El Blogador hasn’t been blogging as often recently, perhaps because he’s spending time in Tapachula instead of London or Antigua:

But a couple of days ago I went to buy a medium-sized cup of iced coffee in the shop within this nicely rennovated bandstand in Tapachula, and was asked to pay 27 pesos for it ($2). It would have cost roughly the same in London, capital of soi disant ‘Rip-off Britain’. But this was Chiapas, which in many other respects still seems to offer the most sensible prices in Central America.

Still, I’ve kind of grown used to rip-off prices in Guatemala, even if I don’t quite understand them. A cup of capuccino or a pizza from Domino’s costs approximately 20% less than it would in London, but I can’t think of any overheads affecting the restauranteur which could mount up to anything like 80% of their UK equivalents.

The killer in London is the cost of renting a retail unit suitable for a coffee shop. Any building in the centre which doesn’t cut it as a locus for shopping can relatively easily be switched to alternative, more rentable uses such as office space or car parking. The owner of the building will generally go for the most profitable usage. Wages are also considerably higher in the UK, with the national minimum set at roughly $9 an hour.

So why is a lot of restaurant food (especially the faster sort) so expensive in Antigua? Can’t be the ingredients (mostly local), the property rent or the labour costs. Maybe red tape is a major overhead here, but then Guatemalan businesses aren’t paying anything like the same sort of corporation tax.

And bear in mind that the average middle class consumer is also earning a lot less (though arguably also paying less to the banks and the government), and so if the pizza seems pricey to me…

Maybe it’s because there’s scarcity, but on the demand side: the number of people able to pay X for a Domino’s pizza in Antigua is as small as the number of affluent tourists in Tapachula and so the price of X has to go up to cover reduced volume. Hmmm, maybe I am economically naive after all.

El Blogador is in Chiapas and is wondering why his iced coffee costs so much when other goods are relatively inexpensive.  Note that he is buying an iced coffee (and we can assume it’s good coffee), not tortillas and beans, and that he’s buying it from a nicely renovated shop.  This hints give us a preliminary understanding of why the coffee is relatively expensive, at least to other goods in Tapachula.

The drink he ordered is not a common one in Tapachula.  Locals don’t drink a lot of iced coffee.  They do eat a lot of tortillas and beans and don’t care how well renovated the eatery is.  They certainly wouldn’t willingly pay more just to eat at a nice eastablishment.  So in the cost ingredient of the coffee we have built in both an exotic product (if not because the coffee itself is exotic because of the relative scarcity of the availability in the aforementioned form), and also a nicer establishment from which to buy the product.  Both of these issues contribute to higher overhead, driving the price higher.  The exotic product requires a greater investment in bringing it to the market and there is a greater risk that it will go unsold.  When you are a bean merchant in Mexico or Guatemala, there’s not much risk of demand evaporating; in Tapachula they have many reasons to worry that foreigners might stop showing up, or at least in as great numbers (Swine Flu, regional violence, economic crisis, etc).

Next El Blogador considers Antigua prices and the overhead, surmising that although prices in Antigua are generally lower than London, the latter’s prices can be somewhat justified when considering overhead.  As we discussed before, overhead is a factor, and although Antigua commercial rents are quite high (you can rent a place in Phoenix at a lower price per square foot), this alone doesn’t justify the price.  (You’ll have to wait for my dissertation on Antigua real estate prices).

Just as in Tapachula the product offering was an exotic one, this also is the case in Antigua.  Whether it is Dominos or a cappuccino, the product is essentially an import.  Yes, I know they make coffee here but the coffee the locals drink and the coffee I get in my cappuccino is not the same, and I’ve seen coffee bags around town that have been imported from the US.  It wouldn’t surprise me to discover the coffee was grown here, shipped to the US, packaged and shipped back.  Even if it remains here and is manufactured and marketed for local consumption, the buyer of that coffee is not the common man, but a wealthy local, extranjero or tourist.  More goes into the packaging, marketing and sales of the product than the actual ingredients.  Don’t fall into the temptation of thinking this isn’t ‘fair’; most products are this way (and life isn’t fair, just ask my teenager).

This means that the market for the product is greatly reduced.  Normally a smaller market means lower prices, because small markets often have corresponding small demands (in the aggregate), but occasionally this is not true.  There is a small market for a Ferrari, but the price remains high because it is an exotic product and the small market has the ability to pay for it.  Ferrari wouldn’t make money selling at half the price, and probably wouldn’t want to sell a product half as valuable, and so at a greatly reduced price the Ferrari would not be available.  It is the same with pizza and lattes in Antigua.  The demand, in the aggregate, is small, but within the market it is quite high.  I suspect prices for coffee and Dominos pizza could go up by 30% and there would be very little change in volume, because the demand-though limited-is intense, and further, the demand is for good coffee.

This deserves an additional consideration.  How are prices determined?  El Blogador considers overhead, and market forces, but neglects to mention the primary motive for setting prices:  profit.  The merchant must cover all of his costs, he must cover the cost of his own time, he must put a value on the risk his capital is taking, and finally he must set prices to provide a profit.

If the price of the product does not cover all these things, then the business will fail.  You see this daily around town as businesses are closing up because at a given volume they could not adequately meet all those objectives.  Where there is not profit, there will not be a lasting, profitable business.  (In this country many will survive but will not be profitable).  In Venezuela we have recently seen why socialism always fails, why it must fail, because prices are subsidized to promote a political ideology instead of allowing to work, which brought about scarcity and eventually a currency devaluation.  That too will have to wait for another time.

Another factor is the government.  El Blogador and other promoters of substantial government involvement in society (also known as Marxists), point to the benefits of governmental involvement and would cite regulations that benefit the consumer, strong infrastructure, etc.  Naturally there are costs that come along with that, first and foremost a high tax rate, secondly the drain on economic growth that comes with government taxation and regulation, and finally the infringement of personal and economic freedoms.  Most importantly when the government consumes money it returns to the economy less than it takes in, whereas private businesses return more through the creation of value, through innovation, etc.

In Guatemala the government is so dysfunctional you have both the presence of taxes and regulation, though they are widely subverted, and you have the lack of the societal benefits or infrastructure that is normally the product of government’s involvement.  For all my complaints about governements in general, the streets in the US are generally well constructed, well maintained, and traffic lights work, etc.  But here in Guate the streets are a mess, there is inadequate parking, buildings are crumbling, and genrally infrastructure is insufficient.  In addition you have the violence, a poorly trained work force, and high rates of crime.

The whole point of this is that there are substantially greater risks to the entrepreneur and his capital here than elsewhere.  If you invest in London or NYC, you do so without a great deal of fear about certain risks to your capital, whereas here you must protect your capital like a pioneer might who was headed west in 19th century America. Those risks keep a lot of businesses out of the market, which reduces the supply of products and services.  This forces prices higher.  (It also means the opportunity for those of us who are here is greater).

As with all prices, the market determines them.  In this case El Blogador’s willingness to ‘overpay’ for that iced coffee is itself a testament to why the price is so high, just as I am willing to pay 16Q for a cappucino at the park or 100Q for a Cohiba or 150Q for a good pizza (not Dominos).  There is a concentration of people like El Blogador and Don Marco in this town, which is why the prices are so high (for everything from real estate to cheese).

So in conclusion, prices in Antigua tend to be high, relative to the economy and the region.  They are high because the goods in question are unique/exclusive, because there are relatively few of them and because the risks to the merchant and his capital are great, and because the demand, while small, is intense.  The next time you find yourself wondering at prices in Antigua (or Atitlan), apply this approach and you’ll find the answer.