Balassy-Samuelsona effect

The Samuelson-Balassa Effect - a hypothesis linking the price level observed between countries with different levels of productivity in these economies. This hypothesis suggests that the faster - in comparison with developed economies - the increase in productivity in the so-called. over-the-counter (CPI) will be accompanied by higher inflation or appreciation of the nominal exchange rate.

Under the law of one price, the same goods should have the same price in the country and abroad (expressed in the currency of any country). If the price of a good in one country would be different than abroad, it would be better to buy goods in the "cheaper" country in order to sell them in the "more expensive" country. Such commodity arbitration would equalize the prices of the same goods in all countries. Thus, the real exchange rate is always close to 1. If it is less than or greater than 1, due to commodity arbitrage, the real exchange rate will be in the long run to 1. In practice, however, the real exchange rate in rich countries is usually higher than 1.

The Samuelson-Balassa hypothesis explains why this is happening. In particular, this hypothesis explains why (in one currency) price level in countries with high labor productivity is higher than the price level in countries with low labor productivity.

This is due to the fact that productivity growth in the non-tradable sector (eg dental services) is usually slower than productivity growth in the commercial goods sector (eg automotive). The increase in productivity in the branches that produce the goods increases rapidly, causing a continuous increase in wages in these branches. This, in turn, raises wage pressures in the non-trading sectors (otherwise, non-profit sector workers will move to the branches that produce commercial goods), while wage growth in these sectors is higher than productivity growth rates. The only way to finance rising wages is to increase the prices of non-tradable goods. They can be made because they relate to non-commercial goods which are not subject to competitive pressure from abroad.

The result of these processes is the higher average (average for commercial and non-commercial goods) price levels in countries with high labor productivity, ie in rich countries. Even if the level of prices of goods traded in rich countries is close to the level of prices of the same commodity in poorer countries, the level of non-tradable goods prices in rich countries far outweighs the prices of these goods in poor countries. Bibliography

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