Memo 1 Example 3 - iSites

683 words Memorandum
To: President of the United States
From:
Subject: Policy Memo 1 – Venezuela
Date: February 13, 2013
Summary
Hugo Chavez has recently been in very poor health. Now, an even more left wing, populist
leader seems likely to get elected if Chavez dies. He has expressed a desire to use OPEC as a
policy tool to raise oil prices, which could prove detrimental to the U.S. economy. Due to the
structure of OPEC, the economic costs to Venezuela of pursuing trade reductions, and the
potential retaliatory actions that the United States can take, a rational Venezuelan leader would
never carry out the threatened oil price hikes. However, in order to have retaliatory actions that
are less costly to the United States, it is recommended that the administration make overtures to
other Latin American countries to prepare for multilateral sanctions.
Background
The United States has historically had a tense relationship with Venezuela. The current president,
Hugo Chavez, was elected in 1999 and has continuously been re-elected. During his time in
office, he has pursued a heavily socialist agenda, opposed various U.S. foreign interests, and
expelled the U.S. Ambassador. (Sullivan)
The likely successor's threat to raise oil prices through OPEC echoes the 1973 oil crisis, during
which OPEC nations proclaimed an embargo. This caused U.S. oil prices to roughly quadruple
and resulted in a short-lived but far-reaching economic recession. These effects were partially
mitigated by improved efficiency and decreased demand, but were disastrous nonetheless.
Potential Venezuelan Actions
Venezuela in this scenario initially has only two actions, though subsequent ones will be colored
by the actions of the other OPEC nations. If the new president does not attempt to raise oil
prices, then no action is necessary on the parts of any other party. If Venezuela does try to raise
prices, other OPEC nations such as Saudi Arabia (which notably did not enforce the 1973
embargo) may not comply. If the other OPEC nations do not comply, Venezuela may choose
either not to proceed, in which case no further action is needed, or to unilaterally cut trade with
the United States. Figure 1 shows these decisions and potential OPEC and U.S. Responses.
Potential OPEC Actions
The structure of OPEC as a cartel capable of setting production quotas and prices results in a
game similar to Prisoners’ Dilemma (Figure 2). This is model is supported by OPEC’s inability
to maintain its collusion in the 1980s and the subsequent drop in prices. (“Brief History”) Even
with repeated play, the punishments have been insufficient to deter countries from defecting.

No
Change
Price
Increase
Status Quo
(0,0)
OPEC
Complies
U.S.
Retaliation
(-10,-10)
OPEC
Refuses
No
Change
Unilateral
Cuts
Status Quo
(0,0)
U.S.
Retaliation
(-10,-1)
If Venezuela pressures OPEC for price increases, and OPEC complies (unlikely, see below), U.S.
retaliation would hurt both countries economically. If OPEC countries do not comply, Venezuela
can either quit or proceed unilaterally. The latter results in significant losses to Venezuela, and
little to the U.S.
Figure 1
Less Oil
Country A
More Oil
Country B
Less Oil
More Oil
2,2 4,1
1,4 3,3
Each country prefers to produce more oil while the others produce less since that country would
be able to sell large quantities at high prices. The second best is for both countries to produce less
oil and take advantage of higher prices. The third best is for both countries to produce more oil,
resulting in lower prices, but larger quantities. The worst is for a the country to produce less while
the others produce more.
Figure 2
Potential U.S. Actions
An increase in the United States’ military presence in the region would signal that the oil imports
are extremely valuable, and that the U.S. would try to protect those imports. Actual use of that
military force, however, is not credible. It is certain to be detrimental, even assuming it keeps
trade open. As Dixit and Nalebluff argue in Thinking Strategically, use of force would draw
international condemnation and stain the country's reputation, thereby impeding future
interactions.

In 2005 the U.S. proposed a resolution at the Organization of American States to monitor
Venezuelan elections. (Weisbrot) This proposal was considered by some to be an effort to have
countries isolate Venezuela for being undemocratic. The rejection of that proposal was seen by
many as Latin American push-back against U.S. Influence. (Brinkley, Weisbrot) The game
matrix underlying these decisions is shown in Figure 3. The two Nash equilibria suggest that this
could change and the countries could condemn Venezuela and impose multilateral economic
sanctions.
Condemn
Country A
Support
Country B
Condemn
Support
3,3 2,4
4,2 1,1
Here the best case is for both countries to support Venezuela, since this reduces U.S. influence in
the region. The next best case is to condemn Venezuela, since the country gains the U.S.'s favor.
The third best is for all countries to condemn Venezuela, since they gain the U.S.'s favor, but also
grant the U.S. more influence in the region. The worst case is to support Venezuela while other
countries condemn.
Figure 3
Venezuela currently imports over $16 billion worth of goods from the U.S. (“Venezuela”), which
is equivalent to about 4% of the country's GDP. U.S. sanctions would therefore have a fairly
significant effect on Venezuela’s economic well-being, since its citizens would have to purchase
goods from elsewhere at a greater price. The same loss of trade would be negligible to the U.S.
Recommendation
Venezuela has sufficient incentive not to raise oil prices because of the threat of U.S. economic
sanctions. It is still beneficial for the United States to try to convince other Latin American
countries to join in multilateral sanctions against Venezuela, which, as mentioned above, results
in lower costs to the United States and makes that threat more credible.
References
“Brief History.” OPEC. OPEC, n.d. Web. 13 Feb 2013.
Brinkley, Joe. “U.S. Proposal in the O.A.S. Draws Fire as an Attack on Venezuela.” New York
Times. New York Times, 22 May 2005. Web. 13 Feb 2013.
Sullivan, Mark P. United States. Congressional Research Service. Venezuela: Issues for

Congress. 2013. Web.
“Venezuela.” CIA World Factbook. CIA, 05 Feb 2013. Web. 13 Feb 2013.
Weisbrot, Mark. “Bush Administration Exceedingly Isolated on Venezuela.” Center for
Economic and Policy Research. Center for Economic and Policy Research, 22 Jun 2005.
Web. 13 Feb 2013.