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The price of development: The Penn–Balassa–Samuelson effect revisited

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  • Hassan, Fadi

Abstract

The Penn–Balassa–Samuelson effect is the stylized fact about the positive correlation between cross-country price level and per-capita income. This paper provides evidence that the price–income relation is actually non-linear and turns negative among low income countries. The result is robust along both cross-section and panel dimensions. Additional robustness checks show that biases in PPP estimation and measurement error in low-income countries do not drive the result. Rather, the different stage of development between countries can explain this new finding. The paper shows that a model linking the price level to the process of structural transformation captures the non-monotonic pattern of the data. This provides additional understanding of real exchange rate determinants in developing countries.

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  • Hassan, Fadi, 2016. "The price of development: The Penn–Balassa–Samuelson effect revisited," Journal of International Economics, Elsevier, vol. 102(C), pages 291-309.
    • Handle: RePEc:eee:inecon:v:102:y:2016:i:c:p:291-309
    DOI: 10.1016/j.jinteco.2016.07.009
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    2. Njindan Iyke, Bernard & Odhiambo, Nicholas M., 2017. "An empirical test of the Balassa-Samuelson hypothesis: Evidence from eight middle-income countries in Africa," Economic Systems, Elsevier, vol. 41(2), pages 297-304.
    3. Bordo, Michael D. & Choudhri, Ehsan U. & Fazio, Giorgio & MacDonald, Ronald, 2017. "The real exchange rate in the long run: Balassa-Samuelson effects reconsidered," Journal of International Money and Finance, Elsevier, vol. 75(C), pages 69-92.
    4. Michael Fidora & Claire Giordano & Martin Schmitz, 2021. "Real Exchange Rate Misalignments in the Euro Area," Open Economies Review, Springer, vol. 32(1), pages 71-107, February.
    5. Ca' Zorzi, Michele & Longaric, Pablo Anaya & Rubaszek, Michał, 2021. "The predictive power of equilibrium exchange rate models," Economic Bulletin Articles, European Central Bank, vol. 7.
    6. Claire Giordano, 2021. "How frequent a BEER? Assessing the impact of data frequency on real exchange rate misalignment estimation," Scottish Journal of Political Economy, Scottish Economic Society, vol. 68(3), pages 365-404, July.
    7. Fischer, Christoph, 2019. "Equilibrium real exchange rate estimates across time and space," Discussion Papers 14/2019, Deutsche Bundesbank.
    8. Chunyun Wang & Xiaoxi Yu & Jiang Zhao, 2022. "Identifying the Real Income Disparity in Prefecture-Level Cities in China: Measurement of Subnational Purchasing Power Parity Based on the Stochastic Approach," Sustainability, MDPI, vol. 14(16), pages 1-24, August.
    9. Urzúa, Carlos M., 2020. "The Balassa-Samuelson and the capital-intensity hypotheses in a nutshell," Research in Economics, Elsevier, vol. 74(4), pages 336-343.
    10. Rui Mano & Ms. Carolina Osorio-Buitron & Mr. Luca A Ricci & Mr. Mauricio Vargas, 2019. "The Level REER model in the External Balance Assessment (EBA) Methodology," IMF Working Papers 2019/192, International Monetary Fund.
    11. Almås, Ingvild & Grewal, Mandeep & Hvide, Marielle & Ugurlu, Serhat, 2017. "The PPP approach revisited: A study of RMB valuation against the USD," Journal of International Money and Finance, Elsevier, vol. 77(C), pages 18-38.
    12. Richard Grabowski & Sharmistha Self, 2020. "Structural change in Asia, the real effective exchange rate, and agricultural productivity," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 44(1), pages 198-210, January.

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    More about this item

    Keywords

    Penn effect; Balassa–Samuelson hypothesis; Developing countries; Real exchange rate; Structural transformation;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development

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