The role of nontraded and traded wages in the productivity differential model.

Summary

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The relationships between traded and nontraded productivity growth, wage growth and relative prices in 14 Organization for Economic Cooperation and Development countries from 1970 to 1990 are studied. Results show that the traded sector has higher productivity growth compared to the nontraded sector. Nontraded productivity growth also varies greatly between countries while wages are not dependent on productivity across sectors.

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The role of nontraded and traded wages in the productivity differential model.

I. Introduction

Purchasing power parity (PPP) remains the benchmark model for long-run nominal exchange rate determination since Cassel's pioneering work [3] despite weak empirical support [6; 7; 12; 14]. Seminal work by Balassa [1] and Samuelson [15] explains that movements in real exchange rates are due to changing real factors in the economy. Balassa and Samuelson show that differing productivity rates between traded and nontraded sectors can explain deviations in PPP; Hsieh [10] has empirically supported the importance of productivity differentials in explaining real exchange rate movements. Although the Balassa-Samuelson productivity differential model is commonly cited by international textbooks as an explanation of PPP failure [4; 11], several assumptions have not been explicitly tested. This paper examines four critical assumptions of the Balassa model for fourteen OECD economies and demonstrates that some are weak and deserve additional study.

Real exchange rate movements affect the competitiveness of a nation's tradable goods sector and represent deviations from purchasing power parity. Seminal work by Balassa on real exchange rates and PPP violations relies on several underlying premises: (1) the traded sector possesses higher productivity growth and larger intercountry differences than the nontraded sector; (2) intracountry wage rates are equalized between traded and nontraded sectors due to labor mobility; (3) wages in the traded good sector are linked to productivi...

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