Price dispersion across Indian states: A club convergence analysis

• Published date: 01 February 2021
• Author: Bhushan Praveen Jangam,Vaseem Akram,Pradipta Kumar Sahoo
• Date: 01 February 2021
• DOI: http://doi.org/10.1002/pa.2134

ACADEMIC PAPER

Price dispersion across Indian states: A club convergence

analysis

Bhushan Praveen Jangam|Vaseem Akram|Pradipta Kumar Sahoo

Department of Liberal Arts, Indian Institute of

Technology Hyderabad, Sangareddy, India

Correspondence

Bhushan Praveen Jangam, Department of

Liberal Arts, Indian Institute of Technology

Hyderabad, Sangareddy, Telangana, India-

502285.

Email: bhushanjp1@gmail.com

This study examines the price convergence across 28 Indian states and 7 union terri-

tories at an aggregate and subgroups level over the period 2011–12 to 2017–18. We

employ a novel approach of Phillips and Sul panel convergence technique, which

accounts for transitional dynamics and heterogeneity in the panel. The results sug-

gest price divergence and evidence of clubs across Indian states at both aggregate

and subgroup level. The outcomes of this study help policymakers in addressing the

price dispersion across states, which in turn improves the market integration, alloca-

tion of resources, and standard of living.

JEL CLASSIFICATION

C23; E31

1|INTRODUCTION

Price convergence is a well-researched topic in the field of economics

to validate whether the markets are integrated or fragmented. Much

of the research is devoted to verifying the notions of absolute (or

beta) convergence and sigma convergence (Brock & Taylor, 2010;

Solow, 1956). The main drawback of these approaches is that they

are based on the single steady state which may not be a true case,

especially when considered a set of countries or regions. To address

this problem, we consider a novel approach of Phillips and

Sul (2007), (2009) (hereafter PS) to test the convergence hypothesis,

which relaxes the assumption of one single steady state. The examina-

tion of price convergence is associated with the law of one price

(LOOP). According to the LOOP, when goods are expressed in a com-

mon currency, identical goods must hold the same price. The rise in

the price of an identical good in a region will result in market forces

consecutively reverting the prices to equality. In the literature, the

growing body of research confirms the validity of purchasing power

parity as a long-run phenomenon (Obstfeld & Rogoff, 2000). Most of

these studies have focused on validating the price level convergence

at the aggregate level. Analysis of price convergence across regions

has attained increased consideration due to availability of data.

Greater dispersion of price across regions and its continuance eventu-

ally have severe consequences on the allocation of resources, wages,

and standard of living in an economy. Figure 1 plots the mean values

of consumer prices of Indian states and union territories over the

period 2011–12 to 2017–18. The huge dispersion of prices from the

figure motivates us to examine if the prices across Indian states con-

verge. Convergence in the prices across Indian states suggests that

the markets are integrated and any deviation in the prices adjust

quickly.

A large number of studies have examined the question of

whether the law of one price or price convergence exists across the

countries. The findings are mixed (Chmelarova & Nath, 2010; Engel &

Rogers, 2004; Méjean & Schwellnus, 2009; Tsai, 2018 and Yazgan &

Yilmazkuday, 2011). Fleming (1971)'s was the first study to highlight

the importance of price convergence. Many studies failed to reject

the random walk behavior of real exchange rates suggesting that any

deviance from the purchasing power parity is permanent. According

to Sarno and Taylor (2002), when modelled through the nonlinear

framework, the LOOP tends to be valid. The emergence of price dis-

parities across regions may be due to the monopoly of the firms,

transportation costs, presence of nontraded products, segmentation

of labor markets, informational asymmetries, and productivity

(Tirtosuharto & Adiwilaga, 2013; Varela, Aldaz-Carroll, &

Iacovone, 2013).

Through regional analysis, the problems associated, such as factor

market rigidities and volatility of exchange rates can be disregarded

(Parsley & Wei, 1996). The empirical validity of price convergence is

abundant, primarily focusing on the developed economies. Studies in

case of Indian states are few. The study by Morshed, Ahn, and

Lee (2006) examined the convergence in consumer price indices for

Received: 16 September 2019Revised: 26 November 2019Accepted: 8 March 2020

DOI: 10.1002/pa.2134

J Public Affairs. 2021;21:e2134.wileyonlinelibrary.com/journal/pa© 2020 John Wiley & Sons, Ltd1of13

https://doi.org/10.1002/pa.2134