The need to raise the level of investment to combat inflation

There are evidently a number of specific and complex factors in inflationary pressures in Venezuela. Nevertheless one key macro-economic parameter undoubtedly would, by itself, produce significant inflationary pressures – this is the insufficient level of investment in Venezuela’s economy.

Historical experience shows that there is a close and predictable relation between the sustainable rate of growth of economy and its investment rate.

Investment can only be financed by savings. Venezuela, in the last four years, has had a high savings rate averaging over 35 per cent of GDP. This is equivalent to the savings rate of a very rapidly growing Asian economy such as Vietnam, South Korea or China. If all such a savings were used in investment in Venezuela’s domestic economy then, based on historical and international experience, a growth rate of 8-9 per cent a year can be sustained.

However there is a very large gap between Venezuela’s savings rate and its investment rate. The average level of gross fixed capital formation in the last four years has only been 21 per cent of GDP. In 2007, the last year for which figures are available, it reached 24 per cent of GDP.

Figure 1

Historical and international experience shows that such an investment level of 20-25 per cent of GDP is, at maximum, able to support sustainably an economic growth rate of around 4-5 per cent. However Venezuela’s average growth rate in the last four years has been far higher than this – averaging 12 per cent a year. This latter figure is undoubtedly somewhat artificially raised through recovery from the effects of the oil strike. Nevertheless in the last three years for which figures are available, that is up to 2007, the annual economic growth rate has been 10 per cent.

It is evidently undesirable itself to have a large amount of unused savings that are not being used for domestic investment. However it is also directly related to anti-inflationary policy.

A disparity between an investment rate that will only support a 4-5 per cent a year growth rate and far more rapid economic growth would necessarily by itself produce inflationary pressures. A decisive means to reduce inflationary pressures over the medium and long term is therefore to raise Venezuela’s investment rate.

It is entirely possible, as shown by the example of other countries (Vietnam, South Korea, China, Singapore, Thailand etc) to maintain a rate of growth of 8-10 per cent a year but this requires that the level of investment in Venezuela’s economy be raised to 30 per or more of GDP – an investment rate that is entirely financeable on the basis of Venezuela’s savings rate.

Considering mechanisms to ensure that Venezuela’s savings will be used in domestic investment there is no evidence that this will primarily be carried out by the private sector. On the contrary, the evidence is that, purely on the basis of the private sector ,Venezuela’s savings will be squandered in capital flight abroad. The fact that, despite the very high level of savings in the last four years, this has not been invested confirms that the private sector cannot be relied upon to ensure that savings are more adequately transformed into domestic investment.

The conclusion that flows from this is that Venezuela’s state sector must undertake a relatively large scale programme of investment that will ensure that the high savings level is translated into a much higher level of investment in the national economy. This is required as an anti-cyclical stimulus measure, to increase the efficiency of the national economy, and to substantially improve the conditions of living of the population. But, by boosting the supply side of the economy, such an investment programme is also a crucial anti-inflationary measure in the medium and long term.

The most effective means of improving the efficiency of the national economy is investment in infrastructure – in particular transport, communication, and housing. Therefore a decisive part of anti-inflationary strategy must be to raise the level of investment in Venezuela’s domestic economy to around 30 per cent of GDP through a major programme of state infrastructure investment.

Evidently such an increase in the investment level from the current 24 per cent of GDP to 30 per cent, which would then make an eight per cent growth rate sustainable, cannot be carried out in a single year as the necessary structures to deliver such a large scale of public investment programmes are not yet in place. It is a matter of concrete study how rapidly such a decisive increase in the investment rate can be achieved – based on international experience an increase in the proportion of GDP devoted to investment of one to two per cent of GDP per year would be reasonable. This would imply acceleration in Venezuela’s investment level from around 24 per cent of GDP to 30 per cent of GDP over a three to five year period.

Such an increase in the investment rate is not only full financeable on the basis of current savings levels but is crucial for very many economic and social objectives – among these is that it is one of the most important medium and long term anti-inflationary steps that are required.

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