Saturday, May 16, 2009

Venezuela Expropriates US Food Manufacturing Plant

The BBC announced that Venezuela expropriated a Cargill pasta production plant in Venezuela because the plant violated regulations in terms of the amount of output it is producing to be sold a government-set prices. The Venezuelan government announced that it will take over the plant for 90 days, but some question whether this will become permanent.

Inflation has been high in Venzuela over the last few years. In order to offset the negative effects of higher prices, the Venezuelan government has laws setting maximum prices (i.e. an effective price ceiling) on 12 different food items in order to provide food that is affordable for the poor. In order to do this, food manufacturing plants in Venezuela are required to produce (i.e. a quota) a certain percentage (varies by type of food) of the amount of food produced at the plant. For pasta the percentage is 80%.

This is not the first time Venezuela has seized control of a Cargill food production plant. The Venezuelan government expropriated a rice plant in March. Cargill states that it was not in violation of the law since this rice plant was not producing basic white rice which is Nor is Venezuela only targeting Cargill food production plants. Polar, the largest food producer had a plant expropriated at the beginning of March 2009 for failure to meet government quotas on rice production. In this case, Polar was adding artificial flavoring to circumvent the government regulation, since the government regulation only applies to basic white rice.

Given the economic environment, the actions of the Cargill and Polar food plants is not surprising. In an article by Venezuelan Analysis, "Polar Chief of Operations Jesús Carmona admitted that the plant was diverting 90% of its rice to artificially flavored products. He said Polar had chosen this route because the actual cost of rice production is more than four bolivars per kilogram, nearly twice the regulated price of 2.33 bolivars per kilogram". Hence the food manufacturing plant is making losses of 1.67 bolivars per kilogram, and in an effort to minimize the firms losses, the plant rationally chooses to produce rice products that are not under the price ceiling regulations.

So, since Cargill knows that the Venezuelan government is serious about enforcing the price ceiling/quota on basic food production, why would the pasta plant continue to produce pasta outside of the regulated amount (assuming that the Venezuelan government is correct - which I am not questioning)? If the plant is making a profit by producing the basic pasta and selling it at the Venezuelan imposed price ceiling, then this does not make much economic sense. But given that the Polar rice plant was making a loss on basic rice, let's assume that the Cargill plant was making a loss on producing basic pasta and selling it at the government imposed price ceiling. If this is the case - again this is an assumption - then producing pasta outside of the government regulations may be a way for Cargill to either make a profit on pasta not included in the regulations or for the Venezuelan government to take the plant over permanently.

In an article about the Cargill rice plant expropriation the author states, "The Venezuelan constitution obligates the government to pay a fair indemnity for expropriated property". As we have seen recently, the Venenzuelan government has paid for the steel plant it expropriated from Ternium. Thus Cargill may be making a pure business decision. If it is unprofitable to produce basic rice or pasta, produce a product that does not conform to the government regulations - and presumably make a profit on that type of product, or wait to see if the government will take over the plant and then negotiate the sale of the food manufacturing plant.

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