Balassa–Samuelson effect

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.

Workers in some countries have higher than in others. This is the ultimate source of the income differential. (Also expressed as productivity growth.)

productivity

Certain labour-intensive jobs are less responsive to productivity innovations than others. For instance, a highly skilled burger flipper is no more productive than his Moscow counterpart (in burger/hour) but these jobs are services which must be performed locally.

Zürich

The fixed-productivity sectors are also the ones producing non-transportable goods (for instance haircuts) – this must be the case or the work would have been off-shored.

labour intensive

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 (real) 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.

exchange rate

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.

Trade theory implications[edit]

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 in traded goods does not lead to as much of an improvement in the living 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.)

History[edit]

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

economic inequality, and per capita income

Free trade

and econometrics

Mathematical economics

with links to the academic Balassa–Samuelson effect discussion

Widely cited examination of the relationship between distribution-sector productivity and the effect

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.

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

.