Wednesday, April 8, 2009

Diesel prices

Diesel prices at Mexico has stopped growing since the President announced an emergency economic program to stimulate growth and support household income. Before the announcement price fuels such as gasoline and diesel had an increasing path, the cause underlying ever higher prices was the high-historic-prices of oil, and thus, of fuel.

At the beginning of this series of increases, the diesel price in Mexico was only a third of that in the US. Subsidies to fuel in all 2008 reached 218 thousand millions of pesos, this is, almost 2 per cent of GDP. Now trucks syndicates claim that since international diesel prices has slumped, Mexican prices should too.

Government has not showed any intention to reduce diesel or gasoline prices, and it is the right thing to do. Let us not forget that tax revenues at Mexico are slightly above of 9 per cent of GDP, only Haiti has lower tax revenues in terms of its product. High fuel prices -or positive fuel taxes- happen to have a number of good features. First, they are a reliable source of tax revenues since their elasticity converges to zero. Second, they tax -whether implicitly or explicitly- the use of motor vehicles, thus the price of pollutants increase. Third, diesel pollutes much more -in relative terms- than gasoline, it is used in heavy work vehicles, thus, high prices provide an incentive to change motor technology.

The immediate answer to the latter argument is based in some kind of inflation pass-through from increases in fuel prices to overall inflation, specially of diesel since it is used in heavy trucks, which in turn transport food from one place to another.
Interestingly, there is no recent research of the latter subject, so maybe here is a case of the so called conventional wisdom, where it is easy to attach high (changes in) price levels to high oil prices, but correlation is not necessarily strong, at least not through channels thought.

A challenging counter-example is the correlation between changes and general price level changes in the U.S. Logic should lead us to conclude that since the U.S. consume much more fuel than Mexico and since prices can overshoot -like they did in 2008's summer- then, for example, food prices should have had increase considerably as a consequence of the former. They did not.

Take now the following fact. In September of 2007 a fuel tax was approved of 2 per cent. As political opposition sounded alarms on the consequences, Mexican government agree that the tax would be levied until January of 2008. Strikingly, consumer prices went up more in the last quarter of 2007 (by 0.505 percent on average) than they did in the first quarter of 2008 (by 0.495 percent
on average).

So, it should be interesting to measure whether Mexicans respond more to fuel price increase announces than actual higher fuelprices. If this is the case, an environmental tax is plausible, government should not lower diesel prices.

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