Globalization Group presentation “One product, two prices: The border effect in retail prices”. Introduction: - Aim of our presentation: demonstrate that the LOP is unrealistic on the grounds of a recent study about price differences between Austria and Germany - Law of one price: definition Discussion: - Description of the study(methodology) → sample region to a 60 km band along both sides of the border; similar consumer preferences (expenditure is highly correlated); transaction level prices of fast-moving consumer goods (food and personal care items sold in supermarkets); comparison between 19 border regions in each country with 6/8 retail groups operating in both countries. - Graphs (price gaps and cross-border price gaps within multinational retail chains) - Main findings (graphs description) Conclusion - 3 implications - link to what we’ve studied in globalization Script Slide 1 Cover page Slide 2 Preview Slide 3 Introduction Have you ever wondered why prices can vary so much between countries that use the same currency, like those within the Euro area? To answer this question today we will discuss article : ‘one product two prices: the border effect in retail prices’ developed by Price Micro Setting Analysis Network aka PRISMA, which consists of economists from the ECB and the national central banks (NCBs) of the European System of Central Banks (ESCB). The aim of the article is to investigate the relevance of national borders for grocery prices in the highly integrated and otherwise homogeneous region shared by Austria and Germany. Using detailed transaction data from a large household panel, we compare the prices of identical products sold within a narrow distance along the border. The "law of one price" says that in a world without barriers to trade, a product sold in two different countries should have the same price. However, in this article, we see significant variation in prices across a national border where the usual factors that explain international price differences are largely absent. Although there are some products that cost the same on both sides of the Austria-Germany border, many prices differ significantly. The authors of the article demonstrate that even retailers that operate in both countries charge different prices for the same products depending on which side of the border they are sold, the average difference in price is 21%. Slide 4 LOP The "law of one price" (LOP) is an economic principle that states that, in a perfect and unrestricted market, the price of a product traded in two countries should be the same. However, such a "frictionless world" is hypothetical and rarely exists in reality due to various trade barriers, cultural differences, administrative policies, and technical restrictions. In this real world, market participants cannot always exploit every arbitrage opportunity immediately. Therefore, deviations from the LOP are common and have been observed in many studies, even among neighboring countries. Despite these deviations, it remains unclear whether purely administrative national borders can cause significant price differences. Many studies have documented persistent deviations from this principle. Some examples include Engel and Rogers in 1996 and Gorodnichenko and Tesar in 2009, who found significant price differences even in neighboring countries after years of economic integration. While regulatory and technical trading obstacles may explain many of these price differences, such as the role of a currency union in price convergence discussed by Neiman et al. in 2013, again it remains unclear whether purely administrative national borders without such obstacles can produce such deviations. Other studies, such as Méjean and Schwellnus in 2009, Gopinath et al. in 2011, and Reiff and Rumler in 2014, also found notable price differences across national borders, indicating that this issue is still not definitively settled. It is challenging to isolate the impact of an exclusively administrative border due to numerous market factors that tend to change at a national border, even when the border remains open. These factors include not only language or currency differences but also variations in traditions, habits, and consumer preferences. The border area between Austria and Germany offers an excellent opportunity to examine the influence of an administrative border since this region showcases significant economic and cultural connections, along with an interconnected retail market involving multiple retail chains operating in both countries. Slide 5 Methodology In the recent research paper (Messner et al., 2023), authors of the article conducted an empirical analysis of price and inflation variances at the border between Austria and Germany. To mitigate the influence of potential confounding factors, they focused on a narrow strip extending 60 km on both sides of the border as our sample region. By doing so, they aimed to minimize the impact of classical trade barriers, exchange rates, and distance on retailers' pricing decisions. Moreover, the high correlation in household expenditure across the border suggests similar consumer preferences in both countries, indicating that they are unlikely to be a significant factor contributing to price differences. The basis of the study consists of an extensive household panel survey conducted between 2008 and 2018 in Austria and Germany. This survey data was provided by the Gesellschaft für Konsumforschung (GfK) and offers comprehensive insights. analysis focuses specifically on transaction-level prices of fast-moving consumer goods, which primarily include food and personal care items sold in supermarkets. The presence of barcode information allows us to compare products across 19 border regions in each country. Notably, six out of the eight retail groups examined in our study operate in both countries, enabling us to conduct cross-border price comparisons, even within the same retail chains. Slide 6 price gaps at the border graph 1 (first graph is percent difference in prices in austria and germany, second one is year-on-year differences in price changes Austrian price changes minus German price changes) When examining identical products sold on both sides of the border, the study discovered substantial price disparities that surpass the differences observed within each individual country. The average log price difference for a particular product sold by a specific retailer within a two-month timeframe between various cross-country region pairs is depicted in the left-hand panel of Figure 1. notes: In the histogram, two panels display distinct aspects. The left-hand panel illustrates the percentage differences in prices across the border (Austrian prices minus German prices), while the right-hand panel showcases the year-on-year differences in price changes (Austrian price changes minus German price changes), also in percentages. Each bin in the histogram has a width of four percentage points, except for the "zero" bin, which exclusively includes zero values. The observational unit for the data analysis is the combination of product, region pair, retail chain, and bi-monthly time period. The dataset encompasses a total of 19 regions in each country. The left-hand panel exhibits a prominent peak at zero, representing approximately 14% of all price comparisons, indicating a significant portion of products with identical pricing on both sides of the border. However, the dotted line illustrates that, on average, prices on the Austrian side of the border are approximately 13% higher. Excluding the mode at zero, the cross-border price differences tend to center around a premium of 15-18% on the Austrian side, indicating a distinct "border effect." This bimodal distribution suggests the existence of a profit-maximizing cross-border price differential that is not zero. The right-hand panel provides a similar analysis but focuses on the year-on-year price changes at the product level. In contrast to the variations in price levels, the distribution of price change differences exhibits symmetry, with a single mode and a median at zero. This suggests that, on average, the price changes (and consequently, the inflation rates) are comparable between the two countries, despite significant variations observed at the product level in either direction. These findings reveal a clear deviation from the law of one price, which is observed only in a relative sense concerning price changes. This discrepancy may arise from shared inflationary factors influencing both countries. Slide 7 Cross-border price gaps within multinational retail chains graph 2 (the cuts at 0 are the differences in price, left side is distance in Germany, right side is distance in Austria) Retailers play a crucial role in determining prices, and variations in pricing strategies among different retailers can lead to international price differences. These differences might stem from disparities in the retail sector composition, where retailers exhibit varying overall price levels. For instance, as demonstrated by Berardi and Sevestre (2018), this scenario can occur even within a sample of multinational retailers that have centralized product procurement and uniform pricing, irrespective of national borders. To address this concern, the study investigates whether our findings remain consistent even when considering retail chains that operate on both sides of the border. In Figure 2, we see the average price differences for each multinational retailer in our sample against the distance of the shopper's residence from the border. Interestingly, within each country, pricing appears to be relatively consistent, showing no significant variation based on distance from the border. However, a notable observation emerges: the prices set by each retailer exhibit a distinct spike precisely at the border. In essence, retail chains operating in both countries demonstrate a much higher level of price uniformity within each country compared to across the border. Although retailers have the option to implement price differentiation along other geographical lines, they specifically choose to align with the national border. notes: The average log price deviation from the mean for each distance bin is represented by the diamonds in the chart. A second-order polynomial curve (unweighted) is fitted to these average values and depicted by the solid line. It's important to note that the chart includes only barcodes of products sold in both Austria and Germany. The horizontal axis measures the distance from the border in kilometers, where negative distances indicate locations in Germany and positive distances refer to Austria. The number of bins is determined separately for Austria and Germany using the optimal evenly spaced method based on the integrated mean squared error. Slide 8 Main findings: First implication - Retailers discriminating among countries The research has significant implications in three key areas. Firstly, it demonstrates that retailers engage in cross-border price discrimination. This indicates that they strive to maximize profits independently in each country, even within the European Union. This finding suggests that the cost of arbitrage, potentially due to information costs involved in obtaining price information, remains sufficiently high. As a result, many consumers are discouraged from taking advantage of these price differences. Slide 9 Second implication - price discrimination due to historical development Secondly, The findings highlight that prices can still be influenced by national borders, even within a fully integrated region such as the European Union. This occurs due to the historical development of logistics networks and marketing regions. The existing distribution networks were established during a period when cross-border trade was more complex compared to the present time. Therefore, the observed geographical alignment of price discrimination with national borders is likely a remnant of economic borders from the past, and their impact is gradually diminishing but persisting. Slide 10 Third implication - inflation rates are same The third significant finding of the study is that while the law of one price may not hold in an absolute sense, it remains valid in a relative sense, particularly with regard to inflation rates. Inflation rates on both sides of the border are comparable, indicating that common cost shocks tend to influence prices in the same direction in both countries. However, the dominant factor contributing to the border effect is product-specific pricing. Consequently, the border effect itself is unlikely to significantly impact the transmission of monetary policy. Slide 11 Conclusion To summarize, the study indicates that retailers possess significant market power over consumers, as evidenced by the border effect. This effect suggests that retailers deliberately employ price differentiation, based on historical factors and existing distribution networks. Slide 12 References
