Ballas-Samuelson effect

Economic area - real exchange rate

Theory

The Balassa-Samuelson effect is a process that results in the fact that consumer prices are systematically higher in more developed than in less developed countries. In practice, this means that richer countries are systemically more expensive than poorer countries, as a result of differences in the prices of those goods that are non-tradable.

Exchangeable goods, when expressed in a single currency, should be of the same value. On the other hand, non-tradable goods (hairdressing, taxi, local specific taxes...) are cheaper in poor countries for two reasons:

Effect of demand - in theory, a large number of goods and services from the category of 'non-tradable goods' fall into the category of "luxury goods" and therefore there is no great demand for such goods and services in poorer countries, and consequently prices are lower due to low demand;
Supply effect - poorer countries lag behind technologically in the production of tradable goods and therefore to be competitive in the international market, the cost of labor in those countries/sectors (wages) must be lower. Since wages cannot be lower in the developed sectors that produce tradable goods, then employers must focus on lower labor costs in the non-tradable sector. Consequently, low wages result in a lower price level.

Interesting stories

Theory of 7 authors - Regarding the conclusions from empirical data, the theory in question has been the subject of controversy among economists since the first day, but precisely because of that, it was also a challenge for the solution of identified shortcomings. Nevertheless, due to the indisputable influence on the development of the theory and the analysis of macroeconomic trends, the approach and findings were never challenged by the creators of the theory, but each modification in fact brought about a 'change in the name of the effect' and therefore the same area is now being worked on.Ricardo–Wiener–Harrod–Balassa–Samuelson–Penn–Bhagwati effect". This makes this terroia one of the most "complex" in terms of names.

The influence of good food on theory formation - One of the creators of the theory, Béla Alexander Balassa, 1928-1991) was a big gourmand. He loved great food, but as a World Bank consultant, he tried to respect the defined consumption allowance limit. This required a serious approach to finding good kitchens within a budget constraint. As a result, in 1979 he published a book that is a culinary guide to Paris - ''An Example from the Culinary Economy, or How to Maximize the Culinary Utility of the Dollar in Paris'. So, some of the conclusions about the real exchange rate, the GDP deflator, and price parity between countries were made while enjoying the restaurants.

Economic "wonderkind" - Another creator of the theory, Paul Samuelson (Paul Samuelson, 1915 - 2009), claimed that he was "born as an economist". This attitude of his was clearly reflected in the fact that he entered the University of Chicago at the age of 16 (!) and then earned a doctorate in economics at Harvard. After graduating, he became an assistant professor of economics at the Massachusetts Institute of Technology (MIT) when he was 25 and a full professor at 32. In 1966, he was named an institute professor, MIT's highest honor. He is the first American winner of the Nobel Prize for Economics (in 1970). He is one of the most influential, if not the most influential, economist of the XNUMXth century.

And where are we and how can we recognize theory in practice

The subject theory can be directly applied in current economic trends and areas and in our economy. Here are some examples for discussion and reflection:

Belgrade is more expensive than the interior - The price of labor for the same position is significantly higher in Belgrade compared to Gornji Milanovac, because the company in Belgrade has to pay a higher price in order to be competitive in relation to labor prices in other industries. As a result, the price of hairdressing in salons in Belgrade (a non-tradable good) is higher compared to the price in the interior because "there is room for a higher price" relatively compared to the average monthly income. The same cannot be said/applied for the price of a computer or TV set (tradable goods) and therefore it follows that "Belgrade is more expensive than the interior" is in fact under the dominant influence of the difference in the price of non-tradable goods, which in practice records one of the postulates of the Balaš-Samuelson effect .

The price of luxury cars - The price of luxury cars at the Belgrade Fair is always lower than the price of the same model at the fairs in Geneva or Frankfurt due to the mentioned "demand effect"

Sources and further reading

"Macroeconomics: European textbook" Michael Burda and Charles Wiplosh, 2001, translated by Professor Danica Popović in 2004.
http://www.nber.org, the official address of the National Bureau of Economic Research (National Bureau of Economic Research); review of works by Balassa, Bela and Samuelson, Paul
Balassa, Béla. A Primer in Culinary Economics, or How to Maximize the Culinary Utility of the Dollar in Paris. Processed. 8th edition, 1987.
publicly available relevant theoretical sources on the works of the two authors