Wednesday, August 6, 2008

Mexico Initiates Price Controls on Food

Last month, the Mexican government froze the prices of 150 basic food items until the end of the year. The reason is to hold down inflation, since food prices have been increasing about 8% - which is faster than overall inflation in Mexico of about 4.5%. This is expected to make Mexican consumers better off in the short-run (for the rest of this year), since they will be paying lower prices than the market would set in equilibrium.

On the whole, economists are against price controls (price ceilings or price caps) since they result in some negative effects.

How can lower prices be a bad thing? Hey - as a consumer - I am all for lower market prices. What makes Mexico's food price control policy 'a bad thing' is that these are lower artificial prices, not lower market prices. Let me try to explain.

Mexico is capping the prices of food. Kraft, Sara Lee and Tyson have recently announced that it will be raising the prices of its products soon. Food companies such as Kraft would be selling its food products at a new higher price than what is legally allowed in Mexico. What incentive does Kraft have to sell their food products in Mexico if they can sell them here in the US or in other countries at higher prices?

But does not that benefit Mexican domestic food producers? Yes,- if their production costs are not increasing. As we have observed over the last year - fuel costs and basic food input costs like corn and wheat are increasing. As Mexican food producers production costs rise - Mexican producers have less financial incentive to produce and sell more costly food in Mexico - but rather have an incentive to sell the food they produce in other countries where they can sell them at higher prices and make more profit.

Consumers living near the Mexican border have an incentive to buy their food in Mexico at the artificially lower prices - which is similar to what has been happening with prescription drugs in Mexico.

Both the producer and consumer incentives lead to food shortages - which is likely to take place - especially in rural or isolated parts of Mexico.

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