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Mexico Price Controls: Bad Idea

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Are Mexico's price controls on food a good idea? Not at all, say most experts.

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Soaring food costs are forcing governments to seek ways to hold down prices. Last month, Mexican President Felipe Calderon announced an agreement with foodmakers to freeze prices on 150 products through the end of the year, and Colombian President Alvaro Uribe is looking for a similar deal in his country. Are such price agreements the way to go? Will more countries pursue them? What social and economic impact will they have?

Sidney Weintraub, William E. Simon Chair in Political Economy at the Center for Strategic & International Studies: The agreement between President Calderon and Mexico's foodmakers to freeze the prices of 150 specified products through the end of this year is essentially a political measure. It is in the same category as the government's decision to provide some $19 billion to subsidize gasoline prices for 2008. The difference between the two is that the gasoline subsidy comes out of the federal budget, whereas the income foregone by the partial food price freeze affects the bottom line of the private sector. The effect on private companies will be limited because the freeze is selective and the extent to which private companies are hurt depends on how competitive the prices for the selected products were before the freeze. The populist element of both is to strengthen President Calderon's popularity at a time of rising inflation and low overall economic growth. The danger of both measures is that once in place, they will be hard to remove. The consumer price index is used to calculate minimum wages, other social benefits, and pensions, and the index will now give incorrect signals. The freeze and the gasoline subsidies distort market decisions, and the subsidies reduce the amount of resources that the government can allocate to other important needs, such as upgrading public transportation and health care. Price freezes designed to augment the popularity of the incumbent leader in one hemispheric country are contagious, as leaders in other countries have an example to emulate.

Arturo Porzecanski, Professor of International Finance at American University: The recent shocks in petroleum, agricultural, and most other commodity prices, which are eerily reminiscent of those that ended up doing so much damage in the 1970s and early 1980s, are once again eliciting all kinds of stopgap measures on the part of governments in Latin America and elsewhere. The populist authorities in Argentina and Venezuela have been controlling domestic prices and adjusting import tariffs and export taxes for several years to benefit consumers, so they are only doing more of the same. Lately, however, even an otherwise sensible government such as Mexico's has reduced or abolished import tariffs (on corn, wheat, rice, beans, fertilizer, and powdered milk), prevented a justified hike in gasoline and other refined oil prices, and even jawboned major retailers into putting a temporary lid on the prices of many foodstuffs. The major difference is that fiscal policy in Mexico is not expansionary, and monetary policy is downright restrictive, with the overnight interest rate now standing at 7.75 percent, and yields on 10-year government bonds above 9 percent, both well ahead of year-on-year inflation (5 percent as of May). Among the major economies in the region, only in Brazil is the Central Bank likewise ahead of the inflationary curve. Chances are that other governments will be tempted to 'do something' about mounting inflationary pressures, but unless fiscal and monetary policies are soon tightened, the 'band-aid' approach will not yield lasting benefits. Even President Nixon learned this lesson in the early 1970s.

Graciana del Castillo, Adjunct Professor at Columbia University: Policymakers often try to impede the negative economic impact of external and internal shocks on certain groups on the belief that shocks are transitory rather than permanent. I was in Mexico when President Calderon announced the price freeze on 150 basic commodities. Efforts were made at pointing out that this differed from price controls because the freeze was voluntarily agreed to by producers. Whatever you call it, the effect is the same: you are interfering with the mechanism of supply and demand, which will make things worse in the future. This will be particularly dangerous if the shock to food prices is permanent. What will happen to prices in December when the freeze ends? The same is true of efforts to subsidize the price of gasoline to avoid the impact of higher oil prices in the international market. People would consume more than they would otherwise, rather than make efforts at conservation which would bring demand more in line with supply. Having expressed my skepticism in general with interference with price mechanisms, I am equally concerned about the impact high food prices is having on the poor and vulnerable across the world. There are a number of policies to deal with the impact of food prices on vulnerable groups in a targeted way. But this should be the topic for another Advisor column.

Vicki Gass, Senior Associate for Rights and Development at the Washington Office on Latin America: Holding down prices is a positive but short-sighted policy solution to the soaring food prices that are hurting poor households from Argentina to Mexico to the Caribbean. A long-term strategy that increases food supply and addresses the underlying reasons for the crisis must be developed. Minimally, the strategy should include two points. First, governments must provide greater investment in the agricultural sector to produce for local and regional markets. The World Development Report 2008: Agriculture for Development recently reasserted agriculture's importance economically, and demonstrated that improving productivity and sustainability reduces poverty and increases food sovereignty. Governments have disinvested in the rural sector since the 1970s, contributing to the current situation. The food crisis demands increased investment in agriculture, including development assistance to diversify rural economies and provide rural populations access to productive resources that produce for local and regional markets. Second, the US government should guarantee that current and future trade agreements include special and differential treatment for agricultural products in Latin America. Latin American governments should also have the policy flexibility to use import tariffs to protect their agricultural sectors and guarantee food security. Without a long-term strategy, the social impact of measures, such as a temporary freeze on prices, will be short term. Poor households will continue to be hurt by rising prices.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter. 

 

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