Non-tradable Goods and Deviations Between Purchasing Power Parities and Exchange Rates: Evidence from the 1990 European Comparison Project

Leon Podkaminer

Chapter 3 in EU Enlargement and its Macroeconomic Effects in Eastern Europe, 1999, pp 62-93 from Palgrave Macmillan

Abstract: Abstract There is a rich theoretical and empirical literature on the discrepancies between purchasing power parities (PPPs) and exchange rates (see Dornbusch, 1991) for a comprehensive survey. The hypothesis linking persistent discrepancies between PPPs and exchange rates to the presence of relatively cheap non-tradable goods (for example, services) in relatively poorer countries is the oldest (dating back to David Ricardo) and simplest one. Why are services relatively cheaper in poor countries? Contemporary theory tends to attribute this fact to production-side differences. Balassa (1964) and Samuelson (1964) started the tradition of analysis focusing on international labour productivity differentials (tradables vs non-tradables.) Kravis and Lipsey (1983) and Bhagwati (1984) initiated a version of the productivity differential model assuming differential factor endowments and factor rewards. The gist of the argument is that in a poor, labour-abundant country, the relative costs of producing labour-intensive services (nontradables) are lower than elsewhere.

Keywords: Exchange Rate; Utility Function; Free Trade; Poor Country; Relative Price (search for similar items in EconPapers)
Date: 1999
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DOI: 10.1057/9780230502475_3

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