When Economics Strikes

Speculation is rampant in Canada right now on whether and why retail prices are higher there than they are in the United States. See here and here, for instance.

As a Canadian that now lives in the US I can say that, anecdotally, things are cheaper here. Every trip back to the motherland is doubly painful: first the prices are higher, then the sales taxes twist the knife.

Well this is the report that’s sparked the furore, which has some real insights. Going in, I was expected tariffs to be the silent consumer killer. They definite contribute but for the most part the poor Canucks (who stay home) are up against plain old fashioned economies of scale.I highly recommend reading the relatively short report, particularly to see what they choose for their duty examples: talk about hitting where it hurts!

If the US didn’t exist, everything would be made in Canada. Introduce the United States and you massively expand the market and so the economies of scale available to producers. Prices go down.

But production isn’t the whole supply chain. There’s also distribution, of which some must necessarily be located near the consumer. Because of Canada’s smaller size, these operations are going to be less efficient. So this comment…

According to Statistics Canada, in 2009, operating profit margins in the retail sector were just above 3.4%. When compared to profit margins in the Unites States (Fortune 500 report on top industry performers – 2009) which were reported to be on average at 3.5%, one can see that retailer profit margins in Canada are the same or similar to those in the United States.

masks a very important truth: the profit margins may be the same, but this is very different from saying prices are the same.

Prices are higher because expenses are higher. Expenses are higher because Canadian companies are less efficient because they aren’t as big. Here’s a great summary from the paper:

“In summary, there were four main interrelated reasons that retail shelf prices were different in Canada compared to the U.S.

The first is scale; Canadian wholesalers and retailers had a smaller scale compared to their U.S. counterparts.

Second, the structure of the Canadian distribution channel included an extra participant, an importer or subsidiary operation, compared to many U.S. distribution channel structures.

Third was the input price to the channel. Prices charged by manufacturers for goods destined to be sold in Canada were frequently higher than in the United States.

The fourth and final reason was the cost of doing business. Factors such as occupancy costs – principally rents – and corporate taxes were higher in Canada at the time.”

US companies can justify higher prices to Canada because Canadian companies can’t do anything about it. These higher US prices are probably still below what a Canadian company could muster using domestic scale only. And there are administrative and other costs that the US company won’t want to bother dealing with without extra profit.

Witness also a window into the future. Some day it will be Chinese and Indian companies with their colossal domestic scale throwing their weight around the local and, to a lesser extent, world markets. The Canadian story will be played out in the Koreas, Japan, Vietnam, Pakistan, Indonesia, etc etc etc in the years to come.

To be middle class in Nepal will one day be to live in a consumer paradise. Well, if it weren’t for the mountains.

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