Barriers to price convergence

Abstract

This paper uncovers novel empirical patterns in the cross-country price mechanism using a nonlinear factor model and threshold regression analysis based on individual goods retail price data for a large panel of countries. To our knowledge, this is the first paper to find strong evidence for club convergence of retail prices. These clubs emerge due to the interaction of traded and nontraded factors. For example, countries physically closer to potential trade partners converge faster than countries in the high distance regime as long as they have low initial labor productivity or low initial income. Moreover, we find an asymmetry in the extent that arbitrage opportunities related to international trade are exploited, with low initial price regime countries exhibiting faster convergence from below than high initial price regime countries exhibit from above, consistent with less resistance to exporting than to importing due to political economy considerations. We interpret our findings as evidence of a local law of one price due to barriers to price convergence influencing the duration of the effect of price shocks. INTRODUCTIONThis paper contributes to the long-standing debate about price convergence by investigating the existence of club convergence in prices using semi-annual micro price-level data for 40 countries and 96 goods and services over the period 1990-2010. Our goal was to answer the following set of questions: Do retail prices for individual goods and services across countries globally converge to a single price or diverge? Do countries form price convergence clubs? If so, what factors determine these? To our knowledge, ours is the first study to find evidence of meaningful convergence clubs in the cross-country price mechanism. This means that there exists a tendency for prices across countries with identical structural characteristics to converge to one another if their initial prices are in the basin of attraction of the same steady-state equilibrium. We find that this tendency is induced by the interaction of traded and nontraded input components of retail prices.At the heart of the debate about price convergence is the law of one price (LOP), which asserts that, as a result of arbitrage, identical goods sold in different locations will have identical prices when expressed in terms of the same currency. Empirical evidence in favor of the LOP is mixed. According to one strand of the literature, the LOP does hold in the long run, conditional on cross-country structural heterogeneity due to transport costs and other barriers to trade. During the last decade, a number of studies have utilized micro price levels to assess the rate of price convergence and understand the mechanisms that determine cross-country price convergence. This includes Crucini and Shintani (2008) using Economist Intelligence Unit (EIU) annual price-level data for 1990-2005, Burstein and Jaimovich (2012) using barcode prices, and Andrade and Zachariadis (2016), who find relatively low half-lives using semi-annual EIU prices, also u...

Non‐linearities in international prices

“…The survey covers 300 individual retail products and services across 138 cities in 91 countries semi‐annually over the period 1990–2010. Bergin et al (2013), Andrade and Zachariadis (2016), and Glushenkova et al (2018) have also used these semi‐annual EIU data to study issues of price adjustment. The online appendix of Andrade and Zachariadis (2016) discusses issues related to sample selection and reliability of this data set in great detail.…”

“…Similar to these earlier papers and building on the work by Crucini et al (2005), we assess the importance of the traded and non-traded channels for LOP deviations and price convergence. Our paper also relates to Glushenkova et al (2018) who allow for the interaction of the traded and non-traded channels via which price convergence occurs. 3 An innovation in our paper is that we consider such non-linearities along with TAR-type ones in investigating the role of traded and non-traded inputs.…”

Non-Linearities in International Prices

“…) shown in Table 2 for the structural TAR models estimated here. 9 This means price differentials outside the band are relatively short lived as compared to those within the band, indicating the presence of TARtype non-linear adjustment of price differentials. 10 Reassuringly, the slowest convergence speeds we find are within the bands of inaction for services, irrespective of the statistical model and the bilateral set of comparisons being considered.…”