The World Bank‟s International Comparison Program (ICP) 2005 data on national price levels for tradables and non-tradables (and goods compared to services) reveals that New Zealand has relatively high prices of both tradables and non-tradables when compared to a sample of over 40 OECD-Eurostat countries. This paper seeks to explain both those observed international variations in non-tradables and tradables prices in general, and New Zealand‟s especially high prices in particular.
Purpose
The purpose of the present paper is three-fold:
1. To re-evaluate, using the 2005 ICP data, previous explanations for observed international differences in non-tradables prices;
2. To extend the conceptual modelling of non-tradables price differences to joint modelling of tradables and non-tradables price differences and test this empirically on the same ICP data; and
3. To consider how far each of those modelling approaches helps understand the observed deviations of New Zealand‟s tradables and non-tradables prices from those in other countries.
Key Results
The overall messages from this analysis are:
- Modelling the determinants of non-tradables prices using the extended FG model work fairly well in general, and especially for a group of OECD-Eurostat countries.
- This supports the hypotheses that:
- Non-tradables prices are higher in association with higher values of capital and unskilled labour endowments, and trade deficits;
- Non-tradables prices are lower in association with higher values of skilled labour, and population;
- Tradable prices also tend to be higher where non-tradables prices are higher both because this raises the (non-tradable) input costs for tradables, and because high tradables prices are impacted by „trade impediments‟ and indirect taxes.
- The model suggests NZ‟s relatively small population and high tradables prices tend to raise its non-tradables prices relative to other countries. NZ‟s lower than average capital endowments should serve to counter-act these high prices, but modestly. (NZ has the 28th highest ranked capital endowment, and 25th highest capital/labour ratio, out of 43 countries).
- For labour endowments, taking a ratio of skilled labour (differences) to population (differences), NZ is ranked 29th out of the 43 OECD-Eurostat countries in this ratio, so that its relatively low skilled labour per capita also serves to raise its service prices.
- NZ's relatively high price of non-tradables is estimated to add around 40% to the domestic consumer price of tradables, compared to border or factory gate prices. This is also around the OECD-Eurostat average cost share.
- However, after accounting for this 'cost share of non-tradables' contribution, NZ's tradables prices remain fairly high by international standards. A 'good candidate' to explain this are the transaction costs associated with NZ's distance from markets. Though we have not examined direct evidence on this here, numerous other studies have suggested the importance of such factors; see, for example, McCann (2003, 2009).
- Based on 'adjusted' tradables prices that removes the 'cost share of non-tradables' element, NZ's tradables prices are around 6th highest in the 43 country OECD-Eurostat sample – behind such countries as Iceland, Norway and Japan (see Figure 6). These are also countries relatively distant from many of their key markets. (For Japan at least, other protectionist measures may also be relevant). However, Australia is ranked 19th out of 43 countries in its adjusted tradables price, suggesting that to the extent that there are 'disadvantages of distance', Australia manages partially to avoid or overcome these.
- As Figure 6 shows, NZ is like a number of other small countries with a high adjusted tradables prices (e.g. Cyprus, Malta, Denmark, Finland, Israel, in addition to the 'small and distant' economies of Iceland and Norway). This suggests that size or other characteristics of domestic markets/populations may be important in ways not already accounted for by the FG model‟s variables.