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), productivity biased purchasing power parity (PPP) (Officer 1976) and the rule of five eights (David 1972) is either of two related things:
This article deals with point (2): Balassa and Samuelson's causal model. For a fuller description of the fact it attempts to explain see: Penn effect.
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 have high transportation costs, which makes deviations from 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.
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