Price convergence (?) in the Eurozone

When the European Union and the Eurozone were created, one of the main objectives of their foundators was –together with more labour mobility and productivity- to achieve price convergence between the member states. For obvious reasons, the focus of the comunitarian institutions is nowadays on other issues: a fair recovery of the financial crisis, the refugees, the high popularity of anti-Union extreme-right wing political parties, etc. Notwithstanding, the for and against view points of having a common currency is still a debate that needs to get going in order to forecast the future (if any) of the Eurozone.

It is generally understood that having price convergence between different countries is benefitial. Besides, this is usually related to having price transparency (the consumers can compare prices better). The most relevant variable in this regard is the Coefficient of Variation (‘CV’) which is the standard deviation over the mean of prices. As long as there is no perfect price convergence yet, economists refer to this matter as ‘price dispersion’: the higher the price dispersion (CV), the lower the price convergence.

Before discussing whether or not the creation of the common currency system increased price convergence, it is clear that some dispersion still exists. Which are the main reasons for that? According to a research from the European Central Bank (ECB), the diversity of tax rates, local costs, income levels and consumption intensities explains some 40% of the price dispersion between Eurozone countries[1]. Nonetheless, there is much uncertainty about what other factors would also have an influence e.g. net wages or true border effects.

Different sources shed some light on this issue. When analysing the ‘’price index per country versus Eurozone’’ graphic (see the figure below), one can conclude that the price dispersion is still remarkable: in 2005, the price differential between Germany and Finland was roughly a 30%! In other words, the prices in Germany were 13% under the mean whereas the Finish ones were up to 17% over the mean.

This work was based on 160 identical brand-name products in 2005, even though they are mainly supermarket products. The conclusions would be different for other sectors of the market. In addition to it, if we look at price dispersion over time (below), we could conclude that there was price convergence during the 90s but it stopped once the Euro was implemented. Therefore, one first idea would be: taking into account basically supermarket products, the price dispersion in the Eurozone is still remarkable and the price convergence stopped when the common currency was implemented (at least up until 2005).

On the other hand, if we were considering the conclusions of the Working Paper Series 2014 by the ECB the conclusions would be different. In this case, which uses a wider range of products, two periods are compared: 2000-2003 and 2009-2011. The Coefficient of Variation declined from 0.32 to 0.28 in between these periods, which means that even though the price dispersion is still remarkable, the price convergence goes on. The price of a Marlboro package (typically a product whose price varies a lot depending on the country due to the national tax on tobacco packages) is a good example of this statement. We can also derive from this work that slow price convergence took place between 2009 and 2011.

Price dispersion of Marlboro (in terms of Coefficient of Variation) across countries and within countries

There is something else we can clearly see from the figure above: the across-countries price dispersion is way higher than the within-countries price dispersion (in average up to 8 times higher even though in some cases, such as the Gillette Shave one, it can be 24 times higher).

The reader might be thinking that another issue should be pointed out: would there be more price convergence if the common currency was not created in the first place? This is something that was partly answered in an article called ‘’the euro and price convergence: you wanted it… you got it!’’[2]. According to it, the Eurozone has been successful because the price convergence here is 30-50% lower than for countries with a fixed exchange rate with our currency. This was achieved thanks to reducing transaction costs, uncertainty and informational costs associated with purchasing the same exact product in different countries. This research, based on the exact same products from multinational companies such as Apple, IKEA, H&M or Zara, tells us how identical the prices are in some cases within our common currency area. At the figure below, you can see how the dispersion is much higher for countries with fixed (Denmark) or flexible (the US) exchange rate with the Euro in relation to those within the Eurozone.

Notwithstanding, the authors admit that the conclusion would have differed but for having only used clothing, electronics or furniture products. For other sectors, such as fresh food or car market, the price divergence is much higher.

Summing it up, the conclusions in this regard will not be as clear as it seemed at the beginning. There is evidence that the cross-country price dispersion is higher than the within-countries one (due to true border effects, tax rates, etc). We can also say that the price dispersion is more remarkable with no-Euro countries than with those in the common currency system. However, it is not clear whether or not the implementation of the Euro helped to the price convergence: if so, to what extent? In any case, it is definitely true that some products (auto or fresh food, for instance) see higher price dispersion than others.

On top of that, the weak European Union of today does not seem ready to take strong further steps in this sense. Some Eastern-Europe countries see now things very differently (see Poland or Hungary) whilst other states threatens to leave the Union if anti-political union measures are not taken. In the meantime, the banking and fiscal unions are completely forgotten in the European agenda. Perhaps this imperfect and messy Europe is better than a disintegrated one, though.

References

[1] https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1742.en.pdf

[2] Alberto Cavallo, Brent Neiman, Roberto Ringobon, ‘the euro and price convergence: you wanted it… you got it!’, VOX (2013)

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