Since it was discovered in the country in the 1920s, oil has taken Venezuela on an exhilarating but dangerous boom-and-bust ride that offers lessons for other resource-rich states. Decades of poor governance have driven what was once one of Latin America’s most prosperous countries to economic and political ruin. 

Venezuela has suffered economic collapse in recent years, with output shrinking by three-quarters and rampant hyperinflation contributing to a scarcity of basic goods. Meanwhile, government mismanagement and U.S. sanctions have led to a drastic decline in oil production and severe underinvestment in the sector.

What’s behind the petrostate paradigm?

Petrostates are thought to be vulnerable to what economists call Dutch disease, a term coined during the 1970s after the Netherlands discovered natural gas in the North Sea.

In an afflicted country, a resource boom attracts large inflows of foreign capital, which leads to an appreciation of the local currency and a boost for imports that are now comparatively cheaper.

This sucks labor and capital away from other sectors of the economy, such as agriculture and manufacturing, which economists say are more important for growth and competitiveness. As these labor-intensive export industries lag, unemployment could rise, and the country could develop an unhealthy dependence on the export of natural resources. In extreme cases, a petrostate forgoes local oil production and instead derives most of its oil wealth through high taxes on foreign drillers. Petrostate economies are then left highly vulnerable to unpredictable swings in global energy prices and capital flight.

The so-called resource curse also takes a toll on governance. Since petrostates depend more on export income and less on taxes, there are often weak ties between the government and its citizens.

Timing of the resource boom can exacerbate the problem. “Most petrostates became dependent on petroleum while, or immediately after, they were establishing a democracy, state institutions, an independent civil service and private sector, and rule of law,” says Terry Lynn Karl, a professor of political science

How does Venezuela fit the category?

Venezuela is the archetype of a failed petrostate, experts say. Oil continues to play the dominant role in the country’s fortunes more than a century after it was discovered there.

The oil price plunge from more than $100 per barrel in 2014 to under $30 per barrel in early 2016 sent Venezuela into an economic and political spiral, and despite rising prices in recent years, conditions remain bleak.

A number of grim indicators tell the story:

Oil dependence.

Oil exports are expected to finance almost two-thirds of the government’s budget in 2023, a slightly higher proportion compared to the previous year.Falling production. Starved of adequate investment and maintenance,oil output has continued to generally decline,dropping by 2.5%,

in 2022 after increasing slightly the previous year. In 2020, it had reached its lowest level in decades. 

Analysts anticipate that a global shift from fossil fuel energy to renewables such as solar and wind will force petrostates to diversify their economies.

Nearly two hundred countries, including Venezuela, have joined the Paris Agreement, a binding treaty that requires states to make specific commitments to mitigate climate change.  

Economic diversification will be an especially difficult climb for Venezuela given the scale of its economic and political collapse over the last decade. The country would likely need to revitalize its oil sector before it could cultivate and develop other important industries. But this would take enormous investment, which analysts say would be hard to come by given Venezuela’s unstable political environment, trends in oil demand, and rising concerns about climate change.