Competition in the Israeli Economy and its Effect on Prices: A Sector-Based Phillips Curve Analysis

In recent years, the rate of inflation in Israel has declined, despite the fact that the economy is around a state of full employment. The prevailing belief is that one of the factors responsible for this trend is stronger competition, particularly in the tradable sectors. This paper presents an analysis of the factors that influence price levels in the Israeli economy, on a sectoral basis in five different sectors: apparel, food, communications, toiletries and cosmetics, and tours and recreation. In addition to the traditional factors affecting the rate of inflation (exchange rate, import prices, output), we will measure the effect of competition. In this study, we use two alternatives measures for the level of competition, computed at the sector level: (i) markup (sales divided by the sum of the cost of goods sold and selling, general & administrative expenses), and (ii) the expenses ratio (the ratio of selling and marketing expenses to sales). The first indicator has been used in the literature and is related to the Lerner Index. The second indicator is not a classic variable for measuring competition but it fits the specific circumstances that have been observed in Israel. The results are consistent with the existence of a negative relationship between a sector's increase in competition and its rate of inflation. The evidence for the negative relationship is mostly present in the apparel sector.