Government Controlled

Most people lack a true appreciation for the value of competent management, especially as it relates to the decision-making abilities of our elected leaders. We are prone to evaluate our political leaders on their personality, their image or their ideology. We rarely pause to think about their management competence (or lack thereof). After all, it is hard to evaluate a skill that's not readily on display. Most meetings, in which decisions are made or communicated, are closed to the public. Policy-makers make a host of decisions, big or small, every day that may impact their constituents, often in unintended ways (more on that later). From the outside looking in, the context in which the decision was made – including alternate options – rarely comes to light. The smaller the scope of the decision, the more likely it is that the process will lack external transparency. Not every issue makes the papers or is hotly debated, especially the mundane day-to-day decisions (like staffing appointments to obscure governmental agencies), even though over the long-run the impact of these behind-the-scenes policies can add up quickly. A bad decision (either due to ignorance, indifference or corruption) can rapidly snowball into a government program or intervention that hurts economic productivity. Mismanagement takes a while to become apparent, and by that time, it is usually too late (and the politician has usually moved on). 

The perfect example of this phenomenon is Venezuela's gross mismanagement of its largest state-owned enterprise, Petróleos de Venezuela, or PDVSA for short. Normally, you would want professionals running such a large and complex organization. And ideally, you would want such state-owned enterprises to be immune from political interference and graft, especially in a country where the rule of law isn't very well established. Now, no matter your political orientation (left or right) and your views of the role of government in the economy, you have to agree that mismanagement and corruption are a cancer on society. This example isn't about whether state-run enterprises like PDVSA should be privatized or not, or whether foreign companies should be allowed to extract oil from impoverished countries with weak environmental protections, or even how oil income should be distributed or taxed. Reasonable people can disagree about all these issues. Rather, this example illustrates an egregious case of government mismanagement, which ultimately led to the collapse of a country's whole economy. Specifically, I'll show how one person in a position of power can completely destroy the wealth of a country through inefficient policies.

Why PDVSA Matters

Before I go into details, try to estimate how badly gross incompetence at the top can decimate an organization's productivity? Is it 5%, 10%, 15%, etc... Surely, a company with tens of thousands of employees can withstand a little bit of political interference from an charismatic, yet egomaniac, leader? China isn't immune to political graft and expropriation, yet it was able to become an economic powerhouse! Why was the outcome vastly different in Venezuela? [On a related note, it appears the political interference in Venezuela's oil industry was so pervasive that officials at China National Petroleum Corporation working in Venezuela complained about all the government meddling. These were seasoned Chinese officials, accustomed to the whims of a communist regime, and yet couldn't handle the Venezuelan-style of political interference!]

In the late nineties, PDVSA was the world's fourth largest producer of oil. Foreign Policy magazine described the company of that era as having "a lean workforce, an efficient cost structure, and a global outlook: [in the 1980's], the company acquired half of Citgo, the big U.S. refiner". That's right, the company was acquiring Western companies. It was no slouch in the oil game! But that was pre-Chavez. Today, PDVSA can't even pay its bills with key suppliers like Halliburton and Schlumberger, which they desperately need to develop new wells. More troublesome, oil buyers often reject shipments from Venezuela because they fail to meet international grading standards. That's an embarrassing fall from grace for a country so dependent on oil income, both as a source of foreign currency and as an economic engine (i.e. the overwhelming majority of Venezuela's exports are still oil-related; and so are government tax revenues). The stakes don't come any higher for the Venezuelan economy than PDVSA. It's productivity is a matter of life or death for poor Venezuelans who depend on state assistance and/or on imported medication for survival.

History

The late Hugo Chavez rose to power with groundswell of popular support and high expectations to deliver on a populist agenda. In his 1998 campaign, he was intent (at least publicly) on reforms that would chip away at wealth inequity in the impoverished country. Chavez did a lot of things when he seized power in 1999, rewriting the constitution, replacing the Supreme Court and even changing the country's name. But the damage at PDVSA dwarfs all that1. It's hard to imagine worst oversight than the Venezuela government in this case. It didn't start off well: when Chavez took power in 1999, PDVSA's CEO, Luis Giusti, saw the writing on the wall and swiftly resigned. Giusti was well-respected in international circles and had about 30 years of experience in the oil sector. His focus was to reinvest profits at PDVSA to increase production. Chavez needed that cash for his pet projects, and sound fiscal principles weren't top of mind. (Giusti would later end up helping neighboring Columbia reform its then-moribund oil industry, to great success). 

Instead of trying to find a suitable replacement for Giusti, Chavez doubled down on his wrecking ball approach. The executives that didn't initially resign with the CEO were dismissed in a show of pure political theater. The president, wielding a referee's whistle, went on television to fire specific PDVSA managers. On live television! Can you imagine a worst humiliation for an oil & gas executives than to be publicly outed as an enemy of the people by the country's leader? These managers were replaced by members of the military, whose loyalty seemingly made up for their lack of knowledge about oil production. The seeds for disaster were planted! Foreign Policy notes that "in 2005, a top energy ministry official admitted privately that it would take at least 15 years to rebuild the technical skills lost by the mass firings". At the height of the dysfunction, Chavez even merged the oil company with the Ministry of Energy, so he could better control the company. 

However, dumping the top brass was more than a run-of-the-mill clash of personalities between powerful men. It was also ideological. A socialist president can't possibly defend the need for some people to make (and for the sake of argument - earn) multiples of what the common person makes. After all, what does a manager actually do? For a layperson, the job looks easy and the perks look outlandish. Hence, hiring cronies to replace the board of directors isn't such a loss - even in a large organization with a lot of moving parts. Chavez's thinking likely went like this: if being a manager is just like looking over a worker's shoulder while they go about their jobs, well then, a complete idiot can't do that badly, right? Turns out, that fallacy is engrained in many. Dismissing the need for managerial talent is endemic to society2. A person off the street wouldn't claim to be able to perform brain surgery if given the chance, but oddly enough, most would say they can effectively manage other people. The aftermath of a bad surgeon is immediate, the time it takes to expose an incompetent manager isn't. So yes, I'm sure the cronies hired by Chavez told him not to worry, they could handle themselves as managers and directors, despite their overwhelming lack of relevant experience.

These boneheaded personnel moves scared a lot of professionals at the company (think chemical engineers). They went on strike to protest. Chavez, perhaps taking a cue from Reagan's firing of air traffic controllers, responded with a strong-armed tactic, firing almost half the workforce (18,000 employees) for taking part in the demonstration. Not only they did people lose their jobs, they were banned from working in the same industry again in Venezuela. It was a vindictive move, no doubt, despite the political motivations behind the protests. But to Chavez, PDVSA's mass exodus of skilled labor didn't seem like a problem worth worrying about. And the public agreed with him3. Perhaps, Venezuelans were too entranced and distracted by Chavez's persona, to evaluate the long-term consequences of their president's actions. The electorate often don't appreciate how devastating bad policy can be, especially when it is popular. Who wants to stand up for an oil executive? It's no surprise that the general strike failed to topple the government, and instead, Chavez further consolidated his power by demonizing his distractors.

The professionals who weren't fired, left in droves. The low pay further compounded the mass exodus at the company. At one point, the company refused to accept any letters of resignation from staff. That's one idiotic way to solve staffing problems! The Venezuelan government's position was that they were replaceable: they discounted not only their experience and expertise, but also the amount of knowledge a competent engineer has over an incompetent one. We are not talking about an incremental difference, it is an exponential one! You don't know what you don't know. I'm not sure what the mitigation strategy was - or even if Chavez and his crew thought that far ahead - but hiring unqualified ringers or bringing new graduates didn't make up for the knowledge drain. And it isn't like PDVSA didn't try! They ended opening the floodgates during the Chavez/Maduro years: the company went from 40,000 employees to 140,000 about twenty years later. Sadly enough, the quantity didn't make up for the quality of talent that was lost. Experienced hydrological engineers don't just hang out on street corners looking for work! So not surprisingly, PDVSA didn't get the right type of candidates despite their subsequent hiring spree. Besides, no foreigner wants to move to Venezuela to work for a basket case company like PDVSA, especially when Chavez's rhetoric was raging internationally. 

The fact is that PDVSA needed their workers more than the workers needed PDVSA. The highly-trained professionals that left had options elsewhere because their abilities were and are valued by the market. In fact, three quarters of those fired moved out of the country to take other jobs. So where did the Venezuelan "oil intelligentsia" end up? The Economist speculates that more than 3 thousand ended up in oil-rich Alberta, Canada (presumably being paid for their oil-related expertise). But most workers moved to Columbia, where they helped double the country's output over the last decade. Lots of PDVSA's displaced management started companies across the border. Even for low-level machine workers, they can make 3 times the pay in Columbia than in Venezuela (in Alberta, it's more like 100 times, but the country's cold rightfully dissuades many from heading north). Engineers at PDVSA were said to be making only $400 per month, and that was before the country's most recent economic meltdown.

The Invisible Cost

Now back to the question at hand: how bad can bad management be? Luckily, we have comparable metrics before and after Chavez took office, and the results are stunning. According to Bloomberg, in 2014, PDVSA was pumping 8,000 barrels a day per employee, compared to 26,000 ten years before. The complete ransacking and devaluing of "experts" led to a profoundly broken company (one that may never repair itself). To give you an idea of the plundering at PDVSA, it also was speculated that more than a million people were on PDVSA's payroll at its peak (obviously, the vast majority didn't actually work there). By siphoning funds from the PDVSA, the company couldn't conduct exploration for new drilling sites. Their existing wells started running dry (an unavoidable consequence of mismanaging existing reserves and cutting capital expenditures).

The net decline in production since Chavez took power is about 2 million barrels a day. The yield at PDVSA is now barely above 1 million barrels/day (exact numbers are hard to come by because the Venezuelan government started lying about oil production stats to conceal problems and avoid more embarrassment). Sure, U.S. trade embargoes contributed to some of the pain, but this a tragedy of Venezuela's own making. It's so bad that Venezuela, which was the fifth-largest exporter when Chavez came to power, now has to import oil. According to Forbes, the median time to extraction of Venezuelan oil stands at almost 200 years. In other words, it would take several lifetimes to pump out the country's proven reserves at today's production rate. Compare that depletion rate to an efficient energy company like Exxon, where it is a mere 8.2 years. And it's not just output at stake, it's also safety. According to The Economist: "the number of incapacitating injuries due to accidents at PDVSA rose from 1.8 per million man-hours in 2002 to 6.2 in 2012. At Pemex, Mexico’s state oil firm, the rate was 0.6 in 2012". Bad decisions at the top costs lives at the bottom.

Despite this lackluster performance, when the country's economy started to hit a rough patch in 2006 and 2007, the PDVSA was put in charge of milk distribution and importing can of beans to feed its population. I guess that for all of its problems, PDVSA was still the most efficiently-run arm of the government! Needless to say, the distraction from its core mandate didn't help improve the company's focus and productivity. Today, PDVSA is in a death spiral. No amount of capital, no knowledgeable foreign operator, no massive wave of immigration from expats can solve this tragedy. Not even a new government! That's the other insidious thing about bad leadership, it takes vastly longer to fix than the time it took to break it. This example is a cautiously tale in letting political ideology (in this instance, class warfare) getting in the way of informed decision-making. It also shows that checks and balances, even though they are costly, are worth it because of the huge downside of not having them in place when they are needed.

The Obvious Lesson (in retrospect)

For a country, oil isn't the only natural resource worth preserving. A country's organizations and institutions are also part of its shared wealth. Bad management can decimate both natural resources and human capital. And that's why we need to pay attention to the value of competent management. When it does its job, you don't hear about it, but when it fails, you wish you still had it. 

Postscript

The book Crypto Wars by Erica Stanford provided some additional insights into Venezuela's economy:

The government stopped quoting inflation rates years ago but it’s up to 10 million per cent depending on which source you ask. [...] In one year, the currency devalued 97.5 per cent against the dollar. 

One month’s pay on minimum wage gets you roughly your choice of any of the following: 24 eggs or 2.6 kg of tomatoes or 6.5 kg of sugar or half a kg of oats or 1.7 kg of potatoes or 2.8 litres of orange juice or 300 grams of coffee or three-quarters of a pizza or half a burger. 

As we have seen, the country has some of the largest oil reserves on Earth, but lacks the money to extract and process it. 

To give a sense of how cheap petrol really is, you can fill a tank for an average sized car for 200 bolivares. [...] A cup of coffee, in contrast, can now cost 2 million bolivares.

The government has searched for solutions including the creation of its own cryptocurrency. However, the announcement of the 'petro' was bungled and its roll-out failed spectacularly (the government couldn't explain how the digital currency was "backed" by the country's oil reserves, as it claimed). 

Remittance companies such as Western Union enable people working abroad to send money home to Venezuela but [...] charge extortionate rates, immediately taking away 14 per cent or more. [As a result, Venezuelans] hold $8 billion in crypto.