Balassa-Samuelson Effect

AAA

DEFINITION of 'Balassa-Samuelson Effect'

Countries with high productivity growth also experience high wage growth, which leads to higher real exchange rates. The Balassa-Samuelson effect suggests that an increase in wages in the tradable goods sector of an emerging economy will also lead to higher wages in the non-tradable (service) sector of the economy. The accompanying increase in inflation makes inflation rates higher in faster growing economies than it is in slow growing, developed economies.

The effect was proposed by economists Bela Balassa and Paul Samuelson in 1963.

INVESTOPEDIA EXPLAINS 'Balassa-Samuelson Effect'

The Balassa-Samuelson effect suggests that the optimal inflation rate for developing economies is higher than it is for developed countries. Developing economies grow by becoming more productive and using land, labor and capital more efficiently. This results in wage growth in both the tradable good and non-tradable good components of an economy. People consume more goods and services as their wages increase, which in turn pushes up prices.

As emerging economies develop and become more productive they also see increased wages, but they see these increases in both tradable and non-tradable goods sectors of the economy. When wages increase at a slower rate than productivity, countries wind up producing more than they can consume. These countries then have a current-account surplus. When wages grow faster than the productivity rate, workers consumer more goods and the current-account surplus falls.

The effect an appreciating real exchange rate has on an emerging economy depends on whether the country has a fixed exchange rate or floating exchange rate. Fixed exchange rate economies will see an increase in overall prices, while floating exchange rates will see increases in the exchange rate.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by ...
  3. Fixed Exchange Rate

    A country's exchange rate regime under which the government or ...
  4. Endowment Effect

    The endowment effect describes a circumstance in which an individual ...
  5. Freelance Economy

    A freelance economy revolves around hiring self-employed workers ...
  6. Peer-to-Peer (P2P) Service

    A Peer-to-Peer, or P2P, Service is a decentralized platform whereby ...
Related Articles
  1. Personal Finance

    Investing In Emerging Market Debt

    This asset class has left much of its unstable past behind. Find out how to invest in it.
  2. Forex Education

    The New World Of Emerging Market Currencies

    Take advantage of foreign currency markets without stepping out of your house.
  3. Fundamental Analysis

    What is Gearing?

    Gearing, also called leverage, is the degree to which a company’s operations are funded by lenders versus shareholders.
  4. Economics

    Understanding Money Supply

    Money supply – also called money stock -- refers to the total amount of currency and other liquid financial products in an economy at a particular time.
  5. Economics

    What is a Wholly Owned Subsidiary?

    A company whose common stock is 100% owned by another company, called the parent company.
  6. Economics

    Understanding Specialization

    Specialization is when a person, business, or region focuses their productive efforts on a smaller subset of a larger system for a competitive advantage.
  7. Economics

    What is the Income Effect?

    In economics, the income effect is the change in the consumption of goods caused by a change in income, whether income goes up or down.
  8. Investing Basics

    What is a Mid-Cap?

    Mid-cap companies are those with a market capitalization between two and $10 billion.
  9. Economics

    What is M1?

    M1 is a measurement of money supply that includes all hard currency, plus demand deposits such as checking accounts.
  10. Economics

    What’s Missing For A Turnaround In Brazil?

    Today, many investors have written off Brazil following several years of poor performance, decelerating growth and chronically high inflation.

You May Also Like

Hot Definitions
  1. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  2. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  3. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  4. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  5. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  6. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
Trading Center