Proceedings of the Standing Senate Committee on
National Finance
Issue 7 - Evidence - November 1, 2011
OTTAWA, Tuesday, November 1, 2011
The Standing Senate Committee on National Finance met this day at 9:30 a.m. to study the potential reasons for price discrepancies in respect of certain goods between Canada and the United States, given the value of the Canadian dollar and the effect of cross-border shopping on the Canadian economy.
Senator Joseph A. Day (Chair) in the chair.
[English]
The Chair: Honourable senators, I call this meeting of the Standing Senate Committee on National Finance to order.
[Translation]
This morning we will continue our special study on the potential reasons for price discrepancies in respect of certain goods between Canada and the United States.
[English]
In our first session this morning, we are very pleased to welcome Mr. John Baldwin, who has been before Senate committees in the past, and we are pleased to welcome him back. He is the Director of the Economic Analysis Division at Statistics Canada, and he has a background in teaching prior to coming to the federal government. He has a history with Queen's University, if that is of interest to some of our colleagues.
Mr. Baldwin, the floor is yours. You have some introductory remarks, and then we will go into questions and answers.
John Baldwin, Director, Economic Analysis Division, Statistics Canada: Good morning. I have handed out a brief slide deck, speaking notes that I will go through.
I am the director of economic analysis at Statistics Canada, and I am here to report on an update of a study that we conducted previously that examines historical differences in Canada and U.S. prices using data taken from the purchasing power parity program of the national accounts.
For Canada-U.S. comparisons, a bit of background is required. Statistics Canada collects information on the prices of goods and services that Canadians purchase in order to track changes in inflation. This information on consumer prices, which you have probably all seen referred to repeatedly in the press, is summarized in the consumer price index published regularly by the agency. The agency also collects information on prices charged for produced prices of goods and services and develops a producer price index to enable analysts to monitor price trends at the industry level. These producer prices are also used to transform estimates of industry revenue into volume-based or real measures of output, as some people have referred to them.
Both of these programs, the consumer and the producer price indexes, collect information on large numbers of goods and services in order to obtain representative samples of prices in the economy. The expenditure weights used to create averages are determined by special surveys on consumer expenditure patterns for the consumer surveys and from the input-output tables that track output in the economy at the industry level for the Producer Price Indexes. They are the mainstay of the price programs.
Statistics Canada also operates a program that provides the data I have used for a slide later in the slide deck that compares Canada-U.S. prices. This set of data compares prices for goods and services that are purchased by Canadians and Americans. However, these are collected in a different way than the other sets. They are collected in conjunction with the U.S. statistical authorities initially at the behest of the international agency, the Organisation for Economic Co-operation and Development, or OECD.
Price data for consumer and investment goods are extracted from the consumer and producer programs I previously referred to and matched to U.S. data in order to create an overall price index that is referred to as the purchasing power parity index. This is designed to facilitate comparisons of relative expenditures across countries. For example, they allow us to start with the relative values of sales of automobiles in Canada versus the U.S. to derive the relative number purchased.
The purchasing power parity program's key use is to compare levels of expenditures across countries in volume terms. The index is used to create a measure of the relative quantity of expenditures in Canada and the United States and to answer questions about whether the total amount purchased in the way of consumption investment and government output per capita is larger or smaller in Canada than the United States. To do so, the index combines the relative prices of a large number of commodities, summarizes them and puts them into one single index that is then used to divide the relative revenues, the expenditures in the two countries, in order to come up with relative volume measures.
The purchasing power parity program is not a major statistical program compared to those that measure consumer prices and producer prices. It does not collect data on as many commodities, and it is unfortunately not meant to provide much commodity detail or to produce data with a comparable degree of accuracy that the CPI and the PPI programs I referred to earlier are. It is essentially a program that was devised in response to international demands coming from the OECD to permit cross-country comparison of real volume, how much Canadians purchase relative to Americans and to Europeans. It provides that measure to a degree of accuracy that is relevant for that purpose, but it does not provide a lot of data at a detailed level.
It does provide underlying, detailed data. We have updated a previous study covering the period of 1985 to 1999 for your consideration today. I stress that the estimates I am providing are preliminary because we only received the request 10 days ago, but they do give you a first pass and idea of what the relative average prices are.
Before I get to the data on the fourth slide, I want to stress the caveats that are important here. The purchasing power parity program is meant to give us one estimate of relative average prices across a relatively large number of commodities. It is not meant to provide a great deal of detail. The CPI program has approximately 1,000 prices and many underlying types of commodities in each of those. The producer price index has 6,000 prices. This particular set of numbers comes from a much smaller set, something less than 900, if I recall correctly. Then they are summarized in our study down to about 140 groupings, and those contain such things as pasta products, poultry, that level of detail.
On slide 4, to draw more detailed comparisons between the two countries from this database, we drew on the individual commodity data from the database that was used for the purchasing power parity program. We calculated average prices within each of 147 broad commodity groupings. We then took those 147 commodity groupings and created a median, which is sort of a midpoint estimate of the relative price of Canadian and U.S. goods.
The prices we are using here are the final prices charged. They include taxes and all retail markups. Since there are tax differences across the two countries, even if all of the prices that are charged at the producer level were the same, the consumer would not be expected to pay exactly the same prices, but we were not able to take out those taxes for this particular study.
We have also divided up the commodities that we placed before you into two groups, what I call tradeables and non- tradeables. The economics literature, when it talks about whether or not prices equate across countries, tends to do so because it believes there is more chance of the tradeables equating than there is the non-tradeables. Tradeables are such things as cars; non-tradeables are such things as haircuts.
Turning to slide 6, I present the results of this preliminary study for you. This graph compares the price levels in Canada to price levels in the United States correctly for the exchange rate. In other words, we take the Canadian price, divide it by the American price in Canadian dollars and create a ratio of those two. A value of one on this graph indicates that Canadian goods cost the same as the U.S. good when differences in the exchange rate are taken into account. This yields a measure called the ``comparative price level,'' corrected for the exchange rate. A value of greater than one for this measure indicates a higher price in Canada than in the United States, while a value less than one indicates a lower price this side of the border. For example, a comparative price level of 1.2 indicates the Canadian price is 20 per cent higher than the U.S. price. A comparative price level less than 0.8 indicates the Canadian price is 20 per cent lower than the price in the United States.
The data that I was able to pull quickly for today's session cover the period from 1985 to 2008, the last year for which we have data from our U.S. and American partners for the comparison. It actually goes on the graph to 2002, and we have extrapolated the results using other data sets from Statistics Canada.
The underlying commodity prices have been divided into two groups. The tradeables are the red line, non-tradeables are the blue, and we have put the exchange rate on in purple because the relative Canadian price, corrected for the exchange rate over time, tends to move with the exchange rate.
Now, what does this particular chart give you? I will read off a couple of points. In 1985, when we had a 73-cent exchange rate between Canada and the U.S. dollar, the average Canadian price of tradeables was 98 per cent of the U.S. price. The price of tradeable goods moved to 114 per cent of the U.S. price by 1990 after the dollar appreciated to 86 cents. You can see it is going up when appreciation occurs back in the 1990s. It fell over the 1990s to 95 per cent by 2002 when the dollar appreciated to 64 cent. The relative price of tradeable goods in Canada increased in recent years. It stood at 118 per cent of the U.S. in 2005, after the dollar had appreciated to 83 cents, and increased to 128 per cent in 2008, when the dollar appreciated to 94 cents. It has remained about that level since then.
These changes have occurred because Canadian prices tend to be more rigid than the exchange rate. We can see from this long history that when the Canadian dollar depreciates over periods of time, Canadian prices do not increase as much as they might if the U.S. price was being passed on completely. In the late 1990s, you could actually buy a car less expensively in Canada than you could in the United States. On the other hand, when the Canadian dollar appreciates, as it has in the more recent period, and quite quickly relative to its long-term trend, Canadian prices do not decrease as much relative to the American prices as you might expect if the exchange rate was passed through completely.
Turning to slide 7, which are the conclusions from this quick presentation, Canadian tradeable prices tend not to equate to U.S. prices. The price gap between Canada and the United States has changed over time. In the early 1990s, median prices for tradeable goods were higher in Canada than in the United States; by the late 1990s, median prices in Canada for these goods were slightly below U.S. levels, remembering, of course, that these prices include taxes. In more recent years, the median prices for tradeable goods have become higher north of the border.
On the last slide, the conclusions are that movements in the price gap are related to changes in the exchange rate. When Canada's dollar depreciated in the past, Canadian consumers benefited because Canadian prices did not increase in step with the higher cost of imported products. More recently, the reverse has occurred. Finally, the gap between Canadian and U.S. tradeable prices has become larger in recent years.
I should also note that the other curve that I did not make reference to, because people tend to pay less attention to it, the non-tradeables, that relative price has also gone up in recent years; that is, the overall price level in Canada has moved.
That is my presentation.
The Chair: Thank you very much, Mr. Baldwin. We appreciate that. That is an interesting statistic. If you could look at slide 5, the red graph is tradeables, and you talked earlier about this basket of goods. You did not analyze it on a product-by-product basis but rather on an average for this basket of goods. Is that correct?
Mr. Baldwin: We took all the goods that go into the purchasing power parity index and divided them up arbitrarily into what we thought professionally were tradeable as opposed to non-tradeable goods. Those distinctions are not perfect. What was once non-tradeable has begun to trade a little more than it once did, but it was done quickly to indicate that the levels between these two indeed do differ.
The Chair: In your basket of tradeables, how did you deal with products that might normally be described as ``tradeable'' but have a special situation in Canada, for example, eggs and chickens, the kinds of product where production is controlled?
Mr. Baldwin: They are included as tradeables. The earlier study we did that compared what was happening to prices up to the period in 2000 did briefly look at whether or not this bundle of tradeable goods that you might refer to as regulated, or where trade is more restricted than elsewhere, did not behave completely the same as the other goods system. Other studies we have done have also shown differences in those markets. I recall a study we did that looked at whether or not productivity gains are passed on in terms of relative price gains, a study now 10 years old. There we saw several aberrations in some industries that were clearly related to industries that traded in different ways. If I remember, beer did not pass on its productivity gains in quite the same way as others did. We have not looked at this set of data yet with that degree of detail. We could indeed do so, but as I indicated, I am not sure of the degree of precision we have in the underlying series at those levels. The series were not put together with a great deal of resources to do that. As I indicated before, the series responded to a request by the OECD because it does a lot of cross-country comparison.
The Chair: You made a comment that the area of purchasing power parity may not have the same level of credibility as some of the other material because of the work that you have done or not done in relation to purchasing power parity figures. Is that an area that you anticipate could or should grow in the future so that you will have more accurate and reliable data?
Mr. Baldwin: Certainly, more resources can be devoted to it; whether they are devoted to it will depend on the priorities that are set by the agency.
The Chair: Is there any discussion in that regard we should be aware of?
Mr. Baldwin: No, not that I know of.
Senator Finley: I read the two prior papers produced, and the conclusion in both the prior reports and in another report, which I think we will hear about in the next hour from Mr. Chandra, all commented on the fact that the Canadian market is extremely slow to react to exchange rate movements. I think that was one of your primary findings in 2002 repeated in 2004. I could see that a long time ago, pre-computerization, but, surely, we have gotten to the stage where whole inventory pipelines and other elements can be changed or altered relatively quickly on goods. Most goods are supplied by a bar code at point of retail.
Why does it take so much time for changes in exchange rate movements to be reflected, in your view? Is there anything that we could do, perhaps legislate or convince in order to make this more responsive?
Mr. Baldwin: That is a good question. It requires an awful lot of research that unfortunately we have not conducted. You are correct in summarizing the earlier studies as noting there is a lag in adjustment, and the reason for that is prices tend to be sticking. There is certainly long economics literature that has focused on how sticky prices are, whether it is here or in the United States, questions about whether it should be sticky and whether the economic system should effectively react instantaneously to cost changes. I am not an expert in that, nor have I drawn a professional conclusion as an economist as to what we think should occur in a perfect market. I am sorry; I do not have the competence to answer that question.
Senator Finley: I guess perhaps there is someone else we should be asking.
You were certainly right, by the way, about excluding beer as something that reacts to various stimuli. I called a friend of mine in Chicago last night and asked what the price was for a 12-pack of Labatt's Blue. I was told it was $8.99. In Ottawa, a 12-pack of Labatt's Blue cans costs $21.95. Sounds like our national symbol should not be the polar bear or the beaver but a 12-pack of Labatt's Blue; it seems more valuable in a way.
I can understand the concept of tradeables. For non-tradeables, to which you have referred, you talked about haircuts as one example. Could you provide some others? Could these broadly be translated into services as opposed to products?
Mr. Baldwin: They are broadly considered services as opposed to products. I tended not to put them in here as that because the classification we used includes some goods that, when we originally did the first study and looked at the literature to help us in the classification system, were not trading very much but trade more. Even the services in some sense trade now and, therefore, the terminology may have become inappropriate with changes in the economy over time.
Utilities are in here, but we now know that electricity is being traded across borders more than it was at the beginning of the period we looked at. Construction is effectively created in a country and not generally moved. That is not true any longer either. We know Imperial Oil with its Kearl project is moving construction equipment all the way from Korea. Even in those industries, there is more trade occurring and, therefore, you might expect those prices to reflect international pressures more than they once did. Therefore, the distinction is probably less useful than it once was, but it still exists in terms of price levels.
What was the other example I had of a tradeable that is increasingly responding to international demand? Oh, I met a young lady who works for an HR department in Toronto. She would be in the services sector classified under a services industry in Canada, probably under professional services. She spends her entire time serving the HR needs of firms in California. She is in the services sector in Canada, but her price is effectively being impacted by foreign demand, and her services are being traded, despite the fact it is not apparent that is occurring.
Senator Finley: Could medical services be included?
Mr. Baldwin: We have actually excluded medical services in this particular study. We have taken out health and medical services because of difficulties of coming up with prices in that particular area. I did not note it here, but it was noted in the earlier paper; we have excluded the health and education sector and tried to focus on what is generally called the business sector.
Senator Finley: I will go on a second round, if there is one.
Senator Ringuette: Mr. Baldwin, of the 140 groups you mentioned, how many of them are tradeables and how many of them are non-tradeables?
Mr. Baldwin: That is a question I forgot to address before I came to the committee. I would guess the tradeables make up a third to a half of the 140, but I can give you a more precise answer afterwards.
Senator Ringuette: Yes. I am looking at the graph that you supplied to us, which is on page 6. Up to 2002, according to the graph you provided, there were reasonable upswings and downswings that seem to have some kind of relation with regards to the exchange rate and your two groups of tradeables and non-tradeables.
However, then when I look at 2002 to 2010, that relationship is not the same at all as compared to the exchange rate. If I look at 2002 to 2005, the gaps are not at all related to previous years. Then again you have another widespread gap in 2008.
What happened in 2008 that would bring such a difference between the tradeables and the non-tradeables in relation to the exchange rate? We need to identify the cause. What specifically happened there to have such a gap between the exchange rate and the tradeables and non-tradeables in your groupings?
Mr. Baldwin: That is a difficult question to answer. One event we know was going on later in that decade was, of course, the beginning of the downturn. Non-tradeables is a sector whose costs are much more related to internal factors in the economy, relative wage rates. It may very well have been that the non-tradeable sector was effectively influenced more dramatically than the tradeable sector. I do not know. It is a question we can look at more carefully.
It may be that on the tradeables side — we would have to look at this — some of those goods that we talked about earlier that were subject to more protection from trade managed to keep moving their prices differentially over this period of time than others. It may have been the regulated markets that effectively influenced it. Not all of the tradeables are moving in exactly the same way.
I prepared this document for you quickly with averages, where I am happy with the averages being representative of what is happening. Underneath these lines, there are changes going on that we can examine more fully.
The tradeables side is made up of both consumer goods and investment goods. We quickly looked yesterday at the difference in what was happening. Investment goods were responding more to U.S. prices. They were looking more like the non-tradeable sector here; they were not moving up as quickly. It was clearly on the consumer side. We have not looked to see which of those consumer goods were moving more dramatically upwards later in the decade. That is something we can examine more and report to you on it.
Senator Ringuette: I would very much appreciate that.
Mr. Baldwin: Our own interest has been intrigued by the quick examination yesterday. We will indeed report, but we have not yet ascertained that the data will withstand that or is of sufficient quality to answer those questions.
Senator Ringuette: Looking at the graph on page 6, 2010 on non-tradeables, it has peaked considerably more than the tradeables. You indicated that it was because of internal factors. Would that be because of the inflation rate in Canada? Would that cause such a thing?
I am intrigued. I can see the data.
Mr. Baldwin: You would like me to delve into it more deeply.
Senator Ringuette: I would like to know why it is different. What happened? I find that between 2002 and 2010 there seems to be more fluctuation at higher degrees than the previous 15 years. What happened and why?
I have commented in this committee a few times on the difference in the price of gasoline and the fact that Canada has such a huge geography to cover. Gasoline would be, I suspect, in your tradeables.
Mr. Baldwin: I suspect it is, but I am not positive; I will have to check. I cannot spot it quickly in the list of 146.
Senator Ringuette: That is quite a cost factor, whether in Canada or in the U.S.
Mr. Baldwin: Yes, it is.
Senator Ringuette: Could you also provide to us the consumer price index for the years 1985 to 2010, both in Canada and in the U.S.?
Mr. Baldwin: Yes, we can.
Senator Ringuette: Maybe we can see another kind of relationship that could have developed there.
Mr. Baldwin: I could respond to the last one. One of the things that we did to double-check these numbers before we came here was to ask whether or not the time trend in the numbers reflect the aggregates that I referred to earlier. We would hope that these levels and the changes that they ran over time would reflect the changes in the relative movements of the CPI. In our particular case, I actually prefer the relative movements in the implicit price deflator that comes out of the national accounts on consumer expenditures, and they are not the same. We compared it to the implicit price deflator that comes outside of the national accounts. They track one another quite closely, at least over short periods of time. We were relatively confident coming before you and giving you this time path as a result.
We will give you several of those indexes and their long-term trends in terms of relative movements.
The Chair: Do you have a follow-up on that?
Mr. Baldwin: I will let you follow up, but I wanted to answer your earlier question about movements, trying to get at something that is aberrant or unusual.
In looking at this data, we ask ourselves whether the aberration is coming from poor quality observations or the noise that you find over short periods of time in these series.
When you have CPI or the implicit price index I referred to earlier, you have thousands of prices that you can use here. We do not here. I come back to how this was put together. This was put together in response to the OECD. We have to get the cooperation of the Americans. They have to give us a list of products. We have to look and compare and ask whether they are comparable. They are not always. It is easier when you do the data for your own country. You can compare over time, and it is the same product or close to it. It is difficult to compare a Boeing 777 to a Bombardier Dash 8 or to the new CSeries. The relative price there, as you can guess, is not comparable. The same thing occurs in other places. A brick is not the same size in the United States as in Canada. It becomes difficult to choose exactly the same product. That is why we say the quality of this is not the same as the other series. It is not that it is poor quality; it is just that it is not intended to do the detailed studies. Its quality is adequate for the purpose that it was used for, namely, aggregate price index, but as you delve down, probably less so for particular products. It may be less so for short-term movements over time.
We will get back to you with answers to the questions that you put, and we will caveat to the extent that we think it is advisable.
The Chair: Thank you. Any of the information that you send to us, please send it to the clerk, and then it will be distributed to all members of the committee.
Mr. Baldwin: Yes.
The Chair: I appreciate that.
Senator Ringuette: As a quick follow up, you said that all your data included the taxes.
Mr. Baldwin: Yes.
Senator Ringuette: Why is that?
Mr. Baldwin: We are trying to come up with a final product price, which we are using to deflate the revenues that are being spent on products, goods, services and investments in the two countries to come up with a relative volume index. Those revenues include those taxes. For the purpose at hand, that is why the prices were collected with taxes included. Unfortunately, they may not be removable. In other words, the original system may not have sat down and said, ``Give us the price of the good without the taxes and with it.'' If they are not, then we cannot take it out.
Senator Finley: Where in Canada would you establish the price with taxes in? Alberta has no sales tax, whereas Ontario does, as does Quebec. Which of those pricings would you use for the tax implication, or is it an average?
Mr. Baldwin: It is supposed to be an average.
For example, all the data for the purchasing power parity index come from the other programs. I said that CPI has a little more than a thousand representative goods. They actually collect 685,000 price quotes a year from across the country to come up with all the averages that are required to take this sort of complexity into account. They then provide us with an average, which is representative.
Senator Marshall: This information is interesting. I know that we will be using it as part of the committee's work, but who uses this data ordinarily, because there is quite a volume? You are generating data and studies. Could you give us some idea as to who is using it besides the Standing Senate Committee on National Finance?
Mr. Baldwin: The history of this goes back to post World War II, with the Marshall plan and the predecessor to the OECD, when they had to collect data to effectively evaluate the progress being made in Western Europe and across the Western countries. The OECD emerges from the original organization, whose name I have now forgotten, and continues to try to collect this data so as to provide cross-country comparisons. They are the ones that led the various statistical agencies around the world to begin to sort through this data and provide it to them.
In fact, for this original program, Statistics Canada did not actually publish the numbers themselves; they produced raw numbers to the OECD. Eventually, however, it got to the stage where it became clear that it was advantageous for both parties if Statistics Canada put more effort into pulling the data together for comparable purposes.
The United States supplied it to the OECD and we supplied it as well. The Canada-U.S. comparison that came out of that indirect process was so bad and so embarrassing that Statistics Canada and the United States began to put more work into coordinating so that Canada-U.S. comparisons would make more sense.
It is the amount of resources that have been devoted to it that meets the purpose, which is for broad comparisons of usually GDP per capita with Canada versus the United States. As we go to the OECD and discuss this, we are careful to point out that when it says that Canada is 85 per cent of the U.S., the numbers have a degree of accuracy that should be recognized. The 85 per cent comes from inaccuracy, and the inaccuracy comes from the fact that there is a confidence interval that must be attached to the relative price estimate. It is such that the real estimate — I am using the 85 per cent figure as an example — is somewhere between 80 and 90 per cent. Therefore, everyone in the Western World who is between 80 and 90 per cent is effectively the same as Canada. You cannot draw distinctions. That is the sort of quality that goes into that program.
There are a lot of price gaps when I look at comparisons, if not gaps, that are problematic, such as the price of airplanes that I provided as an example earlier.
Senator Marshall: It is historical data. Is it used to make any changes? I am asking that because we have had other witnesses appear before this committee, and some of them recommended changes be made to tariffs, duties and personal exemptions. Do you focus just on the past? What happens to that data? Are there changes made? Can you take proposed changes and imprint them on your data to find out what will happen in the future?
Mr. Baldwin: We have not done so, and I am not sure that we could.
Senator Marshall: Going back to my previous question, with respect to the data that is produced and reported on, what happens to it? Does it cause changes to be made, or is it just valuable for its historical purpose?
Mr. Baldwin: As I said before, the data is primarily used for the inter-country comparisons that analysts both here and elsewhere make in terms of trying to evaluate Canada's economic performance. Whether or not that influences policy in terms of improving economic performance is as much your opinion as mine.
Senator Marshall: If the committee were to consider recommending changes like increasing the personal exemption or reducing tariffs, it would not be Statistics Canada that could utilize those changes to find out what impact it would have within the country. Is that right?
Mr. Baldwin: We do not have a modeling group that I think could respond in a short period of time to do that, but it is clearly up to Statistics Canada, not I, to answer that question should you put it to them.
Senator Marshall: Thank you.
Senator Wallace: Thank you, Mr. Baldwin. Tradeable goods that are purchased and consumed in Canada and the United States could be produced either domestically in those countries or imported from other countries.
Do you have statistics on any changes that might have occurred in the percentage of tradeable goods or the nature of tradeable goods that would be imported into Canada? Do statistics exist for the United States as well to determine if there have been any changes in those importation patterns into Canada and the United States so they could be compared? I am thinking that if there has been a change where one of the countries has imported more goods from low-cost producing countries, that would result in lower tradeable product cost in that country. If we compare Canada and the United States, we might find differentials in pricing arising from that simply because of the fact that one country is importing more tradeable goods than the other.
Are there statistics that could be analyzed to consider that? If there is, if you have looked at it, has there been any change in the pattern of the importation of those tradeable goods between Canada and the United States?
Mr. Baldwin: In answer to the first part of your question, there is data that could be used to look at the extent to which imports of particular commodities — tradeable goods, for example — whether the penetration ratio of those relative to total demand in the country have changed over time. I have not conducted that study, but it could be conducted.
I do not know of a U.S. study in this area. That does not mean there is not one. If both sets of data existed, you could indeed look at the extent to which those import penetration rates changed over time, and you could indeed ask, I think, how it might impact upon the prices of the final product. It is a complex exercise, but I can see that it could be done.
Senator Wallace: In comparing Canada to the United States, we think of the cost of domestic production, the influences on that domestic production and how it translates into retail pricing. However, as we know, the impact of imports into each of our countries, which could be offset by countervailing import duties that can change the cost to consumers, could be a significant issue if any country decided to rely less on domestic production and more on imported production and reduce the cost to consumers. In any event, as you say, the data may be there.
Mr. Baldwin: One of the concerns that have been addressed by economists looking at this issue is to what extent the exchange rate has lowered the cost of imported goods and to what extent the Canadian manufacturing sector has taken advantage of that to improve its cost competitiveness. I have not seen the results of any such study at the present time.
Senator Wallace: Thank you, Mr. Baldwin.
The Chair: As a follow-up to that, with respect to importing goods, the assumption was made that it would reduce costs to the consumer, but it also might be used to increase the profit margin for the importer or retailer. In your analysis, do you consider the margins in the United States versus Canada for the same product?
Mr. Baldwin: No.
The Chair: Thank you.
Senator Peterson: Thank you for your presentation. With respect to the law of one price, does it have any validity? Does it work? Is there any benefit?
Mr. Baldwin: My reading of the literature is that a large number of economists who have studied this have come to a general conclusion that the law of one price does not hold consistently across all products or even across rather large bundles of products. That is, very specific studies generally find there is a deviation from it for short periods of time for some countries.
The study that we produced earlier that Senator Finley went to sleep reading last night —
Senator Finley: I stayed awake.
Mr. Baldwin: — does say that for the short period of time we looked at earlier, Canada and U.S. prices averaged out over the 1985 to 1999 period, though there were periods when they were above and below. On average, it came close, though as we have seen, it does not look like it is coming that close post-2000.
The second part of the question is whether there is benefit from it, and that is a harder question to answer. I think it goes back to whether there is a benefit generally from trade that equates prices across countries, so that consumers can take advantage of the lowest price available to them. That becomes a more philosophical issue.
Senator Peterson: Senator Finley's beer example is a good one. That is quite a dramatic shift, and asking what happened there would lead us somewhere. I am sure there may be others as well, but I would have thought it might give us some direction there, but maybe not.
The Chair: Do you have a follow-up question, Senator Peterson?
Senator Peterson: No, thank you.
The Chair: We may want to delve into the price of beer more deeply at a later time. We will put that on our list.
Senator Finley: I do not know whether I should be addressing this question to your particular directorate. Do you measure, or is there a form of measurement of the second-hand market in tradeables, for example, cars, agricultural equipment, aircraft or any number of items between Canada and the United States? Is there a measurement, or is that one of the measures that you have already taken into account?
Mr. Baldwin: I cannot answer that question as to whether or not second-hand markets are included in the price indexes. I have not seen them in the Canada-U.S. comparisons; I have not seen a second category. However, there is another, and I will find out if they are there. It would be a difficult market to sample and keep accurate prices on.
Senator Finley: I talked again to another friend from the United States who recently moved from Canada to the United States. Before he knew he was moving to the United States, he and his wife decided to buy a second-hand car. They bought it in the United States. He figures he saved between a minimum of $11,000 and probably as such as $20,000 on the transaction. We did a study on it and found that a used 2011 Ford F-350, which I believe is a pickup truck, in the United States second-hand market is $25,000; in Canada, it is $44,000. Those are huge numbers of extremes. There are many other examples of this.
I am asking you if you can do such a thing, and if you cannot, then I will keep asking people until I find the person who can, I suppose. I do wish and hope that you will look at that, and if you do not currently, perhaps put it in your product basket and maybe there is a way that you could.
Mr. Baldwin: Thank you.
Senator Ringuette: I agree with Senator Finley that the prices of cars seem to be everywhere, whether they are made in Canada or not, especially the North American-made ones, the brands that we have grown up with. That does not seem to be the case with Honda and Toyota cars made in Canada.
I go back to the question that I wanted to ask: How many international marketing firms would be paying Statistics Canada for its data?
Mr. Baldwin: I will have to give you an answer on that.
Senator Ringuette: I am going back to your chart on page 6. The globalization phenomenon brought many other techniques with regard to marketing and pricing. Going back to the answer that you provided to Senator Marshall, you build up historic data on Canadian consumer prices and how much Canadians are willing to pay for groups of products. That would tend to continue the trend that we have seen and probably also be a factor in the increase in discrepancy from what we have seen from 1985 to 2002 that I asked about earlier. There is a lot more sophistication and information.
If a manufacturer in Germany or in France knows that Canadians will buy a product even though the pricing will be 10 or 12 per cent higher in Canada than in the U.S. — they are only 10 per cent of the North American market — then that would probably be an indicator of this major flux in 2008 in your data. I am referring to this level of sophistication and this knowledge from international marketers that they can price their products higher in Canada. Canadians historically show that they will pay a higher price.
I go back to my question: How many international marketing firms would pay for your data? I am assuming that you sell it.
Mr. Baldwin: I answered your question a little quickly before. I know of no international marketing firms that have asked for this or paid for it. That does not mean that it has not occurred. We have a marketing department, but I suspect they have not. One of the purposes of the economic analysis division is to inform debate effectively where they can, to find data that are in the databases of Statistics Canada to help the debate. That is what we have done in this case, and that is what the original paper was written for. At that time, there was an interest in whether or not prices were equating.
As you know from discussions around Statistics Canada, we do have the Statistics Act that requires that we not produce data that is confidential. I did personally have one request for very detailed data that came out of this database at a level where we would be producing data for specific markets on specific prices. We ascertained that we were down to a level at which we would be producing data on specific companies and that would become illegal.
We also required cooperation from our American colleagues and asked them whether they would be willing to have their data released at what I call the ``aggregate 147 industry level,'' and their answer was no. We are forced, as we go down in this database, to look at not only quality in terms of what we can do to inform public debate. My function is to help with those who are asking those questions, but we cannot go beyond a certain point because we are governed by the Statistics Act, and we have to be very cognizant of the concerns of those who supply data to us.
That would be an issue as we go down and it would certainly be an issue if international marketing firms came to us and asked us for very detailed data. I was thinking if your question was ``Do they want the PPP?'' well, they can get that off CANSIM without paying more than what CANSIM charges for it. However, this specific data, on very specific markets, begins to become confidential in some instances and we would then have to go back and look at the original data and ascertain whether it came from a very small number of companies and therefore determine whether it meets the criteria that it can or cannot be released under the Statistics Act.
Senator Ringuette: Would you do that on a per request basis?
Mr. Baldwin: Yes.
Senator Ringuette: I suppose you have guidelines to identify to what extent specific data can be released to the requester.
Mr. Baldwin: Very much so.
The Chair: Mr. Baldwin, from Statistics Canada, thank you very much for bringing this very interesting information to us. We will look forward to receiving the follow-up material as well.
[Translation]
Honourable senators, we are continuing our special study on the potential reasons for price discrepancies in respect of certain goods between Canada and the United States.
[English]
In this second session this morning we are very pleased to welcome Professor Chandra, who is an assistant professor of business economics at the University of Toronto's Rotman School of Management. He recently moved to that position from British Columbia.
Professor Chandra, you have the floor, sir, and we are very pleased to have you here today.
Ambarish Chandra, University of Toronto, Rotman School of Management, as an individual: Thank you, Mr. Chair. I am very happy to be here. My name is Ambarish Chandra and I am assistant professor of business economics at the University of Toronto. I received by Ph.D. in economics from Northwestern University and, until June of this year, I was a professor at the University of British Columbia in Vancouver.
My research examines firm competition and consumer behaviour in industries such as media, gasoline and automobiles. The topic of my current research is also the topic at hand today, which is price differences between Canada and the U.S. I have three studies that are directly relevant to the issue at hand.
The first, in association with Keith Head and Mariano Tappata, who are former colleagues of mine at UBC, examines how Canadian and U.S. residents make the decision to cross the border to shop in the other country and, in particular, how exchange rates, gasoline prices and travellers' distance to the border determines this decision. The second study examines the extent to which Canadians choose to fly out of U.S. airports rather than Canadian ones when flying to destinations in the U.S. or internationally. This is a particularly pressing issue at the moment. The third study examines how and why Canadians choose to buy cars in the U.S. rather than in Canada.
I will turn to the issue at hand, which is price discrepancies between the U.S. and Canada. There appear to be two questions: First, why do these price discrepancies exist, and, second, what, if anything, can we do about them?
I believe there are three major reasons for price differences between the U.S. and Canada. First, Canadian firms generally need to pay higher taxes and tariffs on imports of raw materials and other inputs than U.S. firms do. Second, the U.S. is a larger market. This fact allows costs to be spread over a larger consumer base and also permits more competition. Both of these factors tend to lower final prices. Third — and this is the point I would like to focus on — is the exchange rate. We already heard a little bit about this earlier this morning from Mr. Baldwin.
Currently the Canadian dollar is extremely strong by historical standards, and Canadian goods appear overpriced primarily because we are using today's exchange rate to compare prices in the two countries. The problem is that when exchange rates change, firms do not always change their prices in response, and therefore it can appear that prices in the two countries are not aligned. This works the other way as well. A decade ago, prices in Canada were a relative bargain and many more Americans were coming to Canada shop rather than the other way around today.
It is an inevitable consequence of Canada's size compared with the U.S. and of the large role played by commodity markets in our exports that the relationship between the Canadian and American currencies will be volatile. There have always been large swings in the exchange rates, but the degree of volatility has been pronounced in recent years. The Canadian dollar went from record low of 62 cents in 2001 to a record high of $1.08 in 2007. That is just six years. In the period immediately after the financial crisis, namely, in the fall of 2008, the Canadian dollar lost 20 per cent of its value within five minutes and appreciated again quickly following that period.
We are living currently in unprecedented economic times. Swings of 1 or 2 per cent of the value of the currency within just one day are not uncommon, but this was unheard of in the past. Within this environment firms face a lot of uncertainty, both in terms of future exchange rates as well as in their more general economic outlook. It is impractical for them to respond to short-term fluctuations in the price of their inputs. Firms are always reluctant to cut prices but especially if they believe that they will only need to raise them again in the future. To some extent, this behaviour of firms is understandable, although I am not completely here to apologize for how firms are behaving.
I will turn now to the question of whether there is anything that Canada could or should do to address this issue of price differences between the U.S. and Canada. I believe there are two possibilities. First, Canada should consider harmonizing taxes and tariffs for firms that need to source materials and inputs from abroad with what the U.S. tariffs are for the same inputs. Some media reports actually suggest that a proposal like this may already be under consideration in the forthcoming perimeter deal between the U.S. and Canada.
The second proposal, which is something that I have worked on and thought of a fair amount about, is the panel to consider relaxing personal exemptions for Canadians travelling abroad. The Canadian dollar is currently very strong, as the panel currently is well aware, and the strength of loonie is for many reasons. As I argued in conjunction with Keith Head at UBC in an op-ed in the The Globe and Mail earlier this year, it is time for all Canadians to enjoy the benefits of the situation.
As we had noted in that article, Canadians currently have a zero exemption from taxes and duties when travelling outside the country on same-day trip — that is, for a trip of less than 24 hours. Compare that to a $200 exemption for U.S. residents on a same-day trip to Canada. In general, for trips less than a week Canada's exemptions are more restrictive than in the U.S. Interestingly, the U.S. Congress is considering legislation that would raise same-day exemptions for U.S. residents to U.S. $1,000 compared with the current situation of zero dollars in Canada. However, reports indicate that Canada is opposing matching these exemptions for Canadians despite urging by the U.S. to do so.
I believe that Canada should seize this opportunity and liberalize personal exemptions. There are many positive outcomes for Canada for such a move. First, this would take considerable pressure off the Canada Border Services Agency. As we had noted in our op-ed, every additional resource that the CBSA expends on checking consumer purchases is less resources for the other functions, which are considerable and vital. In 2007, a Senate committee noted exactly this point and noted that Canadian policy does not currently strike the right balance and recommended that Canada harmonize its exemptions with those of the U.S.
The second reason for such a move would be that liberalizing personal exemptions provides a direct benefit to Canadians. As mentioned above, it is time to allow every Canadian, taxpayers and citizens, to enjoy the benefits of our strong currency and a relatively strong economic outlook.
The third reason is that doing so would increase pressure on retailers in Canada to match U.S. prices. For this reason, all Canadian consumers, not only the ones who shop across the border, would benefit.
Fourth, I believe that we would have an historic opportunity to increase cross-border travel and trade, something that is of benefit to both countries but especially to Canada. For years, Ottawa has raised concerns about the thickening of the U.S.-Canada border. Here is an immediate opportunity to make the border less cumbersome, less bureaucratic, essentially less thick, by allowing Americans and Canadians to travel and trade more easily with each other.
There may be some concerns about my proposal. One concern may be that government tax revenues may be affected. I do not believe that increasing personal exemptions would have a significant effect on revenues. I am happy to talk more in detail about that. The other concern is that firms in Canada, Canadian firms, will oppose such a move. I have no doubt they will oppose it vigorously. A few points to consider: First, current public policy is weighted toward the interests of firms in Canada. All I am proposing is to shift some of those benefits to Canadian consumers and taxpayers. Second, many of the firms that benefit from the current restrictions on travel and trade across the border are not even Canadian; most are American. For example, Apple sells its products at considerably higher prices in Canada than it does in the U.S. Media reports have noted the same about firms like J. Crew and Best Buy. There is academic research showing that American firms such as Amazon and Safeway, big booksellers and grocery chains, are selling identical products in Canada at higher prices than they do in the U.S. This is not a question of higher costs; this is simply the same firm charging a higher price in Canada because they can get away with it. I believe that if firms can get away with it, they should; firms are in the business of making money. As a counter to that, I believe that we should make it easier for consumers to shop where they choose. It is a mystery to me why we would design Canadian public policy to expressly benefit American firms.
With that, I will end my remarks. I am happy to take questions.
The Chair: Thank you very much. There are interesting points that you raise, Professor Chandra. I have senators who wish to engage in the discussion with you. I will start with Senator Eggleton from Toronto.
Senator Eggleton: Welcome; thank you for being here. This is intriguing. If we went to $1,000 a day, there would probably be a flood of people heading over the border, would you not think? How much of a disruption would this cause to our own retailers? You think that ultimately it will force them into being more competitive, but by the same token they say there are higher tariffs and taxes here so it is not just all the desire for more profit. I think a lot of people would be very concerned about that part of it, the effect on businesses.
Can you demonstrate that, in the medium and long term, this is not something we need to fear?
Mr. Chandra: I am not necessarily advocating that we go to $1,000 overnight. What that right number should be for the exemption is something that we can work out and I am happy to give you my opinion on that. The current exemption is zero. You could go to the U.S. today and come back with a pack of —
Senator Eggleton: Within 24 hours I think you get $25, do you not?
Mr. Chandra: You get $50.
Senator Eggleton: You get $50, but it is not the same day.
Mr. Chandra: If you go today and come back with a pack of chewing gum, in theory you would be paying taxes and duties on that. In practice you probably do not notice, but the point is that the current exemption is zero. I am not saying that we should raise it to $1,000.
Senator Eggleton: What do you think we should raise it to initially?
Mr. Chandra: First, it would be great if we had some sort of agreement that in principle the exemption should be higher than zero. What that right number is, I cannot give you a number right now but I am happy to contribute to that discussion. It does not seem as though that discussion is on the table yet. If we raise the exemption to something reasonable, for example we matched current U.S. exemptions — although I would urge that we should be bolder and raise them higher than that —
Senator Eggleton: What are the current exemptions?
Mr. Chandra: The current U.S. same day exemptions are $200.
If we were to do that, there are a few things. Initially, there will definitely be a flood of people who say, ``Wait a minute. We can actually get good prices in the United States. Let's go there.'' I am sure you will inevitably see media reports about loss of sales to the U.S. You will inevitably see firms here complain about lost sales. This situation might last for a few months but, over time, the novelty of this will wear off. Over time, I predict that you will see prices in Canada converge, especially for tradeable goods, things like small electronics, an iPad that Apple would sell. You will see those prices converge between the two countries.
Second, we might be concerned about the loss of tax revenues, but the CBSA noted last week to this panel that currently they collect just $190 million in taxes and duties from cross-border purchases. The exemptions are zero, but in practice the CBSA does not have the time and resources to monitor small-scale exemptions. We should codify that. What is the point of having a law that says the exemption is zero when that will not be enforced, and when it is not even clear that is not a big dent to government revenues?
Senator Eggleton: That is a good point. On your other proposal about harmonizing taxes and tariffs, can you take a product and sort of describe how lowering the tariffs to match the U.S. would be done and how it would benefit Canadian prices?
Mr. Chandra: I could give you — this is not an area of my immediate expertise. The area that I work on is cross- border travel and pricing, not so much imports of raw materials that firms have. However, I do believe that if we were to have a level playing field and Canadian firms were to pay the same tariffs and taxes on imports from Asia, for example, and on raw materials, electronics or clothing goods, that would bring prices in line with the U.S. It would reduce the incentive for consumers to shop across the border.
Senator Eggleton: That is if the retailer or the manufacturer passes the price on to the consumer.
Mr. Chandra: Ultimately, if we believe there is enough competition in Canada, they would be forced to. I think, ultimately, there is enough competition in Canada for them to be able to do that. Currently, they are paying high taxes. As I said, I am not here to apologize for firms, but they do have more restrictive conditions than their U.S. counterparts do.
Senator Runciman: If memory serves me correctly, I think you are the third witness appearing before the committee who has recommended adjustments to the exemptions. I tend to agree, as one living near the border. I think there is an unofficial exemption already in place with a lot of the border services folks. We did have some testimony from border services that certain levels of groceries, for example $100, go on through. If you start getting into having those folks pulled over, it will simply bound the border up even more than it is today.
You talked about the rationale with respect to why Canada has not moved in this direction. You talked about tax revenue. Have you had any direct interaction with the government with respect to the rationale? We are talking about the retail sector getting up in arms, but the retail council itself contends they have not taken a position on this informally with the government. What kind of feedback have you heard with respect to the government's rationale? I know the tax revenue side, but is it primarily to protect domestic retailers? What is your sense of that?
Mr. Chandra: I am not entirely certain. After we wrote the op-ed, both my colleague Keith Head and I were asked about this by the media and a few other people. Apparently, the media also contacted the finance minister and asked for his response, and at least as stated in the media, his response was that he was concerned about the tax revenue, the fact that more purchases in Canada would imply a loss of tax revenue in the United States. I said, if we were to liberalize this, I am sure the retail association will be up in arms. Whether they are lobbying behind the scenes to prevent this is something I have no idea about at all. That may be one unstated reason why the government is slow to act.
Senator Runciman: Therefore, essentially for you and your colleagues it is difficult to test this theory until it actually occurs, whether it is on a gradual scale or not.
Mr. Chandra: You are exactly right. This is impossible to test until we put it into practice. The most we can do is provide our best estimate of what would happen, based on what theory says, and our reading of how integrated the two markets are. We believe that integrating the markets further would force prices to converge more quickly, and therefore we would not see the flood of people crossing the border to shop. We might in the short run — I am not disputing that — but in the long run, I do not think that is sustainable.
With that said, you are right, which is also why I would not advocate rushing to $1,000 exemption the same day. We could do this gradually, at least, if we are open in principle to the idea that Canadians should not be prevented from their freedom of mobility and freedom of purchase from buying wherever they want.
Senator Runciman: One of your areas of study was the auto sector. Could you speak to that? We heard some testimony about significant differences, especially autos that are produced in Canada for example. Can you give us your understanding on why that occurs?
Mr. Chandra: I was listening to Mr. Baldwin's testimony, and he classified autos as tradable goods, and, fundamentally, that is correct. However, in practice they are not tradeable because there are many regulations that prevent you from just going to the U.S. and bringing the car back. For example, Transport Canada has regulations over and above what U.S. specifications of cars are. Also, and this is something that is just coming out of our research, U.S. manufacturers are not transferring warranties any longer for Canadians who buy cars in the U.S. and bring them back. I am not surprised because they like to see this situation of segmented markets. They like to be able to price products differently in different markets. All the theories suggest that is exactly what is profit maximizing for them. Cars are problematic because we have this issue of warranties, and if firms want to segment the market, they can do so. It is hard for government or public policy to change that.
I was listening to Senator Finley's example. It is true that many cars here are more expensive. Some cars here are not; some are cheaper. Going back to the fact that today's exchange rate is, by historical standards, very strong. A decade ago, cars here were cheaper; most things were cheaper. Even three years ago, when the Canadian dollar fell, as Mr. Baldwin testified, prices do not adjust that quickly, so it is a consequence of the fact that the loonie is so strong right now.
Senator Runciman: Have you looked at the impact of provincial regulation? Senator Finley was talking about beer prices. For example, in Ontario, the government sets a minimum price, so you cannot use it as loss-leader, for example, which a lot of American retailers do. How significant is the provincial government with respect to keeping prices higher in Canada?
Mr. Chandra: I think it varies from product to product, but if you are talking about something like beer, not just the minimum price but the fact that we have essentially a monopoly on retail sales in Canada, that is the choice of the Ontario government. I think if it were different, the price would be different, too.
The Chair: We keep getting back to this beer issue.
Senator Finley: I hope that this $1,000 will include up to $1,000 worth of beer because Labatt's Blue at $8.99 a dozen looks awfully attractive, and that from someone who does not even drink beer.
I want your opinions, if I may, Professor Chandra, on a couple of things. First, I read that your Globe and Mail op- ed raised the subject with CBSA last week about the fact that if we were not worrying about the small everyday items going backwards and forwards that it would be easier for CBSA to conduct their more important tasks, perhaps. Initially, they agreed, and then very late in the meeting, one of the gentlemen said that, of course, if we raise the exemption it would create vast amounts more of cross-border traffic, therefore making their job more difficult.
It is a one way of looking at it. Let assume that was true for a second. In your report, and I understand it is still not complete yet because it was an awful lot of question marks and references that had no place to go in it, but at one point you say, on the other hand — and this is a word I am not familiar with, I have to admit — an exogenous doubling of border wait times will lower crossing frequencies by 30 to 48 per cent depending on the province.
On the one hand, you have a proposal to increase this to make it easier for the Canadian border services who say it will not make it easier but will make them busier. If it is busier, then the border times will be longer, which in turn will create a reduction. Can you square that circle for me?
Mr. Chandra: It is very hard to square, which is why I used the term ``exogenous increase'' in border wait times. If border wait times were to increase exogenously, that is, for reasons completely unrelated to more people driving to the border, if let us say CBSA were to cut its staff by 50 per cent or double inspection times for some reason, we have the data and the capability to predict what would happen to wait times and to the number of people who would choose to go to the U.S. If more cars were to drive to the border in response to a stronger loonie or higher exemptions, and that increases wait times, what would that do in turn to depress traffic? That is virtually impossible to work on until we have all the statistics in place. I cannot claim to be able to answer that question.
Senator Finley: It sounded like a difficult problem to me.
In one of your reports, you mentioned that consumers place a value of $20 per driving hour on whether or not it is worth it to go across the border. From where I live, I can actually see Erie, Pennsylvania. Unfortunately there is a large tract of water in the middle — called Lake Erie — so I have to go around either end, which takes a rather long time. If we look at exemptions and add the other economics — and I am wondering if you put this in as part of your model — to get over the 24 hours almost inevitably means an overnight somewhere. Certainly to get into places that the $20 an hour driving time would make it worthwhile, you are into several nights. Does that play into your modeling system? You are quite the guy for formulas, I must say. I was absolutely thrilled to death, but I could not understand any of it.
Mr. Chandra: You are exactly right. It takes a while to drive to the border. You need to drive around Lake Erie. I need to drive around Lake Ontario to drive from Toronto to Niagara, or the other way through Kingston. In fact, that is what our results show. Despite all the media reports, it is not as though all of Canada is sitting and waiting to cross the border to shop. It is a long way to drive. It takes time, money and gasoline, which is expensive. We have detailed data from the CBSA and from Statistics Canada to work out where people live and how far they are willing to drive. Most people who cross the border are people who live close to it. You might occasionally hear anecdotes from family or friends about someone driving from Edmonton to the United States to get a good deal, but the example is isolated. Most people who would drive to the border are people who live nearby. It is not worth driving six hours.
Senator Finley: There are diminishing returns.
Mr. Chandra: Exactly. That is why liberalizing exemptions will not lead to a flood of people shopping in the U.S.; it might lead to a few people. I think it will put pressure on Canadian firms. If Apple wants to price its iPad 20 per cent higher in Canada, then do so. Let Canadians respond by buying it 20 per cent cheaper in the United States. I think that would lead to prices converging rather quickly.
Senator Finley: I asked this question of Mr. Baldwin, who was here before. Of all the reports that I read — yours and those from Statistics Canada — you all agree that the system does not react well to exchange-rate fluctuations. Mr. Baldwin talked about sticky prices, et cetera. What is your view? Is there something that can be done to make it more reactive, or is it out of the question with the way the supply and inventory chains are? With computers and bar codes, you would think with a snap of the fingers you could redistribute.
Mr. Chandra: Prices do not adjust quickly in response to exchange-rate movements. That is not because the speed of price adjustments in Canada is particularly slow. There is no evidence to suggest that. In general, firms across the world take time to respond to any sort of changes in situations. What is unusual here is not the speed of adjustments of firms, it is the speed with which the exchange rate changes. As I said in my testimony, you can have a swing of 1 or 2 per cent in one day. We could leave this meeting and see that the loonie appreciated 1 per cent this morning, especially in these economic times. That speed of exchange-rate fluctuations is something we have to live with, given Canada's trading relations with the United States.
Senator Finley: It does not seem to work at the gasoline pump, though.
Mr. Chandra: Firms might appear slow to adjust their prices, but it is not as though Canadian firms are slower than elsewhere.
For example, if the exchange rates were to change 1 per cent today, it would not be practical for Tim Hortons or Starbucks to change their prices, menus and signs on a daily basis by 1 per cent. It is not practical. It would not be worth it for them. To take another example, Amazon.com and Amazon.ca sell identical books on either sides of the border. They do not have brick and mortar stores. They have electronic prices they post on their websites. You think it should be easy for them to change prices immediately as the exchange rate changes, but they do not. Researchers in Montreal have shown that Amazon — a firm that could respond to prices quickly — does not. I am not familiar with the internal workings of firms, but these decisions will not be left to computers or to managers. For whatever reason, they take time to make these decisions.
I think gasoline is a special case for a few different reasons, which we could talk about if you like. In general, I would not worry about the speed with which Canadian firms change prices. I think they are doing the same as everywhere else.
Senator Ringuette: Professor, in the brief you gave us this morning you say, for example, that Apple sells its products at considerably higher prices in Canada than in the U.S.
Let us assume that the Government of Canada adopts your first recommendation to increase the personal exemption. Canadians start to buy Apple products in the U.S. because of the personal exemption. Do you really think that by doing that, Apple will reduce its prices in Canada to match the ones in the U.S.?
Mr. Chandra: Not immediately. In general, firms hate to cut prices. It is something they are reluctant to do. There is a lot of research showing they would rather let prices stay flat for a long period rather than cut them. However, I do not think Apple would raise their prices in Canada, so over time the two prices would converge.
Senator Ringuette: That is an assumption. Are you talking about 10, 20 or 30 years?
Mr. Chandra: I do not think it will be that long but it will not be overnight, either. It would depend on the product. Car prices will not adjust, primarily because car manufacturers are careful enough to have slightly different specifications for cars sold in Canada and the United States. It is hard to compare the same brand across the border. A product like that may not adjust at all. However, if you give consumers the ability to buy products that are exactly the same in the U.S., firms selling them here would have to cut prices. I do not know the time frame, but that would happen.
Senator Ringuette: I live along the border. I also look at different prices on the Internet. Earlier, you mentioned Amazon.com and Amazon.ca. If you are a U.S. citizen and order a book on Amazon.com you pay zero transportation costs. It is delivered to your door. If you are a Canadian citizen and you order on Amazon.com because the prices are lower than Amazon.ca, you have to pay shipping costs. This brings us back to the other issue that you mentioned, which is that gasoline prices are 28 per cent higher in Canada than in the U.S. Most of that 28 per cent is taxes, both federal and provincial, on these items.
Mr. Chandra: That is right.
Senator Ringuette: Although you would increase the personal exemption, that cost factor for consumers, for retailers and for manufacturers that want to sell their product in the Canadian market will not be gone.
Mr. Chandra: Absolutely. As I said before, there are at least three important reasons why there are price differences between the U.S. and Canada. We will not eliminate the first two of those. We will not eliminate the fact that Canada is a smaller market, and it is more expensive to do business in a smaller market. We will not eliminate the fact that there are high gasoline prices here. That is a choice that Canadian governments and citizens have made over the years. We will at least address the third issue, which is that firms are not responding to exchange rates quickly. The price differences are not justified purely by the first two factors.
Senator Ringuette: In all of your analysis, have you considered all the different market intervenors that add a markup, from the manufacturers to the transporters, to the first wholesaler, which could be the continental one, and then to the more regional wholesalers, et cetera? At the end of that supply chain, you have the retailer. They have to live with and adjust to the market and to their suppliers. Also, they have to live with the fact that they pay, on average, 3 per cent to Visa and MasterCard and that Visa and MasterCard are spending billions advertising for Canadian consumers to pay for everything with their credit card.
Mr. Chandra: The question at hand is why the price difference between the U.S. and Canada exists. We are focusing on what the differences in the markets are between the two. American firms need to pay credit card fees as well. They have supply chains, middleman markups and all of that, as well.
Senator Ringuette: And volume?
Mr. Chandra: Exactly, volume. As I said, that is probably the primary reason. The volume is smaller in Canada, and it always will be. We are a tenth of the size of the U.S. That is something that, fundamentally, we might never be able to address.
Senator Marshall: Thank you very much for being here this morning.
I want to go back to the vehicles. I am from Newfoundland and Labrador, and we are on an isolated island. Yet, I know people who do drive do the states and buy their vehicles there. I was aware of the change with regard to the honouring of warranties. Your recommendation on the exemption will not work here.
Mr. Chandra: No.
Senator Marshall: Tariffs and duties will not work here.
Mr. Chandra: That will not work.
Senator Marshall: What is the solution to bringing the Canadian prices in line with the American prices, or is that something we are stuck with? Is there no way to address it?
Mr. Chandra: I think there are a number of things we are stuck with. We will never reach a situation of exactly equal prices on all goods between the two countries. We should also recognize that, based on the exchange rates, there are plenty of times when products are cheaper in Canada. As I said, a decade ago, given how weak the loonie was, prices seemed like a bargain, and Americans came here to shop. I do not know if that was true for cars then — we could study that — but it was true for many products. I do not think a feasible goal would be to equalize prices for all products in both countries. I think a feasible goal might be to somewhat address the issue of what we know are large price differences, especially for small goods that could be easy traded and consumed on both sides of the border.
Senator Marshall: What about vehicles in particular? That is such a big ticket item that people look at that and see the discrepancy. You go to the States, and you can buy it for thousands of dollars cheaper. Is there anything this committee can recommend to address that?
You were talking earlier about regulations. There are so many regulations wrapped up in the pricing of vehicles. Is that one area that could be addressed?
Mr. Chandra: I do not think that is the biggest problem currently. I think that regulations have decreased somewhat, over the years. We are moving in the right direction. However, every time you require cars in Canada to have certain requirements that they do not necessarily have, as a default, in the U.S., you are allowing firms to take advantage of that to not set the same prices for the two vehicles. They know that consumers cannot easily buy products in one market and consume them in the other. Reducing these regulations will usually bring prices down. However, I do not think that is the biggest problem right now. The biggest problem is that manufacturers can institute these programs. My research shows that, over the last few years, they have dramatically reduced the number of warranties that they honour in Canada. These are all the manufacturers, foreign as well as North American.
Senator Marshall: I am aware of that because I do know people who do go to the United States and buy their vehicles.
You indicated in your opening remarks that there is an ongoing study on this by some colleagues of yours. Did I understand that correctly?
Mr. Chandra: On the automobile market?
Senator Marshall: Yes.
Mr. Chandra: I am working on that with a colleague of mine at UBC, but it is preliminary.
Senator Marshall: When do you expect to report on that? Will it be reported on by the time we finish our study?
Mr. Chandra: I do not think so. The pace of academic research is glacial.
Senator Marshall: Is any preliminary information put out, or do you wait until the study is finalized?
Mr. Chandra: We usually prefer to wait until it is finalized, rather than making any claims about numbers that may not be accurate.
The Chair: So that I have this clear in my mind, car manufacturers have dramatically reduced the warranties that they will honour for automobiles that are manufactured in the U.S. and sold into Canada?
Mr. Chandra: That is right.
The Chair: Is this the second-hand market?
Mr. Chandra: No, this is new cars. In many cases they require that the car that is purchased in the U.S. be at least six months old or older before they will honour U.S. warranties in Canada. In some cases, they do not honour them at all.
Senator Runciman: With regard to big ticket items, a marina operator in my area was talking about Bombardier Sea- Doos that are manufactured in Canada. The retailer is paying the manufacturer or wholesaler a significantly higher price than the person across the St. Lawrence River is. Have you taken a look at some of these other big ticket items, and why there are some significant price differences?
Mr. Chandra: There are. There are a number of studies one could conduct for each of these industries and products. Airlines are particularly problematic because, again, it is the big market-size issue. We have, essentially, two or three airlines in Canada, one big one and a couple of smaller ones, compared with many more airlines and a much bigger market and demand for them in the U.S. The bargaining power of U.S. airlines for the same jet is much greater than Canadian Airlines have. They will always get pretty good prices on those.
Senator Runciman: It is what the market will bear.
Mr. Chandra: Exactly.
Senator Nancy Ruth: My understanding is that the Sea-Doos and Ski-Doos were moved to being manufactured in the United States between seven to 10 years ago. Would that impact the price difference? Your answer to Senator Runciman assumed it was a Canadian manufacturer, and I am suggesting it might be American manufactured. How will that impact that price difference?
Mr. Chandra: I am not familiar with the industry enough to be able to comment.
Senator Nancy Ruth: My question is hypothetical. It is sort of about smuggling, for which we have no data. We all have stories, I am sure.
First, is there any pressure from the banks to increase, say, a $1,000 limit? There are not many Canadians who could pay off a $1,000 limit without using a credit card.
Mr. Chandra: That is right.
Senator Nancy Ruth: The banks will collect whether the good is purchased here or in the USA, but would there be an advantage to banks to increase the rate?
Mr. Chandra: Possibly. Any industry that could be classified as a support industry to an activity like travel or crossing the border would benefit from more people crossing the border. That could include the banks, but I am not aware of any particular action that they have taken to advocate this move.
Senator Nancy Ruth: Say those Canadians who could afford to drop $1,000 to go on a day trip or to attend a conference for a weekend, pick up, for example, two exquisite Italian ties or a Gucci handbag that costs $1,000 or $2,000. Do you think it would increase the rate of smuggling?
Mr. Chandra: I think it would decrease the rate. The current exemption for purchases is zero. I read the CBSA's testimony to this committee last week. They said that in many cases they do not have the time to check cars. People could be claiming zero purchases when in reality they might well have purchases. I would not be shocked if that were the case. As you said, people do not have $1,000 to drop on a single trip; that is a large amount of money, and I am not advocating a $1,000 limit. An occasional trip to the U.S. to purchase clothing and electronics is something that many, if they were to do before, would not declare but would do now and declare as long as it was legal.
Senator Dickson: That was an excellent presentation. As you may recall from previous witnesses before the committee, they thought one of our challenges was to educate the public as to some of the simplistic solutions that might be there. I must say that you have identified some in your paper. One with which I wholeheartedly agree insofar as public policy is concerned is that public policy should be there for the benefit of the majority of Canadians, not just for the large retailers. Would you like to elaborate on that, please?
Mr. Chandra: I am a professor of business. One might think that I advocate for business-friendly solutions or a policy that would benefit firms. On the contrary, I am essentially an economist, and I believe that public policy that allows stiff competition between firms is of the ultimate benefit to consumers. We should design public policy to benefit consumers and taxpayers. We should design public policy to benefit Canadians, fundamentally. That is usually achieved by having firms compete stiffly with others firms, whether in Canada or abroad. This is one of the ways in which they will be forced to do that.
Senator Dickson: Are you suggesting by increasing exemptions?
Mr. Chandra: For example, yes.
Senator Dickson: The other point that really struck me, being a lawyer at one time, was that we should not be treating Canadians as petty criminals. Therefore, we should move ASAP to giving Canadians a minimum at the border, whether it is $200 or another amount. I am not in a border province. It would clear the conscience of people and be at zero cost to the government.
Mr. Chandra: It is funny: We used exactly that phrase in the op-ed article we wrote a few months ago. We have the choice of either treating Canadians as petty criminals for something that strikes most of us as harmless and something that I think many people would do or allowing Canadians to do something that appears natural and allowing resources that would be used to monitor or clamp down on this activity to be used more wisely elsewhere.
Senator Dickson: They are probably smuggling cigarettes, for example.
Senator Finley: Or beer.
Senator Dickson: Or beer, right.
My last question comes from the third page of your paper, where you say that you are turning to questions of whether there is anything Canada should do or could do to address the issue of price discrepancies. You list two possibilities. I am concerned with the first one, which is that Canada should consider harmonizing taxes and tariffs for firms that need to source materials and inputs from abroad. Have you given any consideration to the cost of initiating that proposal?
Mr. Chandra: As I said, that is the reason I mentioned that proposal briefly. It is not my immediate area of expertise, which is why I spent more time with the second proposal on exemptions. Briefly on the first proposal, it would be a comprehensive move in conjunction with the second proposal and would leave Canadian firms with no room for complaint because they would be on the same playing field as American firms with respect to importing duties. The cost, of course, would be lower tax revenues for Canada on tax and tariffs on the imports of raw materials from countries like Asia. As I said, this is not my area of expertise, so I do not know how much lower those tax revenues would be. I do not think we need to necessarily lower tax revenues across the board, but if we were to do so in that area, it might make more sense to do so there and offset them in other areas.
Senator Dickson: Do you know whether any studies have been done on quantification of the cost on your first point?
Mr. Chandra: I am not aware of any.
The Chair: Senator Dickson, in that paragraph, Mr. Chandra says that in many cases this will involve lowering taxes and tariffs for these goods. You have the sense, without any specific study having been done, that the taxes and tariffs in Canada are higher than they are in the United States.
Mr. Chandra: Yes, they are higher on the imports of raw materials and imports from abroad generally.
The Chair: If there is nothing further, on behalf of the Standing Senate Committee on National Finance, Mr. Chandra, I thank you very much for coming here on short notice. You have written a lot of material and brought it to our attention, which we will review. I expect we will continue this study through the first half of 2012. If there are any further developments or comments that you wish to make known to our committee, send them along to the clerk of the committee. We would be pleased to hear from you.
Mr. Chandra: I will do so; thank you.
(The committee adjourned.)