Are Food Price Differences in EU Member States a Result of the Penn Effect

Abstract

Abstract Panel data from 14 EU member states and non parametric techniques are used in this paper to investigate the relationship between food prices and real per capita incomes. The empirical results suggest that the largely holds for Total Food prices but not for the prices of certain among the seven disaggregate food commodities considered. In particular, for Cereals, for Fats and Oils, and for Other food products poorer countries are likely to face prices no lower than those prevailing in richer ones. Keywords: Food Prices, Living Standards, EU JEL Classification: Q11, C14 Introduction The completion of the Single Market and the establishment of the EMU are two important steps in achieving European economic integration. The Single Market has facilitated the free movement of people, goods, and capital, while the EMU reduced the exchange rate volatility and the risks of cross-border activities, and increased transparency thanks to prices expressed in a common currently. In addition, initiatives have been undertaken towards tax harmonization and other structural reforms in product markets to enhance competition and to reduce distortions caused by different forms of government intervention. Despite the distinct efforts to integrate national markets, it is generally recognized that cross-country price dispersion (a key indicator of the degree of integration) in the EU has been persistent, and rather stable over time (e.g. European Commission 2001a, 2001b, and 2004). The large and persistent cross-country price differences for virtually identical products suggest that the European markets are still away from the efficient (integrated) ones in which prices tend to uniformity. This naturally has been the focus of intense public debate (European Commission 2001b, and 2004). Multiple factors are thought to play a role in preventing the Law of One Price (LOP) from holding true in the EU. These include macroeconomic factors such as differences in living standards as well as microeconomic factors such as transportation and distribution costs, imperfect competition, and product differentiation (European Commission 2001b). This paper examines the relationship between food prices and real per capita incomes in the EU. In the International Economics literature, the term Perm Effect refers to the tendency of consumer price levels in wealthier countries to be higher than those in poorer ones (e.g. Dorbrinsky, 2003; McDonald and Ricci, 2001; Dombusch, 1988). The has both supply and demand side explanations. The former relates to the socalled Balassa-Samuelson (Samuelson, 1964) which emphasizes the role of intercountry differences in the relative productivity of the tradable and non tradable sectors. The later views price differences as a result of differences in relative money abundance. The is considered to be a good thing for poorer countries since it allows them to attain welfare levels higher than those suggested by their relative position in the cross-section distribution of nominal per capita incomes. Empirical evidence of the has been typically pursued through simple regression equations relating general price levels to real per capita incomes or productivities (e.g. Dowrick, 2002; Bahmani-Oskooe and Rhee, 1996). The regression analysis, however, with its dominant focus on the average or representative country is not quite informative about the welfare implications of the Penn Effect. What one really wants to know is not whether an increase in the real per capita income of the representative country will result in an increase in its general price level but whether there would be poor countries (not necessarily all of them) that would end up with price levels similar to that in rich countries experiencing, thus, a deterioration of their relative position in terms of living standards. Also, the pre-occupation with general price levels (commonly represented by Consumer Price Indexes) may mask important differences among countries with regard to commodity groups an aggregate price index is made of. …