02 December 2014

ECB: Retail market structure and consumer prices in the euro area

Authors investigate the empirical relationship between product market competition and prices in the retail grocery sector in the euro area. 

The distributive trades sector provides an 'intermediation' service between upstream (e.g. producers) and downstream economic agents (e.g. consumers). As such it in uences the functioning of the market economy as a whole, and it is especially relevant to monetary policy because of its crucial role in price formation: increasing competition in the distributive trades sector may affect not only price levels, via a reduction of mark-ups, but also price dynamics, through greater price exibility. The structural features of the sector are thus important for price determination and may also in uence the measurement of consumer prices.

The relationship between market structure and price levels has engendered two strands of literature. Works bearing on industrial organization find that a more competitive market structure implies lower prices and enhances consumer welfare, while the macroeconomic literature analyses the relationship between the frequency of price adjustments and monopoly power, finding a positive relation between the absence of price changes and monopoly power.

In this paper authors provide a multi-product analysis of the relationship between market competition, proxied by concentration measures, and price levels for nine euro area countries at the regional level. They construct Herndahl-Hirschman indices (HHI) both at the buying group level (where wholesale prices and selling conditions are established) and at the parent company level (where final consumer prices are set). They consider 13 categories of goods, selected by Nielsen based on their availability on the shelves and aggregate them following their classification in the harmonized index of consumer price (HICP).

Their results point to an overall positive and statistically significant relationship between retail market concentration at parent company level and prices for the pooled sample of countries, using the regional concentration measures for most of the reference products.

Therefore, authors retrieve the well-established relation between competition and price levels: a more competitive market structure implies lower prices and enhances consumer welfare.

Moreover, a higher degree of concentration at the buying group level tends to be associated with lower prices. Thus, their estimates suggest a welfare-enhancing role for buying groups, which could be explained in a countervailing-power framework, as a balancing mechanism between retailers' and producers' bargaining power, particularly in markets where the ex-ante contractual strength is widely asymmetric to the benefit of the latter.

The static nature of the dataset prevents exploiting the temporal dimension to account for endogeneity, as so precludes a causal interpretation of our results. An endogeneity bias could arise from several sources. One may be omitted-variable bias: when wholesale prices are raised smaller stores could exit the market or could join a buying group. In this case, consumer prices rise because of higher input costs, while buying group concentration decreases because of a decline in the demand share served by fringe firms.

Additionally, a reverse causality problem could drive the results: concentration could be greater where prices are higher (it is more profitable to open new stores). Authors address these issues by an instrumental variable regression approach. The proposed instrument is the change in land cover/use from agriculture to urban, on the assumption that where many building permits are issued, local concentration should be lower. The results of the instrumental variable approach are broadly in line with those from the baseline model.

An interesting policy implication of their findings is that there are significant non-monetary determinants of the levels and short-run dynamics of prices, not under the direct control of monetary policy, but depending on the way specific markets work (and on how distant they are from the ideal benchmark of perfect competition). In a broader context, the study suggests that at least in the short run appropriate competition-enhancing policies may facilitate the monetary authorities' task of preserving price stability.

Full working paper

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