Yesterday, the EU updated its analysis of differences in consumer prices across European countries. With over 2,500 goods surveyed over a three-year period in 37 countries, this survey is the benchmark for “purchasing power” studies on the continent. The EU won’t win any awards for stating that Norway and Switzerland are the most expensive countries in Europe – or for finding that prices in Macedonia or Albania are the lowest – but the obvious headlines hide valuable details.
Ireland cheaper than the average?
Irish readers will no doubt be interested to discover that across the twelve areas of spending analysed, prices in Ireland are below the EU-27 average (which includes many central and eastern European countries) in five segments: clothing, footwear, furniture, household appliances and consumer electronics. Meanwhile, utilities like communications (4%) and energy (11%) are somewhat above the average, as are transport services (21%). While eyebrows will be raised at the fact that Ireland has the most expensive alcoholic beverages and tobacco (70% above the EU-27 average), two areas are of greater concern for policymakers.
The first area of concern is food prices, which are 20% above the EU average. What is quite amazing, digging deeper into the statistics, is that food prices in Ireland rose just 2% in the six years to January 2011, compared to a 20% rise on average in the EU (15% elsewhere in the Eurozone). This means that the food price gap between Ireland and the rest of the EU was about twice as large in 2005 and has been closing rapidly since then.
Closing the gap
A year ago, I presented a graph that showed the evolution of price levels across the Eurozone, based on the 2005 batch of surveys and annual rates of inflation before and after. I’ve updated that graph now using the latest HICP information (EU-wide statistics on inflation) – it doesn’t match with the EU survey above perfectly, but the general picture is very similar.
Zero marks the Eurozone average each year. Three of the “periphery” economies – Greece, Spain and Portugal – are the only economies that are below the average; over 15% below in Portugal’s case. The D(e)utsch grouping of Germany, Austria and the Netherlands effectively represent the average, while – until recently – Ireland and Finland were about 20% more expensive. Since 2008, though, Ireland has closed about one third of the gap between its price levels and those of the Eurozone average.
Unfortunately, barring something dramatic, it will take another three years of falling prices – or more realistically five to six years of inflation in Ireland that is substantially below inflation elsewhere – for Ireland to be no more than 10% more expensive than the average.
The power of devaluation
Ireland was happy to join the euro in the 1990s. It meant an end to high and volatile interest rates – and thus volatile investment – and an end to being at the whims of markets and currency speculators. Indeed, this mode of thought lasted throughout Europe well into 2009: the initial reaction in late 2008 to the global financial and trade crisis was for countries like Sweden, Denmark and Iceland to look to join the euro, as “shelter from the storm”.
However, once the decision to join a currency union is made, competitiveness comes down to nothing other than price levels (including wages), and – as economists know but find incredibly difficult to explain – prices are sticky… very sticky. The second chart below shows price levels in a range of countries in the two most recent EU surveys (2005 and 2010), relative to the EU average. Yellow marks Scandinavia, red marks new EU member states (only a handful of the costlier ones are given) while green marks the PIIGS countries.
There are only three countries “south of the line”, i.e. that improved their competitiveness position: one is Ireland (green), which has seen the smallest improvement. The other two are the UK (blue) and Iceland (the dramatic yellow outlier), both of which have suffered significant falls in their currency. These falls have been largely unwelcome by-products of poor macroeconomic fundamentals, but the alternative is not “no falls”. The alternative is an adjustment through prices, which – as Ireland is discovering – is a slow and painful process.