Why are things made in the UK, with UK components and ingredients, going up in price post-Brexit?

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24 November
16:56
November
2016

There are two principal reasons why prices of UK produced goods might rise post-Brexit. One is that trade costs such as tariffs and/or non-tariff barriers [eg quotas or levies] might rise, and to the extent that most products – even if produced domestically – entail a significant amount of foreign input, these trade costs would be reflected in higher prices.

Of course, we don’t yet know what kind of trading arrangement the UK will have with the EU, and whether or not it will effectively leave the Single Market. If so, the potential for trade costs to rise would presumably be larger.

"Big investment decisions are typically made in a forward-looking manner, so anything that changes firms’ expectations about future market conditions would have implications right now."

The second reason is indirectly related to Brexit, as the British currency lost a good deal of its value in the aftermath of the Referendum. As a rule, whenever the pound sterling depreciates, that makes imports more expensive. Again, even domestically produced goods typically contain a significant amount of foreign inputs. If they’re not inputs in a physical sense, such as ingredients or the technical parts in a smartphone, they could be services such as phone calls or banking from foreign service providers who have set up shop here.

What presumably sparked this question is the Marmite War [where producer Unilever demanded a 10 per cent rise in payment from Tesco]. In that case, it’s because Marmite has inputs from abroad and Unilever, with the pound sterling depreciating, has an incentive to raise prices because otherwise its revenues suffer.

After that, it’s a question of the pass-through – the extent to which exchange-rate movements translate into product prices. Almost all firms have some sort of market power to set the price above their marginal cost so as to make some sort of profit, and if they are faced with shocks to their costs then part of the adjustment will come from adjusting consumer prices, but part will be absorbed in mark-ups. In each case, it depends on how strong a position the producer has.

If it’s in a very competitive market, such as low-end clothing, where consumers are very price-sensitive, then firms might have to suck up any rise in costs because if they raised the price even a little bit all their customers will run away. If it’s in a market with a relatively upscale, differentiated product in which a firm either has a monopoly or its product is viewed as unique, such as an iPhone or Marmite, then the producer has a lot more leeway to raise prices and consumers will take that to some extent.

I think there are good reasons to believe that it might also be because firms are planning in advance. Big investment decisions are typically made in a forward-looking manner so anything that changes firms’ expectations about future market conditions would have implications right now.

Equally, Brexit may also have provided a focal point for trying to raise prices anyway. In the case of Marmite, telling apart what can really be attributed to the exchange-rate depreciation and what can be attributed to just a tug of war between two monopolies, Tesco and the producer of Marmite, is hard because neither side is perfectly competitive. They’re basically two monopolies because Tesco is so big that it has a huge amount of bargaining power.

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