Why is the UK so expensive?

by on July 26, 2006 at 1:27 am in Economics | Permalink

A loyal MR reader, Erik Alberts, writes:

I’ve made several
trips to the UK in the past few months in preparation and it amazes me
how much more things cost there (in London) then here in California.
What I’m trying to understand is why.  I realize that some things like
gasoline cost more in the UK due to taxes.  But for other things, it
appears that prices in the UK are 40 to 50% higher.  How would you
explain this?

Here are a few examples:
1.  Apple iTunes –
costs $0.99 per download in the US, costs $1.47 (0.79 pounds at 1.8594
pounds/$) in the UK.  Why should downloading a song in the UK cost 48%
more when on the internet you can just download them off the US site?
 
I realize that higher
taxes and higher labor costs may be factors (although at my company UK
labor is cheaper than it is in California), but I find it difficult to
believe that this would explain a 50% difference.  Could this be a sign
of currency imbalance like the big mac index, a supply and demand
issue, or are UK consumers simply used to paying more?

I have wondered the same about Switzerland.  The standard explanation is that expensive countries are extremely productive with their tradables (North Sea oil and London finance?).  That appreciates their exchange rates and renders non-tradables quite dear.  This is the flip side of cheap barbers and prostitutes in Thailand.  But are the Brits really so productive?  If so, why can’t they get both hot and cold water coming out of the same tap?  And aren’t some of the expensive goods tradables rather than non-tradables?

One factor for sure is that American retailing is the most efficient and most productive in the world.  Perhaps the Brits are especially inept in this regard.

A further factor may be that foreigners, even those who are considering moving, sample British prices in biased fashion.  We see lots of hotel rooms, cab rides, and restaurants.  Fish and chips is still pretty cheap outside of London.  As for Marmite I could not say, but that is exactly the point.  Your preferred consumption basket will always look expensive in another country; just try getting Ocean Spray grapefruit juice in Western Samoa.

Your thoughts? 

James Newton-King July 26, 2006 at 2:29 am

Some of the difference would be caused by VAT. The UK has VAT rate of 17.5%.

Alex Tabarrok July 26, 2006 at 2:39 am

Exchange rates are more flexible than goods prices.

Alex

cbooker July 26, 2006 at 2:44 am

Hmm…the Ikea UK Website quotes the “Bjursta” table at GBP 185, which at current exchange rates is roughly USD 341 (GBP 1 = USD 1.8409, according to Bloomberg). The Ikea US Website quotes the “Bjursta” table at USD 349. It’s not exactly the Law of One Price, but I’d say that PPP more or less obtains. Or am I missing something?

Don Lloyd July 26, 2006 at 2:58 am

Erik,

For any given product, the profit-maximizing price is a function of the shape of the demand curve faced by the firm (possibly modified by competition), and forward-looking marginal cost. To the extent that the UK has a lower intensity of competition and a lower population that can be profitably serviced at lower prices, you would expect the resultant prices of many goods to be higher.

Regards, Don

BillWallace July 26, 2006 at 3:56 am

Aren’t their labor costs much higher, especially for low-end labor like retail?

Aren’t they the consequence of the “if you restrict labor supply you raise the price of consumer goods” statement?

Ross Parker July 26, 2006 at 4:16 am

A minimum wage of £5.05ph (about $9.34) in the UK and US Federal Minimum wage at $5.15 may have something to do with it. Also, land prices are much higher in the UK as we’re a smaller place, so property rental is high. We’re also pretty used to paying high prices for services as standard – such as hotels, eating out, etc. This is one of the reasons we can’t fathom out why on earth you Americans tip everyone in the service industry!

Oh, and it’s interesting to note that some comments will be skewed towards ‘Why is London so expensive’. I live in the centre of London and stuff is very dear here. However, near my mother-in-law’s place in Wales, I feel like I’m in a SE Asian economy and live like a king.

Incidentally, the great thing about living in London is that ‘airport prices’ (the markup each outlet whacks on things in airport departure lounges) start to seem reasonable.

sammler July 26, 2006 at 4:50 am

Note that London in particular has had a property boom this year (again): mean house prices in Chelsea are up to 1400 GBP (i.e., $2600) per square foot. Look around at wherever you live and think about that.

Matt July 26, 2006 at 5:43 am

I live in London. Amongst those of my friends who travel abroad frequently it has become something of a joke that retail goods – particularly electronics – are sold for the same headline figure in the US as in the UK – just with a dollar sign in front.

House prices are high in London and so a certain amount of inflation is expected in London. That clearly translates into food and drink prices: a pint of beer costs £3.20 in central London, and about £2 in Newcastle, a much poorer city in the north of England.

But brand-name goods – electronics, designer clothes, and so on – tend to cost the same across the country, and they tend to be of the order of 30-40% more expensive than in the United States or Japan. While all of the arguments that people have been suggesting about house prices and illegal immigrants make sense if you only compare the UK to the US, they make less sense if you compare the UK to Japan.

Max July 26, 2006 at 6:24 am

Being not an economist, I can only guess here, but it has something to do with currencies and exchange rates. Taxes and subsidies might be understandable in the case of the UK, but not in Switzerland. I am often buying things in Switzerland and go to BAsel over the weekend and I also must conclude that NOT everything is expensive. F.e. if you just buy gasoline you have one big times, because in Germany it is too expensive.

On the other side, it is a highly specialized country with a high standard of living, perhaps this also contributes (due to quality) to high wages and high costs.
The UK and Switzerland are two countries which haven’t accepted the Euro, therefore to compare prices is difficult…

Andrew Smith July 26, 2006 at 7:54 am

My perspective is that of a Canadian living in London–and Canadians and Aussies are even more likely to complain about London prices than Americans! Obviously tourist goods are expensive everywhere, but once you get beyond that I think that expensive land is the key factor. My accomodation in London costs at least twice what similar accomodation would be in Toronto (let alone a smaller Canadian city, where property is at least twice as expensive as in a small English city). Population density coupled with the severe restrictions on urban sprawl must be largely responsible for this. On the other hand, clothing, etc, costs the about the same (there is sticker shock because sales taxes are generally included in prices here rather than being added at the checkout, but on most goods the total sales tax is equivalent). Most things at the supermarket are about what you would pay in Canada, but restaurant meals are much more expensive, which is probably a function of high land and labour costs (at any decent place in central London the waiters are paid well above the national minimum wage– and this is with free immigration from Poland!). I’m not certain you can say that US retailing is more efficient than in the UK: Asda, a supermarket chain, is owned by Wal-mart and applies their practices, while certain UK chains (e.g., Tesco) are world leaders at lean distribution systems and have even acquired supermarkets all over the globe. Supermarket prepared foods (e.g., hot cooked chickens you can take home) are roughly the same price as in Canada, despite higher labour costs.

Frank DiTraglia July 26, 2006 at 9:11 am

Though perhaps a bit trivial, Tesco brand chocolate mousse is half the price of comparable American chocolate pudding. At least my dessert was inexpensive!

Sandy July 26, 2006 at 9:51 am

What about the fact that Apple alone does not set prices, but must negotiate with local license holders? That’s why you can’t download songs from the US iTunes store in Britain, and vice versa. These prices are not set by managers but as the result of hard-fought legal negotiations.

The British counterpart to the RIAA may simply be much more effective at price-fixing than they are here.

Dan Kahn July 26, 2006 at 10:35 am

Another example of Brits paying lower prices is textbooks. I used to buy many of my textbooks via Amazon.co.uk AND pay international freight and they were still cheaper.

Two quick examples:
1. Mankiw’s 5th edition of Microeconomics
£40.99 (about $75-76 at market exchange rates) vs. $125.96 on Amazon.com

2. Mankiw’s 3rd edition of Principles of Microeconomics paperback w/Xtra
£31.34 (about $58 at market exchange rates) vs. $106.95 on Amazon.com

All said, I could still save about $30 per book, even with paying for 2-day delivery.

Robert July 26, 2006 at 10:51 am

The cost at iTunes is a perfect example of third degree price discrimination. You cannot just use the US store if you’re a Brit, because you have to have an American VISA/Master Card to do so. If you could, why would there be different nation specific versions?

Laeeth Isharc July 26, 2006 at 11:56 am

I believe import duty = 10 -12%, VAT = 17.5%. Real estate/sq foot trades richer and intensity of usage/efficiency is lower. High transportation costs (fuel taxes, traffic jams?). Higher regulatory burden. This may have changed with acceleration in immigration from E Europe but would hazard that low-skilled labour remains more expensive in UK.

joan July 26, 2006 at 1:58 pm

After reading these comments what occures to me is that maybe the US is the one that is exceptional in some way.The number of hours of US labor to buy a toyota is much greater the the number of UK or in general EU hours. With our low cost of living, good cheap transportation, etc, why are our exports so costly (as reflected by the $ exchange rate).

PEmberton July 26, 2006 at 2:22 pm

“how much more things cost there (in London) THEN here in California.”
Then ? Then ? Dear God! Up with this spelling I cannot put.

Lance July 26, 2006 at 5:21 pm

I think we can see a lot of reasons the UK is expensive above, but I also think these factors interact with a more global pattern in a way to make London more expensive.

That is, it has never been more expensive to be rich, and therefore travelers who are consuming luxury goods, even lower end luxury goods such as hotels and meals, are especially hit.

This seems essentially a monetary phenomenon. With most manufactured goods and many low end services becoming low priced commodities, those goods which are not fully exposed to competition (luxury goods) from abroad or efficient retailers including prime real estate, restaurants, etc., see a tremendous increase in disposable income (especially from the rich) headed their way. If many prices are falling in a relative sense one would assume other goods should increase. The marginal effect is tremendous. When combined with the many other factors mentioned above it is especially seen in high end goods, services and real estate in London. I think that plays a large part in the travelers experience in the UK.

bdwnnc July 26, 2006 at 6:26 pm

Erik – Spend $4.77 US and buy yourself a copy of ‘The Wealth of Nations’.

john July 26, 2006 at 11:18 pm

All of Europe is expensive now. Five years ago gold traded for abou $275/ounce. Today gold closed at 624.70. The dollar has lost more half its value in five years. Greenspan and Bernanke have not been doing their job of keeping the value of the dollar constant.

joan July 27, 2006 at 4:49 am

As someone pointed out the wage ratio between the US and the UK for mimumin wage workers is about $1 to 1 GBP. However for the median wage it is about $2 to 1 GBP. If the exchange rate is determined by the median wage ratio(which seems reasonable), Americans in the UK see goods and services produced by low skill workers as costing nearly double what we think they should. The US is exceptional in this (see plot of the gini index vs gdp at)
http://www.visualizingeconomics.com/2006/01/04/gdp-per-capital-vs-gini-index/
or a list of gini index by country at
https://www.cia.gov/cia/publications/factbook/fields/2172.html

daniel July 27, 2006 at 10:09 am

i think andrew has hit the nail on the head here. prices clear at the levels which supply and demand are equalized.

though there may be some differences between retailing efficiences, they’re not high enough to account for the differential, and while the size of the markets does differ, the UK is a huge developed country with a large enough population to make it worthwhile to develop effective supply chains. higher taxes are responsible for some inefficiency but also not on that order.

the only thing that is massively different is real estate, which is severely constricted in supply by the green belts. when you restrict supply, you shift the supply curve up and increases prices. for retailers in an urban setting, real estate makes up an enormous proportion of cost and the differences accounts for most of the price differentials you see with less urban/expensive locations.

Chris Meissner July 27, 2006 at 2:44 pm

Interesting comments. I live in the UK in Cambridge. When I am bored I contemplate the same question. After 6 years here I am not sure if I have a definitive answer or whether there can actually be one given the fact that consumption bundles, policies from good to good vary, etc etc. Here are a few thoughts:

1. The property issue matters. Supply is extremely restrcited. Martin Wolf of the FT a few weeks ago, citing Kate Barker’s report, notes that a hectare of “residential” land costs several millions pounds while farmland is an order of magnitude less.

2. These policies feed into severe congestion (though other policy W%#%-ups matter here too^1). Try moving around this country between 8 AM and 8 PM. You can’t do it. Even at night (when nobody works anyway) it’s not that great.

3. VAT matters, gas taxes matter.

4. Someone needs to spend some time and look up the Heston Summers PPP or Maddison conversion factor. I looked at that a few months ago and noted it impied that the UK was pricey but not 50 percent more so.

4.1 The pound is extremely high compared to its medium run 1.5. This could explain maybe 20-30% right there.

5. People’s baskets differ. Things like heat, showers, and other modern conveniences that US consumers love are often not consumed here. Presumably this makes a littl moe space in the budget for “over-priced” restaurants etc.

6. The undiscering consumer that also happens to be a snob (this is all part of the class system I ahve yet to even come close to understanding yet) has to have some effect. If you’ve been to the Cambridge market or Waitrose and compare the prices of the produce to that in France where I am often buy my produce you’d be shocked. Transportation costs matter obviously for that too. However, I find much food cheaper than in Berkeley where I used to live.

Footnotes:
1. The M25 a sort of London beltway has a toll booth crossing at the Thames. I guess nobody ever had a session with an economist on this one. Doesn’t everyone now these days that you should only have a toll going in only one direction? This M25 is also a great invention. There is no contraflow or reverse commute since it’s a circle. Great idea guys! (There was a picture from India on this very blog which shows a similar policy mistake. (Perhaps we need a post on those last two. There must be a good reason for them). Making London the hub of the country may not have been the greatest of ideas either. Try going the 90 miles from Oxford to Cambridge….It takes about 3 hours no matter which way you try it.

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