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Do Foreign Supermarkets Improve Household Welfare in Developing Countries?

Development Challenge

The arrival of global retail chains in developing countries is causing a radical transformation in the way households source their consumption. This process has led to heated policy debates and stark differences in the policy approaches towards retail FDI across developing countries. Critics of retail globalization tend to emphasize the large share of employment in traditional retail formats, and fear that global retail chains have adverse effects on retail employment and incomes. Proponents have pointed to the potential for welfare gains by lowering consumer prices and increasing product variety.

The retail sector is an important segment of the economy in developing countries, representing on average fifteen to twenty percent of total employment, ten to fifteen percent of total GDP, and over half of total household consumption expenditures among developing countries.[1] As a result, some developing countries, most notably India, have maintained policies to restrict foreign retail entry. Other countries, including Argentina, Brazil, Mexico and much of Eastern Europe have fully liberalized their retail markets to foreign direct investment (FDI). This study evaluates the impact of entry of foreign supermarkets on household welfare in Mexico.

Context

Mexico began to transition from a closed economy toward open foreign investment following the country’s sovereign debt default in 1981. This movement culminated with the negotiation and enactment of NAFTA in 1994, which allowed for full foreign ownership in the retail sector and others.

The Mexican retail sector, like many developing countries, was previously dominated by street markets, traditional store formats and independent shop owners. Foreign retail expansion proceeded in several waves. Between 2002 and 2014 the number of foreign owned supermarkets expanded rapidly from initially 365 supermarkets to 1,335. During this period foreign retailers established store presence in all of urban Mexico and well beyond the main metropolitan centers of the country.

The study uses data from this period of rapid foreign investment in the retail sector to track the impacts of foreign store entry on average household welfare in the municipality of entry, the channels through which impacts were achieved, and to what extent these effects differ across rich and poor households. 

Evaluation Strategy

The researchers start with a general theoretical expression of the welfare effect of foreign retail entry, and then propose an event study design that exploits the micro-data in order to empirically estimate the various components of the total effect on local households.

Effect of Foreign Supermarket Entry on Household Cost of Living 

  • Direct Price Index effect:  Increases in consumer welfare due the availability of the new foreign store in town (cheaper prices, new products and different store amenities).
  • Pro-competitive effect:  Impact of foreign store entry on consumer prices among domestic retailers due to increased competition. This effect is net of the potential losses in store variety due to domestic store exit. 

Effect of Foreign Supermarket Entry on Household Nominal Incomes

  • Income effect for workers in domestic stores due to wage and employment changes. 
  • Retail business income effect for domestic storeowners due to increased competition. 
  • Non-retail income effect for workers in other sectors

Researchers then utilize rich micro-data on foreign store locations and opening dates in combination with high frequency data on barcode-level store prices, household consumption quantities matched to specific retailers, and household incomes and municipality employment over the period 2002-2014. Data was used to conduct an event study to analyze the impact of the entry of foreign retailers into a municipality on the above mentioned welfare indicators. The analysis compared welfare information prior to the foreign retailer entry to welfare status after foreign retailers were established. To ensure a fully balanced estimation sample of municipalities, events were restricted such that store entry had to have occurred at least one year after baseline. In addition, welfare changes were evaluated three years after foreign retail entry when domestic price changes were observed to have stabilized.

Results and Policy Implications

Results show a significant increase in average household welfare. On average the effect was seven percent of initial household income. This varied by income group, where total welfare gains for the poorest households were five percent compared to ten percent for the richest households. This disparity is largely due to different spending patterns, as higher income groups will generally do a greater proportion of their shopping at new foreign retailers (fifty percent) than lower income households (ten percent). 

Welfare gains are primarily driven by reductions in the cost of living. Foreign retailer prices were on average twelve percent lower than domestic stores. These price differences arise in addition to a significant price reduction among domestic stores due to foreign entry. These price effects alone accounted for approximately one third of the welfare gains. The remainder of the price index reduction is driven by gains from product variety and better store amenities

No significant impact was observed on average municipality level incomes, wages or employment after foreign store entry. However, when focusing on outcomes among retail sector workers and store owners, the estimates suggest negative effects of about five percent in domestic retail sector wage earnings as well as store profits. While these results present evidence in favor of some of the concerns expressed in public debates, the negative effects on retail sector workers and store owners appear to be on average significantly outweighed by the gains in overall consumer welfare that are shared by all households in the locality.

As welfare gains analyzed in this study are on average significantly positive for all household income groups, there are important policy implications for developing country governments. One clear implication of these findings is that public debates may frequently focus too little attention on the potential for significant gains in purchasing power that appears to be shared widely across local households.

Timeline

2014

[1] These figures are based on reporting developing countries in ILO data (employment), UN National Accounts statistics (GDP), and household consumption surveys (retail expenditures).

Photo: Store in Guadalajara, Mexico. Via Wonderlane, Creative Commons.