Sample Essay

Topic: Implications of the Balassa-Samuelson effect on Non-Traded goods and real exchange rates.


International trade is an essential element in the progress of all the major countries. Workers and the labor force in the country are mobile in nature and they usually switch between the domestic arena rather than international borders. Workers mobility is an important factor in determining the rates of productive and the real wage rates. However, the change in the rates of productivity can result in the change in exchange rate or purchasing power parity.

The difference of productive growth and real exchange rates is termed by the economist as Balassa-Samuelson effect. Since the wages are rising and the combination of wages with the no productivity growth in sectors which are treated as non-traded results in the rising of prices in the non- traded goods.  This effect is usually referred to situations like when yen was dramatically appreciated in relation to the US dollar in the period of 1960 and this goes on till late 1990s. Japan experienced productivity in the traded goods sectors which results to increased Japanese wages, and labor mobility. The Balassa-Samuelsson affect can be explained by evaluating the patters of traded goods and non-traded goods of United States and Japan. History shows that Japan is moving rapidly in nontrade items as compared to United States.  The generalized theory of Balassa-Samuelson affect revolves round the scenario that the price level of the richer countries should be higher than the poor countries because countries that have high GDP have higher price levels. Similarly, another important implication of Balassa-Samuelson effect is why non-traded goods usually are cheaper in poor countries as compared to the richer ones. This implication can be explained like when there is low productivity in traded goods it results in low wages in poor countries. India is the most apt example of this scenario.

Statement of Problem:

Immobility of workers across the international borders is one of the most important determinants of the international trade theory, and the differences in the countries’ productivity growth cause changes in the real exchange rates. The case highlights this characteristic of world market using the balassa- Samuelson effect, the phenomena given states that rapid growth in the trade-goods sector leads to a wage rise and with workers being mobile between the sectors this also leads to a wage rise in the non traded goods sector. A wage increase accompanied with no productivity growth in the non trade goods sector results in higher prices for non traded goods as compared to the trade goods in the local economy and with no productivity growth in the foreign non traded sectors, the relative price of the local non traded goods also raise.

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