Aitken, Brian, 1999, “Ireland and the Euro: Productivity Growth, Inflation, and the Real Exchange Rate,” IMF Working Paper, forthcoming.
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Bragoudakis, Zacharias, and Demetrios Moschos, 1999, “Relative Prices and Sectoral Labor Productivity Differentials: A Long-Run Analysis for Greece,” University of Athens Discussion Paper No. 1999/5, June.
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Prepared by Phillip Swagel.
See Lipschitz and McDonald (1991) for a discussion of this effect and implications for measures of competitiveness.
This will not necessarily be the case for unit labor costs if there is a divergence between total factor productivity, which drives the Balassa-Samuelson effect on prices, and labor productivity, which determines unit labor costs.
Three equations are estimated in the VAR (one per variable), but the focus here is on relative prices, so only this equation is written out.
This calculation also implicitly assumes that each country was on average in equilibrium over the sample period, since only the equilibrium relationship between prices, productivity, and wages is used to calculate the contribution of the Balassa-Samuelson effect to inflation. As discussed below, some changes in the relationship are taken into account in the estimation by the addition of trend terms or shifts in the coefficients when these are needed to estimate a statistically significant long-run relationship.
The countries include Belgium, Denmark, Finland, France, Germany, Greece, Italy, the Netherlands, Norway, Portugal, Sweden, and the United Kingdom, Spain is not included because capital stock data are not available by sector, while Ireland is excluded because Aitken (1999) shows that the usual measure of TFP growth is distorted by the presence of large multinationals.
The industry breakdown follows the ISIC classification for production. Tradables consist of mining and quarrying, and manufacturing. Nontradables are: electricity, gas, and water; construction; wholesale and retail trade, restaurants and hotels; transport, storage, and communication; finance, insurance, real estate and business services; community, social and personal services; and government services.
Agriculture comprises less than 5 percent of the value of output on average over the sample period in all countries except Denmark (5.0 percent), France (5.5 percent), Italy (6.6 percent), Finland (9.3 percent), Portugal (12.0 percent), and Greece (13.8 percent).
The income ranking in Table 1 is based on real per-capita GDP for 1990 from the Penn World Tables International Comparison Project (popularly known as the Summers and Heston database, version 5.6). This provides internationally comparable measures of output based on price deflators with common baskets of goods and is the most widely used database with which to make cross-country comparisons of per-capita output. See Summers and Heston (1991).
Finland and Sweden are omitted from the calculations for 1990–96 because productivity growth and inflation differentials in these countries appear to be affected by particular events in this period that result in unusually large values for relative productivity growth. These include the financial crisis in the early 1990s in Sweden, and the development of the high technology sector in Finland.
The only exception where stationarity appears more likely than not is for relative prices in Denmark; the results are mixed for wages in Italy and productivity in the Netherlands, with acceptance or rejection of a unit root depending on the number of lags and inclusion of a trend in the augmented Dickey-Fuller test. The finding of a long-run co-integrating relationship for Denmark is somewhat weaker than in most other countries, which is consistent with the lack of a unit root in relative prices.
Bragoudakis and Moschos (1999) estimate the model of Alberola-Ila and Tyrväinen (1998) for Greece over 1962–97 (and again, use labor productivity rather than total factor productivity), but find no evidence of cointegration and implausibly large coefficients for the response of prices to productivity and wages. In contrast, the estimation here uses total factor productivity and produces reasonable coefficients though the existence of a stable long-run relationship in Greece is accepted at a lower level of statistical significance than in some of the other countries.
However, adding oil prices or dummy variables in years of oil shocks as exogenous variables did not result in a finding of cointegration.
Leaving government services out of nontradables eliminates most of the wage differential between tradables and nontradables, giving an estimated contribution to inflation close to the predicted 1.8 percentage points from the model.
The amount would be smaller to the extent that the Balassa-Samuelson effect contributed to higher inflation in the United States, but this contribution is likely to be quite small.