Should the Government Sell You Goods? Evidence from the Milk Market in Mexico∗

Should the Government Sell You Goods? Evidence from the Milk Market in Mexico∗ Diego Jiménez-Hernández Enrique Seira January 4, 2021 [click for latest version] Abstract We study a nationwide welfare program in Mexico in which the government, in an effort to eliminate hunger, sells milk to households at subsidized rates via a network of thousands of specialized “ration stores.” Existing in many countries, such direct-provision programs often appear puzzling to economists, as it seems unlikely that the government would have any comparative advantage over the private market in procuring and distributing milk. To understand direct provision, we develop and estimate an equilibrium model of the market, then use the model to compare this program against natural (budget-neutral) alternatives, such as milk vouchers or unrestricted cash transfers. Using rich household-level panel data and the variation generated by the staggered introduction of new government stores, we show that market power by private milk suppliers is an important concern and that government-sold and privately-sold milk are close (though imperfect) substitutes. Consequently, direct provision plays an important role in the milk market in Mexico by disciplining private-milk prices. Indeed, our results suggest that in the absence of government milk, private market prices would be 3% higher. Moreover, direct provision generates 4% more gains in consumer welfare relative to milk vouchers and 2% more relative to unrestricted cash transfers. JEL: H42, L33, L44, L66, O15. Keywords: private and public provision; market concentration; milk. ∗Corresponding author: Diego Jiménez-Hernández, Stanford University (Email: [email protected]). Diego is extremely grateful for the guidance, mentorship, and helpful comments provided by Pascaline Dupas, Liran Einav, and Melanie Morten. We wish to thank Tim Bresnahan, Camilo Castillo, Arun G. Chandrasekhar, Jose Ignacio Cuesta, Yiwei Chen, Marcel Fafchamps, Matt Gentzkow, Aprajit Mahajan, Neale Mahoney, Seema Jayachandran, Brad Larsen, Peter Reiss, Mauricio Romero, Meredith Startz, Paulo Somaini, Ali Yurukoglu, and the seminar participants at the ITAM Alumni Conference, NEUDC, the Development Tea, and the IO Workshop who provided helpful comments at various stages of the project. We also wish to thank Adalberto Gonzalez Hernandez, James Peter McCarthy, and Rodolfo Camacho Estrada for numerous discussions on the milk market in Mexico. Margarita Khvan, Paola Mejía, and Ricardo Olivares provided outstanding research assistance. Diego gratefully acknowledges the funding provided by the Ronald I. McKinnon Memorial Fellowship, the Shultz Graduate Student Fellowship in Economic Policy, the Stanford King Center on Global Development’s Graduate Student Fellowship, and the Leonard W. Ely and Shirley R. Ely Graduate Student Fellowship. Some of the computing for this project was performed on the Sherlock cluster. We would also like to thank Stanford University and the Stanford Research Computing Center for providing both computational resources and support that contributed to these research results. All errors are our own. 1 Introduction Governments across the world expend considerable resources providing or subsidizing essential goods and services: from food and public housing, to schools and healthcare. In many cases, they provide goods directly, often despite the existence of privately-supplied alternatives. An example of this are the “ration stores” widely used in low- and middle-income countries, at which households can typically purchase staple foods or basic household consumption goods at subsidized prices.1 Economists often find direct-provision systems of this kind puzzling, as it seems unlikely that the government would have any comparative advantage over the private market in procuring and distributing goods. To justify the use of direct provision rather than natural alternatives, such as vouchers or cash, its proponents argue that when incomes are difficult to observe, in-kind provision is an effective redistributive policy as it encourages consumption among needy households while the less-needy consume elsewhere.2 Its opponents argue that such programs constrain choice and may be weakly dominated either by vouchers (if the goal is to maximize consumption) or unrestricted cash (if the goal is to maximize consumer surplus).3 One often ignored aspect, however, is that private suppliers in low- and middle-income countries may have disproportionate pricing power and large markups.4 In such cases, the government option acts as an extra competitor, with ambiguous effects on private market prices and welfare.5 In this paper, we study the nationwide provision of subsidized milk via ration stores in Mexico. The setting provides an ideal context in which to understand the general effects of direct provision, as well as offering insights into similarly functioning systems in other countries. A common feature of these direct-provision systems (and one also present in our setting) is near-universal access in which governments use an “ordeal mechanism” to screen out richer households and reduce errors of inclusion.6 Using ration stores, the government provides a low-cost, low-quality milk consumed 1 Ration stores exist in Bangladesh, Ethiopia, India, Indonesia, Mexico, Pakistan, and Sri Lanka (Gadenne, 2020). For instance, the Indian Public Distribution System serves 65 million individuals, while government spending on it accounts for 1% of GDP (Bhattacharya et al., 2017; Nagavarapu and Sekhri, 2016). In Mexico, around 7 million individuals benefit from this type of store and the corresponding government spending accounts for 0.7% of the GDP. 2 The “targeting benefit” is documented in Blackorby and Donaldson(1988); Besley and Coate(1991); and Gadenne(2020). Other reasons cited include paternalism (Cunha, 2014), shielding households from price volatility (Gadenne et al., 2020), and political feasibility (Epple and Romano, 1996; Bearse et al., 2000). 3 For instance, one oft-cited reason is that redistribution through income taxes dominates commodity taxation when income is observable, firms are price takers, and consumer preferences are homogeneous (Atkinson and Stiglitz, 1976). 4 Firms in low- and middle-income countries often exercise their ability to price above costs (see Appendix 1 of Ivaldi et al., 2016) in product markets (e.g., food and pharmaceuticals) consumed disproportionately by the poor (Goldberg, 2018). 5 Cunha et al.(2019) show experimentally that in-kind provision leads to lower prices than in-cash. A government competitor can increase private market prices if the most elastic consumers substitute towards the government good, thereby segmenting the market. Atal et al.(2020) document such behavior in pharmacies in Chile. 6 Ordeal mechanisms impose a small cost to qualify for a transfer (Nichols and Zeckhauser, 1982). Dupas et al.(2016) and Alatas et al.(2016) show how, in practice, “micro-ordeal” mechanisms work as an effective tool to weed out the non-poor. 1 by 18% of urban households. Government milk coexists alongside private alternatives in a setting in which firms are able to set prices above their costs, another common feature of low- and middle- income countries.7 We show that direct provision decreases the price of private milk, increases consumption, and “disciplines” market power in the industry. Quantitatively, we find that the indirect gain in consumer surplus as a result of lower prices appears to more than offset the cost of the government providing a lower-quality good. These results are important because they shed much-needed light on whether direct provision can effectively increase welfare, vis-a-vis giving cash directly or providing subsidized vouchers. Most of the surplus gains are concentrated among lower socioeconomic status households, which suggests that direct-provision systems may be effective tools with which to redistribute to those in need. To study such a system, we use rich panel data on household consumption of milk from both public and private sources, combined with administrative data on the location of ration stores over time. Our analysis proceeds in three steps. We begin by using a widespread, staggered introduction of new government stores to document (imperfect) substitution towards the government good and a decrease in the price of private milk. Using an event study framework, we show that a year after opening, households are 10 pp more likely to purchase from the government and 3 pp less likely to purchase private milk. The increase in purchases is concentrated among poorer households. Turning to prices, the average price per liter in the private market decreases by 25¢ (2.3% of the mean), and since households substitute towards the (cheaper) government good, the total price per liter falls by 40¢ (3.8%). The effects of the direct-provision system are also evident in the cross section. The government opened stores in census tracts with the highest number of eligible households in previously selected municipalities. Using the residual variation induced by the store-opening rule and controlling for household characteristics, we show that households closer to ration stores consume more milk and pay less per liter for their private-market purchases. Being one standard deviation closer to the government store implies a 13% increase in the monthly consumption of milk, a 3% decrease in the price of private brands, and a 7% decrease in the overall price. Using other consumption goods (e.g., sodas) as placebos,

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