Balassa-Samuelson Effect

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The Balassa-Samuelson effect (also known as the Samuelson-Balassa effect ) is used to describe two economic-theoretical reasons for the characteristics of developing and emerging countries :

1. Developing country currencies tend to be undervalued (Balassa effect).
2. Developing countries that are catching up have higher inflation rates than industrialized countries (Samuelson effect).

The two effects are named after their discoverers ( Béla Balassa and Paul Samuelson ).

Balassa effect

The starting point of Balassas considerations was the idea that developing countries in tradable goods ( tradables ) has a lower labor productivity have as industrialized countries . However, due to global competition and the validity of purchasing power parity , the prices for both goods do not differ.

Furthermore, Balassa assumes that there are no differences in productivity between the two countries for non-tradable goods and services ( non-tradables ) (especially for very labor-intensive services, there are hardly any productivity differences; e.g. hairdresser, restaurant). Compared to industrialized countries, Balassas believes that developing countries are equally productive in these non-tradable goods. (As a result, lower wages result in cheaper production.)

Due to its greater economic importance, according to Balassas, the sector of tradable goods is more decisive for the level of wages, which is thus mainly determined by the productivity of the labor force in the sector of tradable goods and then applies equally to the sector of non-tradable goods due to labor mobility .

Thus, developing countries can produce tradable goods at the same prices as industrialized countries (due to lower wages and lower productivity). However, according to Balassa's theory, the prices for non-tradable goods in developing countries are lower (lower wages for the same productivity) - that is, the average price level of the developing countries is below that of the industrialized countries.

Because the flows of goods on which the purchasing power parity theory is based only arise in the case of tradable goods, the lower price level of the developing countries remains - their currencies remain undervalued.

Samuelson Effect

Samuelson's reasoning is based on Balassa's assumption of lower labor productivity in developing countries in the tradable goods sector . He therefore assumes that rapidly growing emerging countries will record strong productivity growth, especially in the tradables sector. This leads (assuming marginal productivity wages ) to higher wage growth rates.

In the tradable goods sector, prices are unlikely to rise as wage increases are offset by productivity growth. The higher wages are also paid in the non-tradable goods sector, since otherwise all employees in this sector would switch to the tradable sector. In the non-tradable goods sector, however, there is no comparable productivity growth, so that the rising costs are compensated for by increases in the price of goods. Accordingly, an overall higher inflation rate is likely.

Importance of the effects

Both effects can be proven empirically and are therefore accepted as fact by most economists. The Samuelson effect is likely to be of greater economic policy importance; it plays a role today, particularly in connection with the introduction of the euro in the Central and Eastern European countries ( CEEC ). According to Samuelson's definition, the CEEC can be described as developing countries catching up, for which higher inflation rates are to be expected. Should the CEECs introduce the euro, this would possibly lead to two problems:

First, they would first have to meet the convergence criteria of the Maastricht Treaty . According to this, the inflation rate may be a maximum of 1.5 percentage points above the average inflation rate of the three most stable countries in the monetary union. Taking the Samuelson effect into account, this appears both difficult and not absolutely necessary, since higher inflation is associated with stronger productivity growth. Various economists therefore advocate weakening the corresponding convergence criterion for the CEEC. Second, the Samuelson effect might cause problems for the single European monetary policy of the ECB . The ECB has set itself the monetary policy target of inflation “below, but close to, two percent”. The inflation value relates to the average price increase in the entire euro area. Since an increase in average inflation in the euro area is possible following the introduction of the euro in the CEEC due to the Samuelson effect, the ECB could see itself compelled to implement a more restrictive monetary policy in order to achieve its goals. Here, too, some economists criticize that such an approach by the ECB would be wrong, since nothing has changed in the inflation of the previous euro countries and the higher inflation in the new euro countries appears to be of little concern due to the higher productivity growth. The economists argue that if the monetary policy objectives are not adjusted, the restrictive monetary policy makes deflation more likely in the western euro countries.

history

In 1964 the Balassa-Samuelson effect was developed independently by Bela Balassa and Paul Samuelson . It is surprising that both economists carried out their models separately and simultaneously, with a partial explanation of the model described 25 years earlier by Roy Forbes Harrod in The Economics of Foreign Trade .

Theory

The Balassa-Samuelson effect depends on intersectoral differences that show up in the relative productivity of tradable and non-tradable goods.

Shape of the effect

If productivity gains are concentrated against other countries in the trading sector, the domestic price of non-tradable goods will increase. If typical productivity gains are concentrated in tradable goods, high productivity will ultimately complement the RER (real consumption tax).

Economic growth theories usually claim that productivity increases. Hence, the Balassa-Samuelson effect asserts: The tradable sector has a higher productivity increase than the non-tradable sector, which leads to higher relative prices for non-tradable products. Since the prices of traded goods are constant, the relative prices of non-tradable goods are higher and the CPI increases with the average increase in productivity.

The effect in detail

A typical discussion of this argument (e.g. by Paul Krugman) would include the following properties:

- The productivity of workers varies from country to country. This is the crucial source of the income differential or productivity growth.

- Certain labor intensive jobs are less responsive to productivity innovations than others. For example, a highly experienced burger pinball machine in Zurich is no more productive than its Moscow counterpart (burgers per hour). However, these jobs are services that must be performed locally.

- Fixed productivity sectors are also those that produce non-transportable goods (for example haircuts).

- In order to balance local wage levels, McDonald's employees in Zurich have to earn more than Moscow employees, even though the burger production rate per employee is an international constant.

- The consumer price index is formed as follows:

+ local goods

+ Tradables that have the same price everywhere.

- So that tradable goods follow PPP ( purchasing power parity ) (real), the consumption tax is doubled (per price law). The assumption that PPP only counts for tradable goods is testable.

- Since the exchange rate fluctuates with the productivity of commodities, the average productivity changes to a lesser extent, the productivity gap (of real goods) is smaller than the productivity gap in the denominations of money.

- Productivity becomes income , so real income changes less than money income.

- The price level is higher in more productive economies because the exchange rate of real income is higher.

Role of the Balassa-Samuelson Effect

The Balassa Samuelson Effect is an explanation for changes in prices between tradable and non-tradable goods. If productivity develops differently in the two sectors, there will be changes in relative prices. That is, the tradable sector has a higher productivity increase than the non-tradable sector, which leads to higher relative prices for non-tradable products. With the average increase in productivity, the relative prices of non-tradable goods are higher when the prices of traded goods are constant.

The Balassa-Samuelson Effect in Central Europe

This thesis aims to show and analyze the different inflation rates of six different Central European economies . These are the economies of Croatia, the Czech Republic, Hungary, Poland, Slovakia and Slovenia. The scope of tradable and non-tradable sectors is larger and more detailed than in previous studies and the amount of data is much larger (quarterly data collection over a period of 10 years). The main conclusion is this:

average productivity growth per year

Productivity differences explain only a difference between 0.2 and 2 percentage points of the annual inflation differentials in the euroregion. In addition, they explain only a small proportion of the inland inflation in the central European economies. Earlier studies that considered the Balassa-Samuelson effect to be more significant have often disregarded the influence of productivity differences on inflation between the euro countries and referred instead only to domestic inflation. Many studies have also ignored the relatively high productivity growth of non-tradable industries . The financial attacks in this paper suggest that differences in productivity growth between EU accession and the euro area are unlikely to widen enough to become a major factor in the ability of these countries to meet the Maastricht criteria.

Balassa-Samuelson hypothesis

An explanatory approach for structural differences in the inflation development between individual countries in a currency union is presented below. The following applies to the inflation rates:

1) - = - ${\displaystyle \pi \,_{N}}$ ${\displaystyle \pi \,_{T}}$ ${\displaystyle {\hat {a}}_{T}}$ ${\displaystyle {\hat {a}}_{N}}$

• ${\displaystyle \pi \,}$: Inflation rate

• ${\displaystyle {\hat {a}}}$ as sectoral inflation rates or labor productivity growth rates

• T: tradable goods

• N: non-tradable goods

The overall economic price level in rates of change is:

2) = * + (1 - ) * ${\displaystyle \pi \,}$ ${\displaystyle \alpha \,}$ ${\displaystyle \pi \,_{N}}$ ${\displaystyle \alpha \,}$ ${\displaystyle {\hat {a}}_{T}}$

${\displaystyle \alpha \,}$ as the constant assumed fractions of consumer expenditure that are used for tradable and non-tradable goods.

From 1) and 2) → 3) = + * ( - ) ${\displaystyle \pi \,}$ ${\displaystyle \pi \,_{T}}$ ${\displaystyle \alpha \,}$ ${\displaystyle {\hat {a}}_{T}}$ ${\displaystyle {\hat {a}}_{N}}$

Inflation differentials in Euroland

If the inflation rate of tradable goods is constant and the difference in productivity growth between tradable and non-tradable goods increases, then the inflation rate is higher . ${\displaystyle \pi \,_{T}}$ ${\displaystyle \pi \,}$

Further assumptions: appropriate considerations for foreign inflation  : . ${\displaystyle \pi \,^{*}}$

Inflation differential between the two sectors at home and abroad:

Equation : - = - + (( - ) - ( - )) ${\displaystyle \pi \,^{*}}$ ${\displaystyle \pi \,}$ ${\displaystyle \pi \,_{T}^{*}}$ ${\displaystyle \pi \,_{T}}$ ${\displaystyle \alpha \,}$ ${\displaystyle {\hat {a}}_{T}^{*}}$ ${\displaystyle {\hat {a}}_{N}^{*}}$ ${\displaystyle {\hat {a}}_{T}}$ ${\displaystyle {\hat {a}}_{N}}$

The inflation difference is positive or - > 0. There are two reasons for this: ${\displaystyle \pi \,^{*}}$ ${\displaystyle \pi \,}$

• The price of tradable goods abroad is higher than at home.
• The relative price of non-tradable goods abroad is also higher than at home due to productivity growth.

Balassa-Samuelson Effect in the Future

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Then, when productivity growth declines, the impact of the Balassa-Samuelson effect can be limited.

However, the market for tradable goods must always be more competitive than that of non-tradable goods, if only because of its size. In the marketplace for tradable goods, all manufacturers of an article are in competition with other manufacturers of the article. Manufacturers of non-tradable goods only have to assert themselves against local competition. As competition increases productivity, tradable goods will always generate faster growth rates than non-tradable goods, which in turn means that the Balassa-Samuelson effect will persist.

literature

• Paul De Grauwe and Frauke Skudelny : Inflation and Productivity Differentials in EMU , Centrum voor Economische Studien Discussion Paper 15, 2000
• Gustav Dieckheuer : International Economic Relations , 5th edition, 2001, p. 543 ff.

Web links

• How sure are we about the Balassa-Samuelson hypothesis? (PDF; 150 kB)
• wiwi.uni-passau (PDF; 448 kB)
• THE LENS OF THE DEPENDENT ECONOMY MODEL
• How Important is the Harrod-Balassa-Samuelson Effect (PDF; 396 kB)
• (French) Measuring the Balassa-Samuelson effect (PDF; 1.8 MB)
• Inflation differentials in Euroland by Markus Kaufmann and Marco Engemann

Individual evidence

1. ^ Siebert, Horst (2006): Außenwirtschaft, UTB, Stuttgart; Edition: 8. A.
2. ↑ Working Papers
3. ↑ Inflation rate: uni-kassel.de