Price elasticity of gasoline smuggling: A semi-structural estimation approach

doi:10.1016/j.eneco.2018.02.008

Energy Economics

Volume 71, March 2018, Pages 171-185

https://doi.org/10.1016/j.eneco.2018.02.008 Get rights and content

Highlights

•
Price elasticity of cross-border gasoline smuggling in Iran is estimated.
•
Providing quantitative estimates of the consequences of a large-scale fuel subsidy removal program
•
Administrative price setting and natural variations in the cost of smuggling enable a causal identification.
•
A good match between the estimated time-varying elasticity of smuggling and major policy change incidents
•
The highest estimated elasticity observed in areas near Turkish border with a significant price differentia

Abstract

We estimate the price elasticity of the demand for gasoline smuggling in Iran. For this purpose, we employ a detailed panel of monthly gasoline consumption data from 160 distribution hubs during the period 2005–2014. We apply two different approaches which are diff-in-diff and panel data estimations. The results suggest that the foreign-to-home gasoline price ratios have a significant impact on the time-varying elasticity of demand. This finding supports the hypothesis that an increase in domestic gasoline prices will significantly reduce the demand for smuggling. In addition, as the distance of a region from its closest higher-price neighboring country diminishes, the price elasticity of demand for gasoline smuggling for that region declines as well. Finally, we find that when the ratio of foreign to domestic prices is higher, the gasoline demand sensitivities to price in neighboring countries go up. Our work offers new insights regarding the welfare impact of removing fuel subsidies and modifying fuel pricing policies.

Introduction

Smuggling is a common problem across international borders where variation in tax or subsidy policy might create a price differential between the source and destination regions. A notable example is the case of smuggling the heavily-subsidized gasoline from Iran to its neighboring countries, where the price of gasoline has typically been much higher than Iran.

The literature on smuggling¹ suggests that the prerequisite for smuggling homogeneous goods (e.g. gasoline or beverages) is a price differential for the very same good in two areas. Since gasoline is very close to a homogeneous good, the substantial difference in the price of gasoline between Iran and its neighboring countries has created opportunities for an outbound smuggling of gasoline from Iran. For example, before the (partial) subsidy removal in 2010, the price of gasoline in Iran was on average one-fifteenth of the price in Turkey. Such a non-trivial price gap motivated individuals to earn income by the smuggling and transferring of gasoline to Turkey².

The gasoline price in Iran has always been set by the government and is constant across all parts of the country. Following a national plan to reduce and eventually eliminate fuel subsidies, the government increased the nominal price of gasoline in three major events over the past couple of years. The new fuel pricing policy aims to set the domestic price at the worldwide equilibrium to narrow down the gap between domestic and foreign fuel prices. This policy was expected to mitigate or cut incentives for selling subsidized fuel to neighboring countries that typically have higher fuel prices. Capping the fuel smuggling was one of the key motives behind the fuel subsidy reforms Victor, 2009, Dartanto, 2013. The other motives of this policy shift included controlling the ever increasing domestic demand and releasing the fiscal burden of the gasoline subsidies from the government.

The policy has been implemented. For the past few years Iranian domestic fuel prices have been closer to the fuel prices in neighboring countries. However, the effectiveness of this policy experiment on reducing the extent of smuggled fuel has not been empirically examined. Our paper is the first to rigorously evaluate such outcomes.

The objective of this paper is to use domestic variations in order to provide estimates of the price elasticity of the demand for gasoline smuggling in various regions of the country. We use the fact that gasoline prices in Iran are determined by a central government as a key identification factor. Our research uses administrative regional-level data (for 160 distribution hubs) during the years 2005–2014. We utilize the heterogeneity of the various provinces and their closest higher-price neighbors. As all of the provinces are forced to follow the same gasoline price, we estimate the elasticity of the demand for gasoline smuggling as a function of price differentials between Iran and neighboring countries, and the distance to the border.

We offer multiple contributions to the existing research. First, we provide empirical evidence for the impact of changing government-set fuel prices to the demand for smuggling. To the best of our knowledge, this is the first attempt to provide such results in the context of a resource-rich country. Removing domestic fuel subsidies and bringing prices closer to the international levels have been the subject of recent heated debates. Due to various factors, several oil-rich countries have already started removing or reducing domestic fuel subsidies and narrowing the gap between domestic and international prices. However, there is not much literature concerning ex-post empirical evaluation of the results of such policies. We fill this gap by offering empirical evidence from Iran, a vast and largely populated oil-rich country that undertook an ambitious fuel subsidy removal program in 2010.

Second, our paper contributes to the literature of public finance and the demand for smuggling. Prior research has focused on various goods (especially luxury goods such as beverages and cigarettes). We provide evidence for gasoline, a homogeneous and essential good.

Despite the typical reliable data collection issues in developing countries, we believe that the granularity of our quantity and price observations in conjunction with the particular institutional setups, which we exploit for causal identification, enable us to provide a reasonably reliable estimate of the elasticity. We also offer multiple robustness tests to address or mitigate potential concerns.

The paper is structured as follows. Section 2 presents the literature review on the estimation of goods demanded with regard to smuggling, cross-border shopping, and subsidizing fuel. Section 3 presents data. In Section 4 the empirical method used for the estimation of gasoline demand is discussed. Sections 5 and 6 deal with results and robustness checks. Finally, Section 7 draws the conclusion.

Section snippets

Cross-border shopping and smuggling

A seminal work in this area has been conducted by Leal et al. (2010) who provide a comprehensive review of the literature on cross-border shopping as a result of tax differentials. According to Mikesell (1970), tax differences between various states in the United States induced an interest in cross-border shopping from the mid-1930s. The first applied research, however, was performed between the 1950s and 1970s.³

Background on the Iranian gasoline market

In Iran the national fuel price has always been set by the government in a fixed rate across all regions. In fact, there is no equilibrium market price or regional pricing in the country. A key institutional fact is that there are no private oil providers, and the government-affiliated National Iranian Oil Products Distribution Company (NIOPDC)⁴ is the sole importer and distributor of fuels.

Historically, gasoline and diesel prices have been heavily subsidized in

Identification

The key institutional feature of our identification strategy is the existence of an administratively set national price of gasoline. The non-varying prices across time and provinces mitigate the potential endogeneity concern of equilibrium prices at the regional level. If the price was determined through market forces, or even through an administrative mechanism instituted at the regional level, one could argue that the demand for smuggling directly affects the price.

We assume that the fuel

Estimation

Gasoline prices are the same across all Iranian regions and hubs at any given time period. Moreover, the price in each month is less than at least one of Iran's neighboring countries. Therefore, the assumptions presented in Section 4 for the modeling of the gasoline demand function are satisfied. As a result, we can estimate the coefficients presented in Section 4 using the data set introduced in Section 3. Moreover, in all the following approaches, standard errors for panel specifications are

Discussion and robustness checks

In this section we offer multiple robustness checks by changing critical specifications of the model.¹⁷

Conclusion

This paper investigates the price elasticity of the demand for gasoline smuggling in Iran. Toward this goal, a panel of monthly gasoline consumption data has been used that contains observations for 160 distribution hubs of the National Iranian Oil Products Distribution Company (NIOPDC) between 2005 and 2014. The aggregate estimation results of the elasticity of monthly gasoline smuggling demand shows the significant effect of gasoline price ratios between Iran and its neighboring countries. On

Acknowledgment

We are grateful for the comments received following the presentation of an earlier draft of this paper at Sharif University of Technology and the members of NYC's Dark Coffee Economics Discussion Group. We also would like to thank Djavad Salehi-Isfahani, Mohammad Vesal, Sorena Rahi and two anonymous reviewers for their very helpful comments on an earlier draft. The authors are, of course, responsible for all errors and omissions.

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^☆: This paper is based on the masters thesis of Nima Rafizadeh at the Sharif University of Technology supervised by the other two co-authors.

View full text

Price elasticity of gasoline smuggling: A semi-structural estimation approach☆

Highlights

Abstract

Introduction

Section snippets

Cross-border shopping and smuggling

Background on the Iranian gasoline market

Identification

Estimation

Discussion and robustness checks

Conclusion

Acknowledgment

J. Public Econ.

Energy Econ.

Energy Policy

Econ. Lett.

Reg. Sci. Urban Econ.

J. Public Econ.

Border-crossing sales, tax avoidance, and state tax policies: an application to alcohol

South. Econ. J.

Lessons Learned: Malaysias 2013 Fuel Subsidy Reform

Crossing the Line: The Effect of Cross Border Cigarette Sales on State Excise Tax Revenues

Petroleum Product Subsidies: Costly, Inequitable, and Rising

A note on estimating cross-border effects of state cigarette taxes

Natl. Tax J.

Alcohol taxes, tax revenues and the single european market

Fisc. Stud.

Bringing it all back home: alcohol taxation and cross-border shopping

Fisc. Stud.

The economic cost of global fuel subsidies

Am. Econ. Rev.

The economic impacts of climate change: evidence from agricultural output and random fluctuations in weather: comment

Am. Econ. Rev.

State and Local Public Finance (3rd ed.)

How Excise Tax Differentials Affect Interstate Smuggling and Cross-border Sales of Cigarettes in the United States

How Excise Tax Differentials Dffect Cross-border Sales of Beer in the United States

Tax structure and the location of economic activity along state borders

Natl. Tax J.

Iran: The Chronicles of the Subsidy Reform

Effects of Increases in Sales Tax Rates on Taxable Sales in New York city

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