How global retailers increased household welfare in Mexico by reducing the cost of living

Foreign-owned big-box retail stores have transformed the way Mexican households source their consumption, sparking a ‘supermarket revolution’. Traditionally, consumers in developing countries have shopped at street markets and small, independent stores. However, with the arrival of big-box foreign retailers, consumers have a new shopping option that offers a larger variety of products at cheaper prices (Bronnenberg and Ellickson 2015) and a different shopping experience. 

Despite concerns that foreign retailers might adversely affect local employment and household incomes, our evidence shows that allowing them to operate their businesses in Mexico has generated substantial welfare gains for households across the income distribution. In our recent research (Atkin et al. 2018), we find that the key channel is a significant reduction in the cost of living that dominates limited impacts on local employment, incomes, and store closures.  

The debate on allowing foreign retailers to operate in emerging markets

The globalisation of the retail market has led to heated policy debates in many countries. Those against foreign retailers are concerned that the arrival of global big-box stores might drive down local wages and employment, pointing to the fact that a substantial share of employment is in small stores and traditional street markets. Those in favour of foreign retailers emphasise the potential benefits to households from lower consumer prices and increased product variety.

Importantly, these debates have also led to stark differences in policies toward foreign direct investment (FDI) in retail across developing countries. In the early 1990s, Argentina, Brazil, Mexico, and most of Eastern Europe fully liberalised FDI in the retail sector, allowing global businesses to invest in their markets. Other countries have instead taken the opposite route. India, for example, still severely restricts the entry of foreign-owned retailers, and Indonesia, Malaysia, and Thailand re-imposed regulatory barriers on foreign retailers after initially allowing businesses to enter the market. 

The Mexican experience with retail FDI liberalisation 

Our analysis brings to bear a rich collection of micro data to assess the consequences of foreign supermarket chains entering Mexico. The landscape of Mexican retail underwent a dramatic transformation over the last 20 years as foreign retailers came to dominate the domestic market. Over our study period from 2002 to 2014, the number of foreign supermarkets almost quadrupled from 365 to 1,335. Geographic coverage expanded beyond major metropolitan areas and into second and third-tier cities. This rapid expansion provides an ideal empirical setting to study the impacts of foreign retailers on local markets. 

In this setting, we focus on three main questions:

1. What is the effect of foreign business investments on the average household’s welfare in the municipality where the foreign retailer opens?
2. What are the channels underlying this effect?
3. To what extent do the gains from retail FDI differ across the income distribution? 

Foreign retailers drive down the cost of living

Our main finding is that foreign supermarket entry causes large and significant welfare gains for the average household equal to around 6% of initial household income. The majority of these welfare gains come from a significant reduction in the cost of living. First, the entry of a foreign retailer produces an almost 4% drop in consumer prices charged by pre-existing domestic retailers (see Figure 1 for a plot of prices at local domestic retailers before and after the entry of a foreign retailer). This increases welfare by an average of 1.6% of initial income.

Figure 1 Pre-existing domestic retailer price response to foreign retailer entry

Second, consumers also gain from being able to shop at new foreign stores. Foreign retailers on average offer 12% lower prices for identical products and offer more than five times the number of products available in modern domestic supermarkets. After foreign retailers enter the market, they capture one-third of average household spending. The combination of cheaper prices, greater variety, and the different shopping amenities (e.g. more parking, wider aisles, better hygiene) available at foreign stores generates welfare gains of 5.5% of initial income. 

Third, the entry of foreign retailers also leads to some local stores closing down. This effectively raises the cost of living. We find that 4% of domestic stores close down as a result of foreign businesses entering the market. In the median municipality that received a foreign entrant, the number of local domestic retailers falls from 2,088 to 2,007. These closures increased the cost of living and reduced welfare by 0.7% of initial income. Hence, taking all three factors into account, reductions in the cost of living generate welfare gains for the average household of 6.4%.

Limited impacts on incomes and employment

The effects on nominal incomes are small in comparison. We find no effect on average municipality-level household incomes or employment rates. Even though public debates have often focused on incomes and employment of small storeowners and workers, the strongest impact appears to be on the consumption side—reductions in the cost of living.

When we zoom in to particular occupations and sectors, we do find evidence of adverse effects on domestic store profits (including the closing of small, independent stores), as well as negative employment and labour income effects for people initially working in the traditional retail sector. We show that while these adverse income effects are sizable for those who experience them, they affect only a small fraction of households. Therefore in total, negative income effects only generate welfare losses of 0.4% of initial income for the average household. Hence, these reductions in nominal incomes are swamped in the aggregate by reductions in the cost of living that benefit everyone. Simply put, the overall reductions in the cost of living benefit many, while losses to nominal income affect only a few.

Because the average effects may mask substantial heterogeneity across households, we also quantify how the effects are spread out across the initial income distribution. We find that the welfare gains are shared widely, with all household income groups experiencing positive and significant gains from foreign entry on average (see Figure 2 for a plot of the distribution of welfare gains across the income distribution). However, the effects are also regressive: the richest income groups gain about 50% more than the poorest. The key driver of these regressive results is that richer households end up shifting far more of their consumption into these foreign stores. Richer households value the product variety, and the store characteristics and amenities offered by foreign retailers significantly more than poorer households do. One such characteristic is store location, with foreign stores often located outside city centres close to major roads and featuring large car parks. While this is convenient for richer households with cars, this is less appealing for poorer households who find it costly and difficult to travel far from their homes to shop (Lagakos 2016). 

Figure 2 Welfare effects of foreign retailer entry across initial incomes

Policy implications

Our analysis provides a number of insights that relate to on-going debates about developing country policies towards retail FDI. The findings suggest that policymakers may put too little weight on the potential for reductions in the cost of living that benefit the vast majority of households, both those who end up shopping at the foreign retail stores and those who enjoy price reductions at incumbent domestic retailers. Instead the focus is typically on the potentially adverse effects for an important, but nevertheless, select group of households working in the traditional retail sector. Our empirical evidence from Mexico suggests that while these adverse effects on the incomes of store owners and workers are present when foreign retailers come to town, the substantial reductions in the cost of living far outweigh them and give rise to gains in real income across all household income groups. 

References

Bronnenberg, B and P Ellickson (2015), “Adolescence and the path to maturity in global retail”, Journal of Economic Perspectives, 4(29): 113-34.

Atkin, D, B Faber and M Gonzalez-Navarro (2018), “Retail globalisation and household welfare: Evidence from Mexico”, Journal of Political Economy 126(1): 1-73.

Lagakos, D (2016), “Explaining cross-country productivity differences in retail trade”, Journal of Political Economy, 124(2): 579-620.