Mr. Montfort Mlachila, Mr. Edgardo Ruggiero, and David Corvino
This paper examines the constraints that negative externalities (i.e., smuggling from a large neighbor)
impose on the application of automatic fuel price adjustment mechanisms. It is often recommended to
establish an automatic price adjustment mechanism to reduce fuel subsidy expenditures, but this
approach may not work in the presence of these externalities. The paper illustrates the constraints by
examining the case of Nigeria, a major oil exporter that subsidizes gasoline, and that of Togo, an oil
importer and neighbor of Nigeria. It finds that the price differential between formal prices in Togo and
Nigeria is the main driver of changes in formal sector gasoline consumption. Specifically, the lower the
formal price in Nigeria, the higher is smuggling from Nigeria to Togo, and the lower the tax base in
Togo. The econometric results suggest that, unless the real economy is performing very well, increases in
pump prices in Togo are likely to erode the tax base, unless there are greater border controls. The
unintended consequences of Nigeria’s pricing policies are the constraint they impose on fuel pricing
policies of its neighbors and the subsidy Nigeria transfers to them (equivalent to at least 3 percent of
Togo’s GDP in 2011), three-quarters of which was captured by smugglers in 2011, while one-quarter
enhanced consumers surplus through lower gasoline prices.
From the early 1960s to the early 1980s, the officially recorded production of cocoa in Ghana declined by 60 percent. During the 1983–95 Economic Recovery Program, however, cocoa production doubled. Although these developments have inspired much empirical research, most of the studies have been unable to explain the medium-term persistence of cocoa output to remain below its estimated capacity level. The paper argues that the price incentive to smuggle can explain as much as one-half of the observed decline in output and the subsequent recovery. A cointegration analysis and a dynamic error-correction model of cocoa supply support the analysis.