Wealth, price levels, and product quality

Why are price levels in Germany lower than in Switzerland despite comparable productivity levels and the possibility of goods arbitrage in this region? Standard theories in macroeconomics have severe difficulties in explaining this theoretically important outlier. We construct a dataset of 73 developed and developing countries to highlight the tight connection between price levels, product quality, and household wealth. We find that wealth per capita has a 20 percentage points higher explanatory power than income per capita — the key variable implied by standard theories. Analyzing more than 4000 product import categories, we find that Swiss unit values are more than twice as high as German unit values in the median product category. We then provide a theory linking these three forces. Wealth induces consumption shifts toward more expensive goods. As official price statistics tend to underestimate quality improvements, they overstate prices. In turn, higher product quality that comes with higher wealth inflates prices and thus contributes toward explaining price level differences across countries.