The Dallas Fed published a paper decrying Mexican fuel subsidies.
The problem with the paper is that Mexico doesn’t have fuel subsidies as commonly conceived. Unlike Venezuela, Mexico does not sell gasoline below its cost to refine. Nor is the price of gasoline consistently below that in the United States. In fact, right now the price of gasoline in Mexico is higher than in the U.S. Nor is this a new phenomenon: the price was higher than in the U.S. before 2004:
What Mexico does have is a system designed to protect Mexican consumers from price volatility. When crude prices spike, Mexican gasoline prices rise with a delay; when crude prices fall, Mexican gasoline prices do not.
Volatility is costly.In 2005, James Hamilton summarized the findings about the effect of oil shocks on the U.S. economy. The estimates, as you might imagine, varied quite a bit. The Oak Ridge National Laboratories summarized the findings as a GDP elasticity between −0.1 and −0.8; that is, for every doubling of oil prices, GDP falls between 0.1% and 0.8%. From that, they derived a volatility cost between $2.18 and $7.81 per barrel of crude oil. That translates more-or-less into a volatility cost between 11¢ and 42¢ per gallon.
During the 2006-11 period of subsidization, Mexico’s oil subsidies averaged 40¢ per gallon. (See page 11.) That is near the high end of the Oak Ridge estimates of the volatility cost to the United States.
This is not an airtight defense of the policy! The estimates of the impact of an oil price shock could be very different for Mexico. (Someone should write a paper!) Moreover, unlike in the U.S., additional income from gasoline sales goes right to the government, which could choose to spend it. Finally, if protecting the economy from volatility is the goal, then Mexico should let gasoline prices slowly increase to European levels and only then keep them stable.
It is to say, however, that there is a benefit to Mexico’s policy. More study is needed to show that the benefit does not outweigh the costs.
Postscript: Mexico can, like Brazil, continue to control the price of gasoline even it chooses to liberalize the retail sector ... which so far is not part of the energy reform.