol. For a long time, Venezuela was the wealthiest and most affluent country in South America. It was during this time that Chavez enacted a huge multipart humanitarian plan to decrease unemployment and poverty. The plan worked and Venezuela was doing better and better each day however, the plan was expensive, and Venezuela began amassing a huge foreign debt that they could only pay off if the prices of oil continued to rise. However, Hugo Chavez died and only a few years after his successor came into office the value of the Venezuelan petrol decreased significantly and their GDP plummeted as a consequence. Faced with few other options to repay the debt the country began printing more money. This hyperinflated their economy causing unstoppable stagflation and hyperinflation. Because more money was printing and the GDP kept falling the prices of goods skyrocketed and citizens' savings were destroyed. In the economic and political crisis, investors pulled out of the country and stopped loaning money only making the situation worse. In an attempt to address the issue Maduro established a new monetary policy that would remove 5 zeros from each Venezuelan bill and increase the minimum wage increase of 67%. However, the consensus among economists is that this is a bad idea for a few reasons. It doesn’t address the actual underlying issues that have caused the inflation, it doesn’t do anything to increase the GDP of the country because they haven’t decreased taxes or increased government spending with the bill, and they haven’t stopped printing money. The minimum wage increase will likely force businesses that are already struggling to cut hours and lay people off increasing unemployment and it may further increase the inflation rate. And without stopping printing money the economy will only continue to inflate. What's worse is President Maduro has removed everyone in his circle and government who isn’t completely loyal to him and his regime with people who are, which includes most of the capable economists and financialists. The former finance minister to Chavez and Maduro, Rodrigo Cabeza has said that Maduro refuses to recognize the hyperinflation and the enormity of what is at stake because his own political agenda and reelection are more important to him than the well being of his people.

In Conclusion Venezuela's choice to base most of its GDP on oil was a bad idea. It worked for a time especially in the 1970s while oil prices were high when Venezuelans lived the best lives in South America but keeping its exports so centralized on a single form of crude oil is incredibly risky. Venezuela is almost like if the entire well being of a country was decided by the performance of a stock in the stock market. Which is reflected by the general trends for the countries with undiversified exports and economies such as Saudi Arabia, Nigeria, and Chad. As opposed to countries with very diversified exports based on manufacturing such as the US, Japan, and most of Europe.many European powers. It's akin to a stock portfolio having diversified shares across multiple sectors of the market can help to protect your investments if a single sector is doing poorly. 

Works Cited

Mankiw, N. Gregory. Principles of Macroeconomics. Cengage Learning Asia Pted Ltd, 2021.

Mu, Xiaoyi. The Economics of Oil and Gas. Agenda Publishing, 2020.

Nielsen, Barry. “Stagflation in the 1970s.” Investopedia, Investopedia, 31 Mar. 2021, www.investopedia.com/articles/economics/08/1970-stagflation.asp.

Venezuelan, A, and James Ausman. “The Devastating Venezuelan Crisis.” Surgical Neurology International, Scientific Scholar, 26 July 2019, www.ncbi.nlm.nih.gov/pmc/articles/PMC6744797/.