RDP 9707: Internationalisation and Pricing Behaviour: Some Evidence for Australia 1. Introduction

In recent years, increasing attention has been paid to the various impacts that internationalisation has had on the operation of the economy.^[1] The implications of internationalisation for price setting behaviour and inflation have received much attention, particularly in policy-making circles. Alan Greenspan recently put one of the central arguments.

[Internationalisation implies that] a growing share of all output competes in an increasingly global marketplace, allowing fixed costs to be spread over ever broader markets, promoting greater specialisation and efficiency, and enhancing price competition… These trends leave the level of both wages and prices lower than historical relationships would predict. Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, Committee on Banking, Housing, and Urban Affairs, US Senate, July 18 1996

In addition to lowering prices, and even perhaps inflation, it has also been argued that international integration has altered the cyclical behaviour of inflation. By increasing the size of the traded goods sector, more prices become sensitive to movements in the exchange rate, and the presence of international competition reduces the ability of domestic producers to increase prices in periods of strong demand.

In this paper, we examine some of the Australian evidence for these arguments using disaggregated industry-level producer price data for domestic and foreign firms, and wholesale import price data. We take two broad approaches. First, we examine how prices set by domestic producers have changed relative to world prices over the past 25 years. Second, over the period since the float of the Australian dollar, we examine the dynamic response of domestic price setters to movements in foreign prices. In both cases, we examine the extent to which changes in international competition can explain the differential results across industries and across time.

Four main conclusions can be drawn from our analysis. First, the prices of goods produced by most Australian manufacturers have declined relative to world prices over the past 25 years. That import shares in manufacturing have also increased over this period, is suggestive of the fact that this improvement in the domestic competitive position of Australian manufacturing may reflect rationalisation in the manufacturing sector as a consequence of internationalisation. Second, while internationalisation is expected to lead to a once-off improvement in domestic resource allocation, this study suggests that adjustment can be protracted. The disinflationary effects of structural adjustments appear to persist for a considerable length of time.

With respect to the dynamic behaviour of domestic prices, our third conclusion is that prices in the tradeables sector respond more rapidly than prices in the non-tradeables sector to a shock to foreign prices. And, finally, within the tradeables sector we find that the speed of response of domestic prices to changes in foreign prices depends on the degree of openness of the industry. These two conclusions imply that as industries within the traded sector become more open, foreign price shocks will be more rapidly reflected in domestic prices.

The rest of the paper is organised as follows. In Section 2 we provide the context for this investigation, and briefly discuss some of the theoretical and empirical evidence on the links between openness and price setting. In Section 3 we examine long-term trends in real exchange rates for a number of Australian manufacturing industries. We use data disaggregated into 27 industry groups, and examine developments between 1969 and 1994. We first examine these trends graphically and examine the relationship between these trends and changes in openness of the industries. We then test for evidence that domestic and foreign prices have been more closely linked in the later years of our sample.

In Section 4, we look more closely at whether the dynamics of inflation have changed with increased openness. Matching data on the prices of domestically produced manufactures with the domestic prices of their imported competitors, we examine whether the pass-through of import price shocks to domestic prices is a function of the degree of openness of the industry, and whether these relationships have changed over time. Conclusions are offered in Section 5.

Footnote

See for example, Lowe and Dwyer (1994). [1]