Are we paying to live in rip-off Britain?

AUGUST WAS not a good month for the supermarkets. First they learned that they were to be looked into by the Office of Fair Trading, which suspects they are making too much profit. And then the Murdoch press has begun attacking them for overpricing because so much of what they sell can be bought more cheaply in Europe.

So are we really living in "rip-off Britain" where the supermarkets gang up to extort huge margins from the ordinary shopper? I don't think so, but before I explain why, I must declare an interest. I am a regular customer and great fan of our supermarkets, one of which is a customer of my firm.

The reason why I don't think a comparison of a fairly small basket of items bought in England with its counterpart bought in France tells us anything about the profit margins of UK supermarkets is that, in the short run, any comparison of this sort is completely dominated by exchange rate movements.

Think back to that fateful Wednesday in September 1992 when sterling dropped out of the European Exchange Rate Mechanism. In August the pound bought nearly 10 French francs. By October it bought little more than 8 francs - the actual fall was just over 14 per cent between the two months.

Now imagine that the investigators had compared an English and a French shopping basket in August and found that the prices were roughly equal. Then, suppose that they did the exercise again in October. Inflation was low, so prices in each of the local currencies would scarcely have changed. But when the French prices were converted back into sterling at the new exchange rate, they would be 14 per cent higher. Rip-off France?

The sterling devaluation in 1992, although quicker, was actually less than the appreciation of the pound that has taken place over the last two-and-a-half years. It has moved from a low point of just over 7.5 francs in 1995 to a high of nearly 10.5 francs before falling back to the present rate of just under 10 francs. Assuming for a moment that local prices were unaffected - I'll come back to that - this has put the price of the British shopping basket, compared with the French, up by no less than 37 per cent. Rip-off Britain? The rising exchange rate doesn't initially change margins one iota, but it certainly makes our shopping basket look expensive.

Of course, local prices have changed. My charts show what has actually happened. UK retail prices have been growing faster than French prices, as the top chart shows. But the difference, which is around 2 per cent a year, is completely swamped by the exchange-rate movements, shown in the middle chart. The bottom chart puts the two together and shows how French prices, when converted from francs to pounds, have moved. This is the price of the French shopping basket to the British buyer.

Because of currency movements French goods have fallen in price by 15 per cent to the British shopper since the first quarter of 1996, while the price of the UK basket has marched steadily upwards by 8 per cent. No wonder then that Britain seems an expensive place to shop compared with France.

The bottom chart showing relative prices in a common currency is based on index numbers and only tells us about relative movements over time. It accords with common sense. Britain was uncompetitive - that is, UK goods were more expensive than French goods - in 1990-92, which is why the pound was ultimately forced out of the ERM. It was then highly competitive for nearly four years, until it the recent appreciation wiped out that margin. At current exchange rates Britain looks somewhat uncompetitive, and our balance of payments is deteriorating.

Now we must of course look beyond exchange rate movements and ask what their effect will be on prices and on margins. Let us think - pleasant subject - about wine. When the pound is strong the wine in UK supermarkets looks very expensive compared to what you can buy in France. I priced a bottle of Pouilly Fume at a mere pounds 4 in a French supermarket this summer. You would be lucky to buy a wine of similar quality at twice the price in the UK.

Rip-off Britain? No, because the expensive bottle you buy in the UK is more heavily taxed and was probably bought in by the supermarket at a price that reflects the old, less favourable, exchange rates. When the pound rises, individuals can nip over to Calais and buy cheap wine next day. It takes the supermarkets rather longer to replace their expensive stock.

You can be sure that the wine buyers in Tesco, Waitrose and Sainsbury's will have noticed my Pouilly Fume, or similar opportunities, and the vigorous competition between them will ensure that good-value French wine will find its way on to British supermarket shelves. But finding the product in bulk, negotiating terms and drawing up new supply contracts takes a lot longer than a quick trip to Calais. Individuals can arbitrage in wine faster than supermarkets can.

None of this is to deny that there are many things that you can buy more cheaply in French supermarkets than in English ones, even when the exchange rate has settled down to a normal value. The fact is that the supermarkets sell 20,000 to 40,000 product lines, depending on their size. Many of these products may occupy very different niches in different markets and be priced accordingly. So you can always find a basket of rip-off goods if you look for one. To establish whether prices really are higher in general in the UK than in France is actually a pretty laborious statistical exercise. You cannot just select a handful of goods at random: you need to sample a wide variety of goods in a wide variety of locations. You need to establish standards to ensure you are comparing like with like.

The international organisations grapple with this and produce statistics telling us how much cheaper it is to buy a representative basket of goods in one country rather than another. According to the OECD earlier this year, you could buy that basket 7 per cent cheaper in France than in the UK. That is a carefully-researched figure and a fairly small difference. It is much more representative than some of the dramatic differences in the cost of particular items found by the Sunday Times.

And that 7 per cent difference tells us little or nothing about supermarket margins. It simply says UK prices have not fully adjusted to the effect of the rising pound.

Bill Robinson is a director of the consultancy London Economics