The evidence suggests that liberalising retail FDI has generated widespread gains for Mexican households

A radical transformation is occurring in the way households in developing countries source their consumption. The arrival of global retail chains has led to a “supermarket revolution” and households are shifting away from shopping at traditional retail outlets, such as street markets and small independent stores, towards more modern store formats.

To liberalise or not: The debate over foreign direct investment in retail

The globalisation of retail has led to heated policy debates in many countries. Those against foreign retailers point to the large share of employment in the traditional retail sector, concerned that the arrival of global retail chains will drive down wages and employment.  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 towards foreign direct investment (FDI) in retail across developing countries. Argentina, Brazil, Mexico and most of Eastern Europe, liberalised retail FDI fully, in the early 1990s (Wrigley and Lowe 2010). Other countries have instead taken the opposite route. India for example, still severely restricts foreign retail entry, and Indonesia, Malaysia and Thailand re-imposed regulatory barriers on foreign retailers after initially allowing entry. These policy decisions matter for household welfare because retail is a key sector of the economy, on average accounting for 15-20% of employment, 10-15% of GDP, and more than 50% of household expenditure in developing countries.

Household effects of Mexico’s supermarket revolution

Surprisingly, despite the rapid globalisation of retail in the developing world and widespread policy interest, the existing literatures in trade and development have paid relatively little attention to this facet of international integration. In our recent research, we bring together a rich collection of microdata to assess the consequences of retail FDI in the context of Mexico (Atkin et al. 2016). The landscape of Mexican retail underwent a dramatic transformation over the last 20 years as foreign retailers came to dominate the domestic market (Agriculture and Agri-Food Canada 2014). Over our study period from 2002 to 2014, the number of foreign supermarkets almost quadrupled from 365 to 1,335. Geographic coverage has expanded beyond major metropolitan areas and into second and third-tier cities. Rapid expansion provides an ideal empirical setting to study the impact of retail globalisation.

The analysis explores three central questions:

1) What is the effect of retail FDI on average household welfare in the municipality of entry?

2) What are the channels underlying this effect? And

3) To what extent do the gains from retail FDI differ across the income distribution?

Our main finding is that foreign supermarket entry causes large and significant welfare gains for the average household equal to 6% of initial household income. This is a substantial effect, and our rich data allows us to decompose these gains into six distinct channels. Three are related to cost of living (household price indices) and three are related to nominal income effects.

Foreign retailers drive reductions in cost of living

The majority of the welfare gains come from a significant reduction in the cost of living. First, the entry of a foreign retailers produces an almost 4% drop in consumer prices of pre-existing domestic retailers. This increases welfare by an average of 1.6%. 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 five times the number of products available in modern domestic stores. After entry, foreign retailers capture more than one third of average household spending.

The combination of cheaper prices, greater variety and the different shopping amenities available at foreign stores generates welfare gains of 5.5%. Approximately 40% of these gains can be accounted for by the cheaper prices at foreign stores alone, the remainder coming from the variety and amenity channels.  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 entry, and this reduces the price index gains by 0.7%. Hence, in net, reductions in the cost of living generate welfare gains for the average household of 6.4%.

Gains from lower costs of living are shared widely while losses to traditional retailers remain more limited

The effects on average nominal incomes are small in comparison. We find no effect on average municipality-level household incomes or employment rates. We do, however, find evidence of adverse effects on domestic store profits (including store exit), as well as negative employment and labour incomes for workers in the traditional retail sector. We show that while these adverse income effects are sizable for those who experience them, they affect only a fraction of overall households and so in total only generate welfare losses of 0.4% for the average household. Hence, these nominal income reductions are swamped in the aggregate by reductions in the cost of living that benefit everyone.

Because the average effects may mask substantial heterogeneity, we quantify the distribution of effects across the initial distribution of household incomes. We find that the gains are shared widely, with all household income groups experiencing significant gains from foreign entry on average.  However, the effects are also regressive: the richest income groups gain about 50% more than the poorest. The key driver of this regressiveness is that richer households substitute over 50% of their retail consumption into foreign stores, while the poorest households substitute less than 15%. In terms of revealed preferences, these results suggest that richer households value the product variety and store amenities offered by foreign retailers (e.g. more parking, wider aisles, better hygiene) significantly more than poor households do.

The gains appear to be specific to foreign retailers

One obvious question raised by our findings is; to what extent are these effects specific to retail FDI, rather than being driven by modern store formats more generally? To answer this question, we compare the effect of foreign store entry to the effects of store entry by domestic retailers using similar ‘big box’ store formats. We find that the entry of these domestic retailers does not lower retail prices in pre-existing stores, and their post-entry market shares are less than one third of those estimated for modern store entry. These results suggest that, at least in Mexico, the welfare gains we find are specific to FDI rather than capturing the entry of modern store formats more generally.

Implications for Policy

Our analysis provides a number of insights that relate to ongoing 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 retailer and those who enjoy price reductions at 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.

The empirical evidence from Mexico suggests that while these adverse nominal income effects are present, they are swamped at the local level by reductions in the cost of living that on average give rise to real income gains across all household income groups.

Editors' note: This column first appeared on the IGC blog.

References

Agriculture and Agri-Food Canada (2014), “Business Environment: Mexico”, Market Access Secretariat Global Analysis Report. 

Atkin, D, B Faber and M Gonzalez-Navarro (2015), “Retail Globalization and Household Welfare: Evidence from Mexico”, working paper.

Wrigley, N, and M Lowe (2010), “The globalisation of trade in retail services”, Organisation for Economic Co-operation and Development.

Mexico Retail Household income