Ardo Hansson: The slow pace of world market price drops reaching Estonia
Over the past year, global market prices for several key food commodities have fallen significantly, yet that decline is not reflected nearly as clearly on price tags in our grocery stores. As a consumer, that is hard to understand; as an economist, it is even harder to justify, writes Ardo Hansson.
In Estonia, we have long grown accustomed to the idea that when the price of a raw material rises, the change reaches store shelves with astonishing speed. When prices fall, however, the transmission tends to happen in slow motion. This asymmetry inevitably raises questions about the true intensity of competition.
The table below summarizes price declines over the past year on global food commodity markets, measured in euros (as of February 11):
These are not minor fluctuations. They are very large drops in the prices of inputs that make up a significant share of the production cost of many everyday food items — coffee, chocolate, rice products, soft drinks, sweets, dairy products and juices. If the price of cocoa beans falls by 71 percent and orange juice concentrate by 61 percent, that is a shock that should be visible in the final price of food products.
Yet when we look at store prices for these products, we see far more modest declines — if not continued price increases.
According to Eurostat's Harmonized Index of Consumer Prices, the price of sugar in Estonia had fallen by 5.7 percent year-on-year as of December. In all the other categories mentioned, however, prices continued to rise. A pack of coffee was not one-third cheaper but 25 percent more expensive. Chocolate did not fall by 70 percent; instead, it rose by 17 percent. Rice, butter and juices also increased by single-digit percentages.
There are several possible explanations for such discrepancies between the dynamics of raw material prices and final retail prices.
First, long-term supply contracts. Processors and retail chains do not purchase raw materials at daily global market prices but often through fixed contracts lasting months, if not years. When prices fall, the new lower price reaches the supply chain with a delay.
Second, inventory cycles. If producers or retailers have stocked goods at higher prices, they cannot sell them more cheaply without incurring losses. As a result, they try to keep prices as high as possible until inventories purchased at higher prices are sold.
Third, processing and logistics costs. The price of raw materials is only one component of the final price. Energy, labor, transport, packaging and marketing costs may be rising at the same time, dampening the impact of falling raw material prices.
Fourth, market structure. If competitive pressure is weak at any stage of the supply chain — whether in processing, wholesale or retail — the pass-through of price declines may be slow.
All of these explanations are understandable to a degree, but the issue is one of proportion and timing. If input prices fall by 30, 50 or 70 percent, a reaction in final prices that is slow or nonexistent for months on end cannot be considered entirely natural. If prices rise quickly but fall slowly, that may indicate the presence of market power.
It is also worth pausing to consider those commentators who rush to declare tax policy the culprit behind every price increase, arguing that changing it would immediately bring relief. A two-percentage-point increase in value-added tax last July cannot mathematically explain a situation in which input prices have fallen by tens of percentage points while retail prices stubbornly remain in place or continue to rise. Presenting this factor as the primary cause of price increases reflects either economic ignorance or simple demagoguery.
It is equally important to consider the broader macroeconomic picture. Overall price growth has clearly slowed in recent months and forecasts suggest inflation will fall to around 3 percent this year. This means that price pressures in the economy as a whole are easing. Together with falling input prices, this creates the conditions for food prices to gradually stabilize.
At the same time, the economy has returned to growth and consumer confidence has clearly improved from last year's low. Slowing inflation, recovering real incomes and a strengthening economy go hand in hand. As price pressures ease, people's purchasing power improves and their willingness to spend increases, in turn supporting growth.
Ultimately, global price declines will reach consumers sooner or later. The question is how quickly. The pace seen recently understandably creates frustration and a justified expectation that markets should function as transparently as possible, that competition should be robust and that supply chain participants should explain to the public why the pass-through of price declines takes so long.
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Editor: Marcus Turovski
