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- All Things Not Being Equal |
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Written by Surje |
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All Things Not Being Equal
The
macro and micro of retailers, consumers and the Canadian dollar
and why price-parity is not supported by currency-parity
Surje & Company 12/3/2007
by Sunny Bhasin |
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There has been
extensive coverage and commentary recently on the effect on
retailers and consumers of a Canadian dollar trading at
above-parity to the US Dollar. While this is certainly a matter
that is worthy of discussion that impacts all consumers, there
are a number of aspects that are neglected in mainstream
dialogue, especially by and in the media.
When considering the issue of price parity, both the supply and
demand of goods and services is of great importance; on a
macroeconomic level as well as on a microeconomic level.
From a macroeconomic perspective, one must consider issues
related to labour, capital, government interventions and the
flow of goods and services across and within national boarders.
From a microeconomic perspective, one must consider the specific
supply and demand curves for different products and services,
and the price sensitivity of consumers. At the core of
microeconomic analysis is the presumption that some form of
competitive landscape exists. Situations where there is a
complete lack of competition are considered market failures and
as such are not within the scope of this paper. Issues other
than macro- or microeconomic factors, such as anecdotal
cross-border shopping stories or a particular retail item being
cheaper in one country versus another while important and
deserving of public discourse, are similarly not the focus of
this paper. The purpose of this paper is to draw attention to
the underlying economic reasons as to why price-parity is not
supported by currency-parity.
Underlying macroeconomic issues
Based on 2006 figures, Canada’s labour participation was
approx. 17.6 million, giving the nation a labour participation
rate of 67.2%. The unemployment rate in 2006 stood at 6.30%1.
By comparison, the figures for the U.S. show labour
participation of 151.4 million, which translates into a labour
participation rate of 66.2%. The U.S. unemployment rate in 2006
was 4.62%2. Such labour force size and participation
rate differences, when compounded with the GDP per capita
differences, paint a picture where the US economy not only has
more workers and each worker’s contribution to GDP is greater.
Labour force and GDP data indicate that the US labour force is
more productive per capita and its overall market size from both
a business and consumer perspective is larger. The ten-fold
difference in population size also presents immediate scale
issues for Canadian retailers, which affects their ability to
reduce costs.
A comparison of the systemic and structural costs and issues
related to doing business in Canada vs. the U.S. is important in
that why is it important. Given our larger area, smaller and
more sparse population base, large areas with little population,
and colder and harsher climate, the transportation and logistics
costs associated with distributing products are far greater on a
per unit basis in Canada than the U.S. While costs related to
importing (such as fuel and equipment) are reduced, the
contribution from exports reduces by a more significant real
amount. This is due to the fact that because a stronger Canadian
dollar impacts all good and services the producer/exporter sells
abroad, no matter when they were produced. In addition, their
margins further shrink because the direct currency conversion
rate always factors in a speculative premium or discount. It
becomes more and more expensive for non-Canadian customers to
purchase from Canadian exporters which in turn, reduces the
competitiveness of many Canadian exporters versus nationals in
other countries with weaker currencies against the CDN$.
These costs further go up for exporters with the gain in value
of the Canadian dollar against a large basket of other
currencies, including the €, ¥, £, and US$. The Canadian dollar
has gained +12.7% on average against the currencies in the
basket (AUS$, Swiss Franc, Chinese Yuan Renminbi, Euro, UK
Pound, Yen, Korean Won, US$, Brazilian Real, CDN$, Indian Rupee,
and Russian Ruble), including a very significant +22.2% on the
US$. The Canadian dollar has seen a rise of +66.7% since 2002
against the US$3.
Underlying microeconomic issues
The fundamentals of microeconomic theory are based on a
presumption of competition. The existence of competition leads
to companies making decisions that are in their best interest,
with respect to the supply of goods and services at specified
prices. The consumer impacts this business behaviour through
their sensitivity to prices – or price elasticity of demand – by
altering the quantity they demand. Some additional
considerations must be included here, such as the inability of a
single supply-demand curve to either impact or be impacted by
another supply-demand curve. Competition in the true or perfect
sense of the word implies the free flow of goods and services
without any impediment. In reality, there are always barriers
and asymmetries between markets. Let us briefly consider the
European Union (EU) example, where the flow of goods, services,
labour, and currency is free and without hindrance. Does this
mean that the prices of a Big Mac, a sweater, or a car are
identical across the entire EU? The answer is no, owing to the
macroeconomic considerations previously discussed. Moreover, it
is incorrect to assume that a geographic proximity of regions or
the porosity of a border mandates the intersection (or even more
inaccurately, the merging) of two or more supply/demand curves.
The removal of trade barriers between EU countries has led to
increased Purchasing Power Parity (PPP), but the underlying
microeconomic conditions make it very difficult and perhaps
impossible in the foreseeable future, for a home, a car, or a
latté in Paris, France to cost the same in Florence, Italy.
In a similar sense, though many cities within Canada and the US
are short distances apart, it does not mean that the supply of
goods and services is identical across these two neighboring
regions. In addition, it does not mean that the demand for goods
and services across these is the same. The challenge lies in the
common mistake consumers make, where they confuse awareness of
prices in another, relatively accessible area with a rationale
for a price decrease in the area they are currently located.
There are differences in the supply and demand curves of
Canadian and US cities, because the boarders are not
open/removed to an extent where you can have identical supply
and demand relationships. Canada and each of its provinces have
separate taxation systems, separate tariff and excise regimes,
and different border controls. The EU example above points to
the fact that even a legal and structural removal of such
conditions does not eliminate the unique supply and demand
forces within a market or region.
Putting it all together
Let’s take the discussion a bit further and compare two Canadian
cities – Toronto and Calgary – and use some of the commonly used
arguments by consumers vis-à-vis retailers and prices within
Canada. All producers, suppliers, retailers, and consumers
within Canada use the Canadian dollar. So, there is no issue of
price parity. Macro factors such as labour are certainly
relevant, i.e. the amount of available labour is very different
in Toronto vs. Calgary (the latter has a greater shortage of
labour than Toronto, esp. for non-professional occupations). The
macro factors of land and legal/tax differences are also
relevant, as the Alberta government has a significantly
different corporate and personal taxation level than Ontario.
Micro factors such as supply and demand of goods and services
are also relevant – Toronto’s population of approx. 5.5 million
vs. Calgary’s population of approx. 1.1 million4.
Now, if one compares the cost of living differences, as
published in the Global/Worldwide Cost of Living Survey Rankings
2007/2008, Toronto ranks at 82nd with a score of 78.8 (New York
is considered the base score of 100), while Calgary ranks 92nd.
The survey measures the cost of 200 items such as housing,
clothing, and food. In particular, the costs of the following
goods and services are compares: Alcohol and tobacco; Clothing
and footwear; Domestic services; Food at home; Food away from
home; Health and personal care; Household supplies; Sports and
leisure; Transportation, and; Utilities5.
Based on purely purchasing parity and currency value arguments,
Calgary and Toronto should rank at the same (or close to) level
in the above study. This is not the case, because of underlying
microeconomic and macroeconomic reasons. Calgary and Toronto
have different supply and demand curves for goods and services.
In addition, Calgary and Toronto have different
government-imposed regulations and taxation regimes. The two
cities also have different demographic components and different
consumer flow patterns.
By virtually the same reasoning used by proponents of
price-matching between US and Canadian retailers and
goods/services providers, one can argue that it makes even less
sense that there is no price-matching within a single nation
such as Canada. Hence, it follows that making such arguments as
the underlying reasons for price-matching doesn’t make much
sense either. Currency parity does not necessarily translate to
price parity for goods and services. If some form of price
matching does occur, it should be as a result of shifts in the
supply and demand patterns, stimulated by macroeconomic factors.
1
Centre for the Study of Living Standards, 2007 Report on
Aggregate Income and Productivity Trends: Canada vs.
United States, p. 18.
2 Centre for the Study of Living Standards,
2007 Report on Aggregate Income and Productivity Trends: Canada
vs. United States, p. 20.
3
Yahoo Finance (finance.yahoo.com)
4 Statistics Canada, 2006 Census of
Population
5 Mercer Human Resource Consulting, Cost of
Living Survey – Worldwide Ranking 2007 |
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