Balassa–Samuelson effect

As Balassa -Samuelson effect ( Balassa and Samuelson effect) two theoretical economic justifications to features of developing and emerging countries are referred to:

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

Balassa effect

Starting point of Balassas considerations was the thesis that developing countries in tradable goods (trade Ables ) has a lower labor productivity than manufacturing countries. Because of global competition and the validity of purchasing power parity, however, the prices of both goods do not differ.

Furthermore Balassa assumes that non-tradable goods and services ( Non -Trade Ables ) between the two countries no productivity differences exist (especially in labor-intensive services productivity differences are hardly feasible; eg hairdresser, restaurant). In relation to industrial countries are developing countries Balassas opinion so these non-tradable goods equally productive. ( With lower wages is therefore cheaper to produce. )

Due to its larger economic importance of the tradable sector is Balassas view, however decisive for the amount of wages, which therefore mainly determined by reference to the productivity of the workforce tradable in the goods sector and then due to labor mobility equally non-traded for the sector goods is.

Thus, developing countries produce tradable goods so at the same price as developed countries ( due to lower wages at a lower productivity). However, after Balassas theory, the prices of non- tradable goods in developing countries are lower ( lower wages for the same productivity) - that is, the average price level of developing countries lies below which the industrialized countries.

Because the purchasing power parity theory underlying flows of goods come about only for tradable goods, the lower price level of developing countries persists - so their currencies remain undervalued.

Samuelson effect

Samuelson's reasoning is based on Balassas adopt a lower labor productivity of developing countries in the tradable goods sector. He therefore assumes that fast-growing emerging markets recorded strong increases in productivity, especially in the trade sector Ables. This leads ( at an assumed marginal productivity pay) to higher wage growth rates.

In the tradable goods sector, prices are likely to rise resulting in little, since wage increases are indeed offset by productivity growth. The higher wages are paid but non- tradable goods in the sector, otherwise all workers in the industry would switch to the tradable sector. In the sector of non-tradable goods, however, there is no comparable productivity growth, so that the rising costs are offset over goods price increases. Thus, a higher overall rate of inflation is likely.

Significance of the effects

Both effects can be empirically demonstrate good and are therefore accepted by most economists as fact. Of greater importance of economic policy Samuelson effect is likely to be; He now plays in particular in connection with the introduction of the euro in the Central and Eastern European countries (CEEC ) play a role. The CEEC can be described as developing countries are catching up after Samuelson's definition, are expected for the therefore tend to have higher rates of inflation. If the CEECs to adopt the euro, it would bring possibly two problems:

First, it would first require the convergence criteria of the Maastricht Treaty meet. Accordingly, the inflation rate must be no more than 1.5 percentage points above the average inflation rate of the three best-performing countries in the monetary union. This seems both difficult and not necessary in the light of Samuelson effect, since higher inflation even with a stronger productivity growth goes hand in hand. Various economists therefore advocate mitigate the corresponding convergence criterion for the CEECs. Second, the Samuelson effect would bring possibly problems for the single European monetary policy of the ECB with it. The ECB has set itself the objective of monetary policy of inflation of "below but close to two percent " set. The inflation rate refers to the average price increase across the euro area. Because after euro introduction in the CEECs due to the Samuelson effect an increase in the average inflation in the euro area is possible, the ECB may be compelled to perform a more restrictive monetary policy in order to achieve their goals. Here, too, is criticized by some economists that such an approach the ECB would be wrong, because that's changing nothing on the inflation of the previous Euro countries and the higher inflation in the new Euro countries appears to be little concern due to the higher productivity growth. The economists argue here is that without an adjustment of the monetary policy objective deflation in the Western Euro countries will likely due to the restrictive monetary policy.

History

In 1964, the Balassa -Samuelson effect has been independently developed by Bela Balassa and Paul Samuelson. It is surprising that both economists and their models performed separately at the same time, with a partial explanation of the model was described 25 years earlier by Roy Forbes Harrod in the " economics of foreign economic relations ."

The theory

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

Form of the effect

If productivity increases focus against other countries in the commercial sector, the price of non-tradable goods Midland will increase. If focus typical productivity increases in tradable goods, high productivity will ultimately complement the RER (real exchange rate ).

Economic growth theories usually claim that productivity increases. Therefore, the Balassa -Samuelson effect states: The tradable sector has a higher productivity growth than the non-tradable sector, which leads to higher relative prices of non-tradable products. As 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 ( for example, by Paul Krugman ) would include the following characteristics:

- The productivity of workers varies from country to country. This is the ultimate source of income differentials and productivity growth.

- Certain labor-intensive jobs are productivity innovations less responsive than others. So about an experienced highly burger flipper in Zurich not productive than his Moscow counterpart ( burgers per hour). However, these jobs are services that must be performed at the site.

- Fixed productivity sectors are also those who are non- transportable goods produce (eg haircuts ).

- To compensate for the local wage levels, the employees of McDonalds in Zurich must earn more than Moscow employees, although the burger production rate per employee is an international constant.

- The consumer price index is formed as follows:

Local goods

Shift out, which always have the same price.

- This Tradable Goods PPP ( purchasing power parity) follow ( Real), the excise tax doubled (by Price Law). The assumption that only counts PPP for tradable goods is testable.

- As the exchange rate fluctuates with the goods productivity of merchandise, the average productivity changed to a lesser extent, the productivity gap ( the real goods ) is smaller than the productivity gap in the monetary terms.

- From productivity is income, so the real income of minor changes as the money income.

- The price level is higher in more productive economic systems 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 the productivity in both sectors developed in different ways, there are changes in relative prices. In other words: the tradable sector has a higher productivity growth than the non-tradable sector, which leads to higher relative prices of non-tradable products. With the average productivity increase 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 work wants 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 more extensive and detailed than in previous studies and the amount of data is a lot bigger (quarterly data Uplifting drying over a period of 10 years). The main conclusion is the following:

Productivity differences explain only a difference between 0.2 and 2 percentage points of annual inflation differentials in the euro area. In addition, they explain only a small proportion of the inland inflation in the Central European economies. Previous studies that have assessed the Balassa -Samuelson effect as a major have often disregarded the impact of productivity differentials on inflation between euro countries and instead only referred to the Midland inflation. Many studies have also left the relatively high productivity growth in the non-tradable industries outside before. The financial attacks of this work suggest that differences in productivity growth between EU accession and the euro zone will probably not expand so much that they become an essential factor in the ability of these countries to meet the Maastricht criteria.

Balassa -Samuelson hypothesis

An explanation for structural differences in the rate of inflation between countries in a monetary union is shown below. For inflation rates apply:

1) - = -

• : Inflation

• As sectoral inflation rates and growth rates of labor productivity

• T: tradable goods ( shift out )

• N: non- tradable goods ( non- tradables )

The overall price level in rates of change:

2) = * (1 -) *

Than the assumed constant fraction of consumer spending, which are used for tradable and non-tradable goods.

From 1 ) and 2) → 3) * = (-)

If the inflation rate of traded goods is constant and the difference in productivity growth between tradable and non - tradable goods increases, then there is a higher rate of inflation.

Further assumptions: appropriate considerations for foreign inflation.

Inflation differential between the two sectors at home and abroad:

Equation: - = - ((-) - (-) )

Inflation differential is positive or - > 0 There are two causes:

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

Balassa -Samuelson effect in the future

If productivity growth is then declining, the impact of the Balassa- Samuelson effect can be restricted.

However, the market of tradable goods must always be more competitive than that of the non-tradable, if only because of its size. In the marketplace of tradable goods all manufacturers of an article are in competition with other manufacturers of the article. Producers of non-tradable goods have to hold only against the local competition. When competition increases productivity, exchangeable goods are always generate higher growth rates than non-tradable, which in turn means that the Balassa -Samuelson effect stock will have.