Real Exchange Rates, Income per Capita, and Sectoral Input Multipliers

Aggregate price levels are positively related to income per capita across countries. We propose a mechanism to rationalize this observation that relies on sectorial differences in intermediate input intensities. As aggregate productivity and income grow, so does the cost of labor relative to intermediate inputs, which in turn increases the relative price of non-tradables if tradable sectors use intermediate inputs more intensively. In contrast to the Balassa-Samuelson hypothesis, this mechanism does not rely on sectorial differences in the level of productivity, and hence can be easily quantified using input-output data. We show that differences in intermediate input shares across sectors can account for about half the elasticiy of the aggregate price level with respect to GDP per capita. The mechanism also has stark implications for industry-level real exchange rates that are strongly supported by the data.