Mostly Economics

Teresa Messner, Fabio Rumler and Georg Strasser in this voxeu article:

The ‘law of one price’ states that, in a frictionless world, the price of a product sold in two countries should be the same. This column examines price differences across a national border where most factors commonly used to explain international price differences are absent. While some products cost the same on both sides of the border between Austria and Germany, most prices differ significantly. The authors show that even retailers operating in both countries charge different prices for identical products on each side of the border.

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Our work has three important implications. First, it shows that retailers practice cross-border price discrimination. This means that they maximise profits separately in each country, even within the EU. This suggests that the cost of arbitrage remains sufficiently high – potentially owing to information cost (i.e. the efforts people must make to obtain information on prices) – to discourage many consumers from exploiting these price differences.

Second, even within a fully integrated region a national border can affect prices. National borders can still matter even within the EU because the evolution of logistics networks and marketing regions is rooted in history. Current distribution networks developed at a time when cross-border trade was more complicated than nowadays. The finding that price discrimination coincides geographically with the national border is thus likely a legacy of the economic borders of the past, and their effect is fading away only slowly. ⁵

The third finding is that although the law of one price fails, it does hold true in a relative sense: inflation rates are comparable on both sides of the border. Common cost shocks move prices in both countries in the same direction, but product-specific pricing dominates the border effect. Therefore, the border effect by itself is unlikely to affect the transmission of monetary policy.

In conclusion, our study suggests that retailers have considerable market power vis-à-vis consumers, with the border effect pointing to retailers choosing to apply price differentiation – for historical reasons – based on existing distribution networks.