42.5 KB · ⇊ 12 parts · ⤓ Micron 42.5 KB · ⤓ HTML 60.0 KB

layout: Wide · Narrow · Centered

top

The Balassa–Samuelson effect, also known as Harrod–Balassa–Samuelson

effect (Kravis and Lipsey 1983), the

Ricardo–Viner–Harrod–Balassa–Samuelson–Penn–Bhagwati effect (Samuelson

1994, p. 201), or productivity biased purchasing power parity (PPP)

(Officer 1976) is the tendency for consumer prices to be systematically

higher in more developed countries than in less developed countries.

This observation about the systematic differences in consumer prices is

called the "Penn effect". The Balassa–Samuelson hypothesis is the

proposition that this can be explained by the greater variation in

productivity between developed and less developed countries in the

traded goods' sectors which in turn affects wages and prices in the

non-tradable goods sectors.

Béla Balassa and Paul Samuelson independently proposed the causal

mechanism for the Penn effect in the early 1960s.

• Theory

• Empirical "Penn Effect"

• Basic form of the effect

• Details

• Equivalent Balassa–Samuelson effect within a country

• Empirical evidence on the Balassa–Samuelson effect

• Alternative, and additional causes of the Penn effect

• Distribution sector

• Differences in endowment of labor relative to capital

• Dutch disease

• Services are a 'superior good'

• Protectionism

• Trade theory implications

• History

• See also

• Notes

• References

• Further reading

• External links

The Balassa–Samuelson effect depends on inter-country differences in the

relative productivity of the tradable and non-tradable sectors.

By the law of one price, entirely tradable goods cannot vary greatly in

price by location because buyers can source from the lowest cost

location. However, most services must be delivered locally (e.g.

hairdressing), and many manufactured goods such as furniture have high

transportation costs or, conversely, low value-to-weight or low

value-to-bulk ratios, which makes deviations from the law of one price,

known as purchasing power parity or PPP-deviations, persistent. The Penn

effect is that PPP-deviations usually occur in the same direction: where

incomes are high, average price levels are typically high.

The simplest model which generates a Balassa–Samuelson effect has two

countries, two goods (one tradable, and a country-specific nontradable)

and one factor of production, labor. For simplicity assume that

productivity, as measured by marginal product (in terms of goods

produced) of labor, in the nontradable sector is equal between countries

and normalized to one.

M P L n t , 1 = M P L n t , 2 = 1 {\displaystyle

MPL_{nt,1}=MPL_{nt,2}=1}

where "nt" denotes the nontradable sector and 1 and 2 indexes the two

countries.

In each country, under the assumption of competition in the labor market

the wage ends up being equal to the value of the marginal product, or

the sector's price times MPL. (Note that this is not necessary, just

sufficient, to produce the Penn effect. What is needed is that wages are

at least related to productivity.)

w 1 = p n t , 1 ∗ M P L n t , 1 = p t ∗ M P L t , 1 {\displaystyle

w_{1}=p_{nt,1}*MPL_{nt,1}=p_{t}*MPL_{t,1}}

w 2 = p n t , 2 ∗ M P L n t , 2 = p t ∗ M P L t , 2 {\displaystyle

w_{2}=p_{nt,2}*MPL_{nt,2}=p_{t}*MPL_{t,2}}

Where the subscript "t" denotes the tradables sector. Note that the lack

of a country specific subscript on the price of tradables means that

tradable goods prices are equalized between the two countries.

Suppose that country 2 is the more productive, and hence, the wealthier

one. This means that

M P L t , 1 < M P L t , 2 {\displaystyle MPL_{t,1}<MPL_{t,2}}

which implies that

p n t , 1 < p n t , 2 {\displaystyle p_{nt,1}<p_{nt,2}} .

So with a same (world) price for tradable goods, the price of

nontradable goods will be lower in the less productive country,

resulting in an overall lower price level.

A typical discussion of this argument would include the following

features:

• Workers in some countries have higher productivity than in others.

This is the ultimate source of the income differential. (Also expressed

as productivity growth.)

• Certain labour-intensive jobs are less responsive to productivity

innovations than others. For instance, a highly skilled Zürich burger

flipper is no more productive than his Moscow counterpart (in

burger/hour) but these jobs are services which must be performed

locally.

• The fixed-productivity sectors are also the ones producing

non-transportable goods (for instance haircuts) – this must be the case

or the labour intensive work would have been off-shored.

• To equalize local wage levels with the (highly productive) Zürich

engineers, Zürich fast food employees must be paid more than Moscow fast

food employees, even though the burger production rate per employee is

an international constant.

• The CPI is made up of:

• local goods (which in richer countries are more expensive relative

to tradables), and

• tradables, which have the same price everywhere

• The (real) exchange rate is pegged (by the law of one price) so that

tradable goods follow PPP (purchasing power parity). The assumption that

PPP holds only for tradable goods is testable.

• Since money exchange rates will vary fully with tradable goods

productivity, but average productivity varies to a lesser extent, the

(real goods) productivity differential is less than the productivity

differential in money terms.

• Productivity becomes income, so the real income varies less than the

money income does.

• This is equivalent to saying that the money exchange rate exaggerates

the real income, or that the price level is higher in more productive,

richer, economies.

The average asking price for a house in a prosperous city can be ten

times that of an identical house in a depressed area of the same

country. Therefore, the RER-deviation exists independent of what happens

to the nominal exchange rate (which is always 1 for areas sharing the

same currency). Looking at the price level distribution within a country

gives a clearer picture of the effect, because this removes some

complicating factors:

1. The econometrics of purchasing power parity (PPP) tests are

complicated by nominal exchange rate noise. (This noise would be an

econometric problem, even assuming that the exchange rate volatility is

a pure error term).

2. There may be some real economy border effects between countries which

limit the flow of tradables or people.

3. Monetary effects, and exchange rate movementscite-ref-1[note 1] can affect the

real economy and complicate the picture, a problem eliminated if

comparing regions that use the same currency unit.

4. Taxes are very different in many countries, whereas in a same country

taxes are usually equal or similar.

A pint of pub beer is famously more expensive in the south of England

than the north, but supermarket beer prices are very similar. This may

be treated as anecdotal evidence in favour of the Balassa–Samuelson

hypothesis, since supermarket beer is an easily transportable, traded

good. (Although pub beer is transportable, the pub itself is not.) The

BS-hypothesis explanation for the price differentials is that the

'productivity' of pub employees (in pints served per hour) is more

uniform than the 'productivity' (in foreign currency earned per year) of

people working in the dominant tradable sector in each region of the

country (financial services in the south of England, manufacturing in

the north). Although the employees of southern pubs are not

significantly more productive than their counterparts in the north,

southern pubs must pay wages comparable to those offered by other

southern firms in order to keep their staff. This results in southern

pubs incurring a higher labour cost per pint served.

Evidence for the Penn effect is well established in today's world (and

is readily observable when traveling internationally). However, the

Balassa–Samuelson (BS) hypothesis implies that countries with rapidly

expanding economies should tend to have more rapidly appreciating

exchange rates (for instance the Four Asian Tigers); conventional

econometric tests yield mixed findings for this prediction.

In total, since it was (re)discovered in 1964, according to Tica and

Druzic (2006)cite-ref-2[1] the HBS theory "has been tested 60 times in 98

countries in time series or panel analyses and in 142 countries in

cross-country analyses. In these analyzed estimates, country specific

HBS coefficients have been estimated 166 times in total, and at least

once for 65 different countries". Many papers have been published since

then. Bahmani-Oskooee and Abm (2005) & Egert, Halpern and McDonald

(2006) also provide quite interesting surveys of empirical evidence on

BS effect.

Over time, the testing of the HBS model has evolved quite dramatically.

Panel data and time series techniques have crowded out old cross-section

tests, demand side and terms of trade variables have emerged as

explanatory variables, new econometric methodologies have replaced old

ones, and recent improvements with endogenous tradability have provided

direction for future researchers.

The sector approach combined with panel data analysis and/or

cointegration has become a benchmark for empirical tests. Consensus has

been reached on the testing of internal and external HBS effects (vis a

vis a numeraire country) with a strong reservation against the

purchasing power parity assumption in the tradable sector.

The vast majority of the evidence supports the HBS model. A deeper

analysis of the empirical evidence shows that the strength of the

results is strongly influenced by the nature of the tests and set of

countries analyzed. Almost all cross-section tests confirm the model,

while panel data results confirm the model for the majority of countries

included in the tests. Although some negative results have been

returned, there has been strong support for the predictions of a

cointegration between relative productivity and relative prices within a

country and between countries, while the interpretation of evidence for

cointegration between real exchange rate and relative productivity has

been much more controversial.

Therefore, most of the contemporary authors (e.g.: Egert, Halpern and

McDonald (2006); Drine & Rault (2002)) analyze main BS assumptions

separately:

1. The differential of productivities between the traded and non-traded

sector and relative prices are positively correlated.

2. The purchasing power parity assumption is verified for tradable

goods.

3. The RER and relative prices of non-tradable goods are positively

correlated.

4. As a consequence of 1, 2, & 3, there is a long-run relationship

between productivity differentials and the RER.

Refinements to the econometric techniques and debate about alternative

models are continuing in the International economics community. For

instance:

"A possible explanation of the BS empirical rejection may simply be

that there are additional long-run real exchange determinants that

have to be considered." Drine & Rault conclude.

The next section lists some of the alternative proposals to an

explanation of the Penn effect, but there are significant econometric

problems with testing the BS-hypothesis, and the lack of strong evidence

for it between modern economies may not refute it, or even imply that it

produces a small effect. For instance, other effects of exchange rate

movements might mask the long-term BS-hypothesis mechanism (making it

harder to detect if it exists). Exchange rate movements are believed by

some to affect productivity; if this is true then regressing RER

movements on differential productivity growth will be 'polluted' by a

totally different relationship between the variablesfootnote-11.

Most professional economists accept that the Balassa–Samuelson effect

model has some merit. However other sources of the Penn effect RER/GDP

relationship have been proposed:

In a 2001 International Monetary Fund working paper Macdonald & Ricci

accept that relative productivity changes produce PPP-deviations, but

argue that this is not confined to tradables versus non-tradable

sectors. Quoting the abstract:

An increase in the productivity and competitiveness of the

The Bhagwati–Kravis–Lipsey view provides a somewhat different

explanation from the Balassa–Samuelson theory. This view states that

price levels for nontradables are lower in poorer countries because of

differences in endowment of labor and capital, not because of lower

levels of productivity. Poor countries have more labor relative to

capital, so marginal productivity of labor is greater in rich countries

than in poor countries. Nontradables tend to be labor-intensive;

therefore, because labor is less expensive in poor countries and is used

mostly for nontradables, nontradables are cheaper in poor countries.

Wages are high in rich countries, so nontradables are relatively more

expensive.cite-ref-krugman-3-0[2]

Capital inflows (say to the Netherlands) may stimulate currency

appreciation through demand for money. As the RER appreciates, the

competitiveness of the traded-goods sectors falls (in terms of the

international price of traded goods).

In this model, there has been no change in real economy productivities,

but money price productivity in traded goods has been exogenously

lowered through currency appreciation. Since capital inflow is

associated with high-income states (e.g. Monaco) this could explain part

of the RER/Income correlation.

Yves Bourdet and Hans Falck have studied the effect of Cape Verde

remittances on the traded-goods sector.cite-ref-4[3] They find that, as local

incomes have risen with a doubling of remittances from abroad, the Cape

Verde RER has appreciated 14% (during the 1990s). The export sector of

the Cape Verde economy suffered a similar fall in productivity during

the same period, which was caused entirely by capital flows and not by

the BS-effect.cite-ref-5[note 2]

Rudi Dornbusch (1998) and others say that income rises can change the

ratio of demand for goods and services (tradable and non-tradable

sectors). This is because services tend to be superior goods, which are

consumed proportionately more heavily at higher incomes.

A shift in preferences at the microeconomic level, caused by an

income effect can change the make-up of the consumer price index to

include proportionately more expenditure on services. This alone may

shift the consumer price index, and might make the non-traded sector

look relatively less productive than it had been when demand was lower;

if service quality (rather than quantity) follows diminishing returns to

labour input, a general demand for a higher service quality

automatically produces a reduction in per-capita productivity.

A typical labour market pattern is that high-GDP countries have a higher

ratio of service-sector to traded-goods-sector employment than low-GDP

countries. If the traded/non-traded consumption ratio is also correlated

with the price level, the Penn effect would still be observed with

labour productivity rising equally fast (in identical technologies)

between countries.

Lipsey and Swedenborg (1996) show a strong correlation between the

barriers to free trade and the domestic price level. If wealthy

countries feel more able to protect their native producers than

developing nations (e.g. with tariffs on agricultural imports) we should

expect to see a correlation between rising GDP and rising prices (for

goods in protected industries - especially food).

This explanation is similar to the BS-effect, since an industry needing

protection must be measurably less productive in the world market of the

commodity it produces. However, this reasoning is slightly different

from the pure BS-hypothesis, because the goods being produced are

'traded-goods', even though protectionist measures mean that they are

more expensive on the domestic market than the international market, so

they will not be "traded" internationallycite-ref-6[note 3]

The supply-side economists (and others) have argued that raising

international competitiveness through policies that promote traded goods

sectors' productivity (at the expense of other sectors) will increase a

nation's GDP, and increase its standard of living, when compared with

treating the sectors equally. The Balassa–Samuelson effect might be one

reason to oppose this trade theory, because it predicts that: a GDP gain

standard as an equal GDP increase in the non-traded sector. (This is due

to the effect's prediction that the CPI will increase by more in the

former case.)

The Balassa–Samuelson effect model was developed independently in 1964

by Béla Balassa and Paul Samuelson. The effect had previously been

hypothesized in the first edition of Roy Forbes Harrod's International

Economics (1939, pp. 71–77), but this portion was not included in

subsequent editions.

Partly because empirical findings have been mixed, and partly to

differentiate the model from its conclusion, modern papers tend to refer

to the Balassa–Samuelson hypothesis, rather than the Balassa–Samuelson

effect. (See for instance: "A panel data analysis of the

Balassa-Samuelson hypothesis", referred to above.)

• List of international trade topics

• Free trade, economic inequality, and per capita income

• Mathematical economics, and econometrics

cite-note-1note 1. ↑ There may be a causal link from exchange rates to productivity, as well as (or instead of) the opposite direction of causation (from productivity to RERs) given by the BS-hypothesis model. Michael E. Porter's The Competitive Advantage of Nations says that currency depreciations can reduce growth, and that 'overvalued' currencies can contribute to domestic productivity growth by 'forcing' efficiency improvements in the tradables sector (by exposing it to international competition at unfavourable terms of trade). In fact, Singapore gave "Competitive Appreciation" as the official reason for the high SGD policy. (Lu & Yu 1999). Other mechanisms through which RERs can affect productivity growth have been advanced, such as the idea that structural transitions caused by exchange rate volatility have a disruptive effect on the real economy. There is some econometric evidence that the causality from exchange rates to productivity is more significant than the reverse, i.e. the BS-effect. (For instance, citerefstrauss1999Strauss, Jack (1999), "Productivity Differentials, the Relative Price of Nontradables and Real Exchange Rates", Journal of International Money and Finance, 18 (3): 383–409, doi:10.1016/S0261-5606(99)85003-7.)

cite-note-5note 2. ↑ The BS-hypothesis would still explain the Cape Verde price index rise in its own terms if the incomes from rising emigrant's remittances were counted as local traded-goods 'productivity' increases. In their study of Cape Verde, Bourdet & Falck found that the export sector strengthened during the 1990s period of currency appreciation, which might support the theory of "Competitive Appreciation" mentioned in the footnote above

cite-note-6note 3. ↑ A typical reason for, and result of, trade barriers, is that domestic productivity of some tradable-good is below international productivity. In order to protect domestic producers import barriers are raised, allowing the local price for the traded good to rise beyond the international price. If this were a common phenomenon then one of the key assumptions of the BS-hypothesis (that traded-goods follow the PPP-hypothesis) would be invalid. However, the essence of the Balassa–Samuelson mechanism would still remain: Even without Free trade it may be harder to increase the productivity in the service sector as rapidly as in mass-production, so if money exchange rates are still based on the output of mass production the differentials in price level could still be caused by the Balassa–Samuelson effect.

cite-note-21. ↑ citerefticadru-i-2006Tica, Josip; Družić, Ivo (13 September 2006). "The Harrod-Balassa-Samuelson Effect: A Survey of Empirical Evidence". Efzg Working Papers Series – via ideas.repec.org.

cite-note-krugman-32. ↑ citerefkrugman-and-obstfeld2009Krugman and Obstfeld (2009). International Economics. Pearson Education, Inc. pp. 394–395.

cite-note-43. ↑ Emigrants' Remittances And Dutch Disease Archived May 13, 2005, at the Wayback Machine

• citerefbahmani-oskooeenasir2005Bahmani-Oskooee, Mohsen & Nasir, Abm (2005), "Productivity Bias

Hypothesis and the Purchasing Power Parity: A Review Article", Journal

of Economic Surveys, 19 (4): 671–696,

doi:10.1111/j.0950-0804.2005.00261.x, S2CID 154668379.

• citerefbahmani-oskooeerhee1996Bahmani-Oskooee, Mohsen & Rhee, Hyun-Jae (1996), "Time-series Support

for Balassa's Productivity-bias Hypothesis: Evidence from Korea", Review

of International Economics, 4 (3): 364–370,

doi:10.1111/j.1467-9396.1996.tb00110.x.

• citerefbalassa1964Balassa, B. (1964), "The Purchasing Power Parity Doctrine: A

Reappraisal", Journal of Political Economy, 72 (6): 584–596,

doi:10.1086/258965, S2CID 56568906.

• citerefdavid1972David, Paul A. (1972), "Just How Misleading are Official Exchange Rate

Conversions?", The Economic Journal, 82 (327): 979–990,

doi:10.2307/2230262, JSTOR 2230262.

• citerefdornbusch1988Dornbusch, R. (1988), "Purchasing Power Parity", The New Palgrave

Dictionary of Economics (Reprint ed.), London: Palgrave Macmillan, ISBN

978-1-56159-197-8.

• citerefharrod1933Harrod, R. F. (1933), International Economics, London: Cambridge

University Press.

• citerefticadruzic2006Tica, J. & Druzic, I. (2006), "The Harrod–Balassa–Samuelson Effect: A

Survey of Empirical Evidence" (PDF), EFZG Working Paper Series 0607.

• citerefdrinerault2002Drine, I. & Rault, C. (2002), Panel data analysis of the

Balassa–Samuelson hypothesis (PDF), Sorbonne University, archived from

the original (PDF) on May 4, 2005{{citation}}: CS1 maint: location

missing publisher (link).

• citeref-gerthalpernmacdonald2006Égert, Balázs; Halpern, László & MacDonald, Ronald (2006),

"Equilibrium Exchange Rates in Transition Economies: Taking Stock of the

Issues", Journal of Economic Surveys, 20 (2): 257–324, CiteSeerX

10.1.1.472.4319, doi:10.1111/j.0950-0804.2006.00281.x, S2CID 34660598.

• citerefkravislipsey1991Kravis, Irving B. & Lipsey, Robert E. (1991), "The International

Comparison Program: Current Status and Problems", in Hooper, Peter &

Richardson, J. David (eds.), International Economic Transactions: Issues

in Measurement and Empirical Research, National Bureau of Economic

Research Studies in Income and Wealth, Chicago: University of Chicago

Press, ISBN 978-0-226-35135-3.

• citereflipsey-robert-e-swedenborg1996Lipsey, Robert E. & Swedenborg, Birgitta (1996), "The High Cost of

Eating: Causes of International Differences in Consumer Food Prices",

Review of Income and Wealth, 42 (2): 181–194,

doi:10.1111/j.1475-4991.1996.tb00165.x.

• citerefluyu1999Lu, Ding & Yu, Qiao (1999), "Hong Kong's exchange rate regime: Lessons

from Singapore", China Economic Review, 10 (2): 122–140,

doi:10.1016/S1043-951X(99)00009-7.

• citerefmacdonaldricci2005MacDonald, R. & Ricci, L. (2005), "The real exchange rate and the

Balassa Samuelson Effect: The Role of the Distribution Sector", Pacific

Economic Review, 10 (1): 29–48, CiteSeerX 10.1.1.199.5086,

doi:10.1111/j.1468-0106.2005.00259.x, S2CID 16829585.

• citerefofficer1976Officer, Lawrence H. (1976), "The Productivity Bias in Purchasing

Power Parity: An Econometric Investigation", IMF Staff Paper 23, vol.

23, no. 3, Palgrave Macmillan Journals, pp. 545–579, JSTOR 3866641.

• citerefporter1998Porter, M. E. (1998), The Competitive Advantage of Nations, Toronto:

Free Press, ISBN 978-0-684-84147-2 (Discusses national

comparative advantage as well as the productivity—exchange rate link).

• citerefsamuelson1964Samuelson, P. A. (1964), "Theoretical Notes on Trade Problems", Review

of Economics and Statistics, 46 (2): 145–154, doi:10.2307/1928178, JSTOR

1928178.

• citerefsamuelson1994Samuelson, P. A. (1994), "Facets of Balassa-Samuelson Thirty Years

Later", Review of International Economics, 2 (3): 201–226,

doi:10.1111/j.1467-9396.1994.tb00041.x.

• Widely cited examination of the relationship between

distribution-sector productivity and the effect with links to the

academic Balassa–Samuelson effect discussion

• The European Central Bank defines BS-effect from the inflation point

of view but says even countries undergoing very rapid traded-goods

productivity growth only experience inflationary pressure in the 1-2%

range, and inflation sources other than Balassa–Samuelson have proven

more significant for past Euro converge candidates like Greece.

• An Empirical test of Balassa–Samuelson from 2000.

"results do not show supportive evidence for the Balassa–Samuelson

effect in the long run."

• Useful summary of the different Exchange Rate Equilibrium models,

including Balassa–Samuelson, as models for estimating a stable

Koruna/Euro level

• The International Association for Research in Income and Wealth's

Product Price Differences across Countries (2004) traces the history of

the qualitative description given by the Balassa–Samuelson effect back

to David Ricardo.

• Paper disputes the applicability of the law of one price to traded

goods; so that the pure Balassa–Samuelson effect is an underestimate of

likely RER changes - Cincibuch & Podpiera (2004) studied the RER

appreciation to explain why it exceeds the Balassa–Samuelson prediction

in the case of bilateral German-Central European country trade as the

traded goods' productivity gap has declined. They argue that in

practise, border barriers mean that tradables appreciate with

productivity, and say:

"Real appreciation is also observed in tradables and often accounts

for the bulk in the overall appreciation".

• A breakdown of the demand and supply side effects on the exchange rate

from rising productivity by professor Ronald MacDonald of

Strathclyde University and C. Wojcik of the Warsaw School of Economics.