The Real Impact of the Recent Wage Increase in Venezuela

In August, President Nicolas Maduro began progressively introducing a series of wide-ranging economic reforms, including tax changes, a new wage system, a revalued currency, a modification to state gasoline subsidies, plans to peg salaries to the Petro cryptocurrency, as well as pledges to end inorganic money printing and impose fiscal discipline.

The reforms look to halt hyperinflation and extractive smuggling, address shortages, and restore the purchasing power of Venezuelan workers, who received a significant wage increase from 5,500,000 Bolivares Fuerte (BsF) per month to the equivalent of 180,000,000 BsF per month. Many firms have used the wage hikes as an excuse to increase the prices of the goods and services they offer to the public.

The following is an article from the leftist Venezuelan Observatory of Real Economy (OVRE) which analyses some of the measures and asks the question: will the wage increase simply perpetuate the current inflationary spiral as previous salary hikes have done in the past, or will it contribute to revitalizing workers’ purchasing power in Venezuela?

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It sounds logical at first to think that a wage and salary increase would directly impact the companies’ cost structures, reducing their profit margins and even causing the closing of some of them who do not wish to run at a loss.

However, this is not the entire truth and it does not always happen like this.

Like all economic phenomena, the impact of an economic variable on the economy depends on the interrelation of multiple variables and the specific weight of each of these in the global phenomenon which is studied.

In this case, we can say that production is the economic phenomena studied, and the structure of costs is a local variable which interrelates with other local variables such as productivity, sources of financing, available technology, administration models, etc. These variables are interrelated with other external variables, such as the political context, the changing paradigms of consumer preferences, forced reductions in consumer budgets, events of social upheaval, etc. Simultaneously, the cost structures also have their internal variables or components which interrelate with each other, and each has their own specific weight in the total cost structures.

This is where wages and salaries come in as a part of the cost structure of a firm, alongside machinery and equipment or fixed capital, raw materials, rent, administrative costs, publicity, etc.

Each firm has its own cost structure, which is different from the rest and depends on the economic sector they are in, the business model they adopt, and the efficiency levels reached. However, we can take as a reference point some standard recommendations by specialists in the area regarding the proportion which wages and salaries should represent in the cost structure of a firm for it to be considered profitable. Such specialists suggest that wages should make up between 15 and 30 percent of the cost structure depending on the type of industry.

In Venezuela, some analysts have claimed that the specific weight of wages and salaries of most of the businesses of the country made up no more than 1 percent [of their cost structures] before the announced wage increase by the government.

This is not hard to believe, given that the minimum salary was 5,500,000 BsF per month, which represented the equivalent of US $1, and which conferred workers the purchasing power roughly equal to half a kilo of cheese.

If the previous minimum salary represented one percent of the cost structures of companies, then the new minimum salary of 180,000,000BsF or 1,800 Sovereign Bolivars (BsS) represents 32 percent of the same structure, which lies within the recommended parameters for firms to be considered profitable when other factors are taken into account.

Obviously, the lineal relation and the impact on reality is not directly proportional but rather will depend on the number of workers in a company, the wage differences between various employees, and the productivity of the workforce, as well as the marginal output costs. We already know that when more workers are employed, or another productive factor is added, productivity and production increase initially until it reaches the optimum point where marginal income and marginal costs meet. At this point, hiring another worker may decrease production.

In any case, it is inadmissible that a local businessperson hopes that the current situation is to continue and that Venezuelan workers will never recuperate their purchasing capacity. The average minimum salary in Latin America is around US $300, and the lowest after Venezuela is Haiti with US $120. In this sense, raising the minimum salary to the equivalent of US $30 is, for the Venezuelan worker, still well below the Latin American average and does not even return to the level which Venezuela had in 2012 when it was around US $300.

This reality forces the recovery of workers’ purchasing power to become one of the priorities in the economic field. Far from harming business leaders, such recovery would benefit them, allowing them to sell their products, something which currently is extremely difficult given the consumption and production contraction which the country is experiencing.

If the consumer power of Venezuelan workers is increased, a golden chance is given to the business class to increase production and increase their profits, as profits are more stable when they come from volume of sale rather than disproportionate price hikes. This is true as profits derived from price rises have a limit which is the consumer capacity of the population. This is the real cause of the closing of many firms who do not have anyone to sell their products to.

Of course, the wage and salary raise is not enough on its own to guarantee an increase in production.

It is also true that countries which have suffered hyperinflationary processes begin by increasing wages and that this can aggravate the problem. Nonetheless, we have insisted in other articles that a complete economic program is required to combat hyperinflation, where fiscal discipline plays a fundamental role. In this respect, we have seen how the government has announced a series of measures which point towards this fiscal discipline which is so necessary in the current economy alongside the wage hike. They [the government] are conscious that it was fiscal discipline in public spending which allowed those countries who have suffered from hyperinflation to overcome it.

Despite the fact that many of these countries were able to stop inflation, this did not bring about an immediate increase in consumption as fiscal discipline was imposed in the context of a neoliberal program where the recuperation of workers’ purchasing power was never on the table. It was only when socialist governments arrived that the consumption power of the majority of the population recovered, such as in Brazil, Argentina, Bolivia, and Ecuador which suffered hyperinflation in the 1980s, but who enjoyed an increase in their consumption power after 2002.

Hyperinflation in Venezuela follows multiple factors, two of which are highly important given their specific weight: the issuance of inorganic money and the economic war.

Regarding the latter, we know that the economic war can be expressed in different ways according to the circumstances, and in our case it includes everything from international sanctions to the manipulation of the parallel currency exchange rate, the attack against the cash supply, and induced speculation (this term refers to a type of speculation which is not justified by the principles of economic rationality where many businesses raise prices well beyond normal profit levels according to their cost structures because they have uncertainty regarding the new costs when they come to restock goods. Induced speculation follows political, not economic logic). Nevertheless, we have explained on many occasions how the greatest shield against the economic war is a good and coherent economic policy, or put another way, economic problems can be solved with economic measures, not political ones. Imperialist economic wars are winnable, as China, Russia, and Iran have demonstrated, amongst others. These countries have strengthened their economies despite economic sanctions imposed by the USA and Europe. But for this to be achieved, one must remember the working of the global economy and the laws of the market.

Regarding the issuance of inorganic money, the President of the Republic has recognised the damage which this has brought about in the Venezuelan economy, and has committed to stop doing so. This may seem contradictory as he is announcing increases in wages, bonuses, and greater social security. We can, though, share some thoughts to better understand the issue.

The first thing to clarify is that in the Venezuelan case, the greatest proportion of the issuance of inorganic money has not been to finance wage increases, bonuses, nor social spending, but rather the main destination of this type of money without productive backing has been to ease the exchange losses of [the state-run oil company] PDVSA and the gasoline subsidy.

We know that the state oil firm was selling foreign currency accrued from its export activity [to the Central Bank] for ridiculously low quantities of Bolivars in the official system of controlled exchange, when it would have garnered a 2 million percent higher rate on the parallel market. By having to pay its national suppliers and workers at prices referenced by the parallel dollar, the exchange losses were immense, and the Central Bank was obliged to emit inorganic Bolivars to lend to PDVSA. In addition to this, inorganic money has also been emitted to finance other state companies which are showing red figures, such as the Guyana Corporation [of basic industries] (CVG), for example.

On the other hand, the gasoline subsidy has caused a true bleeding out of the Venezuelan economy. Without having official figures, some government spokespersons and economic analysts have suggested that in mere fuel extraction smuggling to Colombia, the country loses between US $10 and $28 billion annually, and this doesn’t even take into account the smuggling to Brazil, Guyana, the Antilles and the Caribbean.

If we take the most conservative figure of US $10bn, this would represent a figure greater than our international reserves, which stand at around US $8.5bn. We also have to add what the treasury loses in providing the subsidy, which is estimated to be US $12.6 billion, meaning that the government is losing around US $20.6bn per year only in the case of fuel.

In correcting this issue of exaggerated gasoline subsidies and the highly exaggerated overvaluation of the currency in the exchange of PDVSA-generated foreign currency income, Venezuela would have enough finances to cover its fiscal deficit, which is more than 15 percent of its GDP, without having to go to the International Monetary Fund (IMF).

The mere fact that foreign currency brought in by PDVSA is not sold at 300,000 BsF any more, as it was before August 20, and is now sold at the [newly established] price of 6,000,000 BsF (now 60 BsS) implies that a great quantity of additional bolivars will be entering the fiscal balance sheet which cannot be considered inorganic because they are backed by oil production. Equally, the extra income in the national vaults due to the sale of gasoline at new prices also has a productive backing.

This debate is not about whether a gasoline subsidy should exist or not, as it is a fair benefit for living in a county with the greatest oil reserves in the world, but rather over whether the subsidy should not be so attractive as to stimulate smuggling mafias.

Such a subsidy should also not be there for all social strata in the same proportion. For example, fuel for the owner of a new luxury vehicle shouldn’t cost the same as that for the owner of an old, modest car. [Recent census data indicates that] only 8 percent of the [national] automobile float corresponds to public transport, which serves 80 percent of the population, while only 10 percent of Venezuelans own cars.

Bringing in a tax on gasoline, as nearly every country in the world does, would allow the covering of a direct subsidy to some sectors such as public transport, as well as possibly setting a higher tax for those vehicles which cross the border. A fuel tax, when added to the others already announced by the government, would work as a tax reform, also helping to reduce the fiscal deficit.

What is certain is that is the government is able to obtain great resources without having to resort to the issuance of inorganic money, and should these measures achieve fiscal discipline, then the wage and salary increases do not necessarily have to turn into greater inflationary pressure. On the contrary, it may increase workers’ capacity to purchase goods, thus stimulating production by converting wage hikes into real demand which would require greater supply of goods and services.

Finally, to avoid greater demand turning into further price rises by the business class who lack a will to increase supply, it would be convenient to establish a mechanism of wage indexing.

Despite the fact that this has proved counterproductive in economies with hyperinflation in the past, this was only so as they didn’t adopt measures of public spending discipline and addressing exchange rate irregularities. However, once this phase has been overcome, the indexing of wages proves extremely effective to avoid speculation, especially if combined with other measures to stimulate production such as tax breaks and credit policies amongst others.

The indexing of wages consists in adjusting salaries every month according to consumer price indices registered at the Central Bank. This allows firms to avoid unjustified price rises because the higher the profits earned, the higher the costs incurred by adjusting wages by an equal amount according to the inflationary index. As prices begin to stabilise and the acquisitive power of workers begins to return, salary raises will start to become trimestral, semestral, and eventually yearly.

I consider the wage index system to be a more effective mechanism for avoiding speculation and, as such, changes in the purchasing power of salaries than [the government’s plan to] peg [salaries] to the Petro [cryptocurrency]. In principal, this is because the Petro depends on a very volatile international commodity such as the barrel of oil, but also as the Petro can only influence one of the variables which impacts inflation, namely the exchange rate. To achieve a serious impact with this peg, exchange controls would have to be totally eliminated and a free conversion between Petros and Bolivars, and Petros and Dollars, would have to be allowed. The salary indexing, however, does not depend on external factors and can end not only speculation for external motives but also speculation for political ends.

In conclusion, we salute all of the initiatives aimed at recuperating the purchasing power of Venezuelan workers, while at the same time warning that for this to be possible and for wage hikes to not bring harmful repercussions, first the economic reasons that cause inflation must be addressed, which are principally: the emission of inorganic money, exchange rate instability, and low productivity.

The views expressed in this article are the author’s own and do not necessarily reflect those of the Venezuelanalysis editorial staff.