Sectoral Decomposition of the Balassa–Samuelson Effect in CEE Countries: A CGE Analysis

Abstract

We examine the impact of the Balassa–Samuelson effect on prices at the industry level, based on the results of computable general equilibrium (CGE) model simulations for four Central and Eastern European (CEE) countries. We decompose the results to explain the differentiation of impact on unit production cost by industry. We find that direct cost savings from productivity improvement typically exceed the effects of higher wages, even when considering the reciprocal effects of increased prices of nontradables. These effects are negative for the price competitiveness of the tradable industries and can be reduced by procompetition regulation in the nontradable sector.

Keywords:

• Balassa–Samuelson effect
• Central Eastern European (CEE) countries
• computable general equilibrium (CGE)

JEL Classification:

• C68
• E31
• F41

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. As opposed to the full CGE model, which treats tax and margin rates on intermediates explicitly, here we redefine margin use as intermediate inputs. We also move all taxes on intermediates into a single tax cost item, together with other taxes on production, in each industry.

2. Explanatory power was measured using R-squared coefficient in the regression of percentage price changes by industries on the shares $S_j^{LT}$.

3. However, when controlling for the cost share of labor originating from tradables industries, the import cost share is negatively correlated with the price response.

4. For larger percentage changes, Equation (5) implies a significant linearization error; therefore, the terms in brackets were computed exactly, rather than by adding percentage changes.

Additional information

Funding

This work was supported by the National Science Centre of Poland, under grant No. 2014/15/B/HS4/01038, titled “Globalny kryzys finansowy a ewolucja teorii optymalnych obszarów walutowych w kontekście przystąpienia krajów Europy Środkowej do strefy euro” (Global financial crisis and evolution of theory of optimum currency areas in the context of the CEE countries’ accession to the euro area).