Estimating shadow prices in economies with multiple market failures

Abstract

Approaches to the estimation of shadow prices generally assume that all but one market function correctly. However, multiple market failures are common in developing countries. We present a theoretical model and an empirical strategy to estimate the shadow price of a subsistence good in an economy where labor markets fail. Our results show that: 1) among subsistence producers, the shadow price of this good must be greater than or equal to the market price, and equal to it for surplus growers; and 2) current methods create biases when the otherwise-perfect-markets assumption is violated. The propositions are tested using a representative survey for rural Mexico. We find that the shadow wage is below that of the market (MXN $93.2/day vs. MXN $132.3/day), and that the shadow price for subsistence corn is over ten times greater than its market price (MXN $32.37/kg vs. MXN $3.19/kg). Unbiased shadow price estimates for subsistence goods help to overcome the limitations of current income poverty measures: their overestimation of the purchasing power of subsistence households and their underestimation of the value of subsistence goods. In rural Mexico, current practice underestimates the population in food poverty by 2%; an additional 9% has income above the poverty line yet fail to meet the utilization dimension of food security.