Over the last few years, the potential consequences of “global imbalances” and their role in the build-up to the current crisis has been the topic of fervent discussion (see for example Obstfeld and Rogoff, 2009).
Eliminating such imbalances could be done through exchange rate movements and indeed, in the case of the US-China imbalance, a revaluation of the renembi has come to be the dominant policy recommendation in the US (see for example Reisen 2009). A weaker dollar, the theory goes, would make US exports cheaper and Chinese exports more expensive and these relative price changes would help balance trade. Yet, for this to happen, markets need to be integrated in the sense that price changes lead to expenditure shifting. If markets are strongly segmented – in the sense that firms and consumers treat the markets as quite distinct with little cross-market interaction – then movements in relative prices will only cause a limited shift in expenditures.
One line of research into the ability of exchange rate changes to shift expenditure patterns looks at the link between exchange rates and local prices. Numerous studies have looked at this response. The vast majority of them find very little “pass-through” of exchange rates to local prices (see for example Campa and Goldberg 2005 and Gopinath et al. 2009).
In particular, large and widespread deviations from the law of one price have been documented. Comparable products, in particular consumer goods, are found to sell for widely divergent prices across countries. In many cases, however, small transaction costs can probably explain a large part of these deviations. For example, while grocery prices may differ significantly across the border, trade barriers, costs of transportation, as well as opportunity cost of time are likely to seriously hamper the role of arbitrage. The lack of information on what those costs may be, as well as their size, makes it difficult to infer to which degree international markets are indeed segmented. In addition, products are often tailored to local markets, and may therefore not be perfect substitutes.
New evidence on the expenditure shifting
In a recent study (Boivin et al. 2010), we purposely focus on a market where such frictions are arguably minimal – online bookselling in the US and Canada. We collected high-frequency data, between March 2008 and June 2009, from the websites of the main players in this market (Amazon.com and BN.com in the US and Amazon.ca and Chapters.ca in Canada).
What are the features that make the online book market and our data set appropriate for this type of study?
- First, each product is identical across retailers, which makes our analysis immune to issues of quality, packaging, and size differences which are present in the data used in earlier studies.
- Second, price comparisons can be readily done online and so shopping or search costs should be orders of magnitude lower than for non-online items.
- Third, according to the NAFTA agreement, books are not subject to trade restrictions or tariffs and there are no constraints on buying books from foreign websites between these two countries.
- Fourth, the nature of the industry is such that the physical concept of distance is irrelevant; the consumer does not have to travel to purchase the good and rather must incur shipping costs, which we observe.
- Fifth, Canada and the US are among the most economically integrated countries in the world, with similar tastes and economic environments.
- Finally, for some websites, we have proxies for (relative) sales, which make it possible to study the reaction of quantities to movements in international relative prices.
One may expect that internet prices should be particularly flexible as frictions such as menu costs are minimal. Yet, our data show that price stickiness is pervasive (there is also tremendous heterogeneity in price setting practices across retailers). Combined with an appreciation of more than 20% of the US dollar versus its Canadian counterpart, the result is significant fluctuations in relative international prices.
Figure 1 shows the fraction of items that an American consumer could find for cheaper at Amazon.ca than Amazon.com, taking into account shipping costs. Based on the shipping costs for a four-book bundle, up to 40% of the 213 best-seller books in our sample are cheaper in Canada from a US perspective. The size of the deviations from the law of one price can also be significant, reaching up to 60% in some cases.
Figure 1. Percenatge of books which are cheaper in Canada, for a US resident, by pairs of retailers (including shipping costs).
Note: Various bundle sizes: 1 book (solid line), 4 books (dashed) and 8 books (dotted).
This evidence does not imply necessarily that the Canadian and US markets are segmented. After all, price differences for online books exist even at the national level. Yet, if retailers were wary of international competition, one would expect that variations in international relative prices through exchange rate movements would lead firms to re-price items. But this is not what we observe, even for a market where frictions are arguably minimal:
- Retailers are not more likely to re-price books which are in deviation of the law of one price
- The timing of price changes is not a function of the size of the deviation from the law of one price or exchange rate movements
- When retailers change prices, there is no conclusive evidence that they move in a direction consistent with the presence of integrated markets
One possibility is that even under the hypothesis of integrated markets, international competition is not a significant concern relative to other forces, and therefore is not reflected in pricing decisions. Yet, even if local prices were to be kept constant, wouldn’t we still find evidence that quantities sold react to exchange rate fluctuations?
If markets are not fully segmented, then the fact that books in Canada become cheaper following an appreciation of the US dollar should be reflected in higher sales for Canadian retailers. Using sales rankings as proxies for quantities, we find no evidence supporting such behaviour.
Discussion and implications
Our study focuses on an activity where trade barriers are minimal, information is cheaply available and products are homogenous. If pervasive cross-border arbitrage was ever going to arise, it would be in sectors like online book retailing. What we find is that even in this sector, we are unable to reject the hypothesis that the international border segments the markets. What, then, should we make of these findings?
- First, one may argue that the international price differentials we observe are simply not large enough to trigger a reaction from shoppers and retailers. The implication, then, is that rather large exchange rate swings may be necessary to fight current global imbalances.
- Another possibility is that exchange rate movements need to be highly persistent in order to have a significant impact on prices and quantities. In particular, persistent fluctuations may be more likely to lead to adjustments of imported input costs, which are then passed through to consumers.
Insofar as the re-balancing of global current account positions is concerned, our work suggests that realignment of cross-country consumption levels may require large and persistent exchange rate changes.
Bernanke, Ben S (2009), “Asia and the Global Financial Crisis”, Remarks prepared for the Federal Reserve Bank of San Francisco Asia Economic Policy Conference, Santa Barbara, CA, 18-20 October.
Boivin, Jean, Robert Clark and Nicolas Vincent (2010), “Virtual Borders: Online Nominal Rigidities and International Market Segmentation”, NBER Working Paper 15642.
Campa, Jose Manuel and Linda S Goldberg (2005), “Exchange Rate Pass-Through into Import Prices”, The Review of Economics and Statistics, 87(4).
Gopinath, Gita, Pierre-Olivier Gourinchas, Chang-Tai Hsieh, and Nicholas Li (2009), “Estimating the Border Effect: Some New Evidence”, Mimeo Harvard University.
Obstfeld, Maurice and Kenneth Rogoff (2009), “Global Imbalances and The Financial Crisis: Products of Common Causes”, Paper prepared for the Federal Reserve Bank of San Francisco Asia Economic Policy Conference, Santa Barbara, CA, October 18-20.
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