Academic journal article The European Journal of Comparative Economics

Balassa-Samuelson Meets South Eastern Europe, the CIS and Turkey: A Close Encounter of the Third Kind?

Academic journal article The European Journal of Comparative Economics

Balassa-Samuelson Meets South Eastern Europe, the CIS and Turkey: A Close Encounter of the Third Kind?

Article excerpt

Abstract

This paper investigates the importance of the Balassa-Samuelson effect for two acceding countries (Bulgaria and Romania), two accession countries (Croatia and Turkey) and two CIS countries (Russia and Ukraine). The paper first studies the basic assumptions of the Balassa-Samuelson effect using yearly data, and then undertakes an econometric analysis of the assumptions on the basis of monthly data. The results suggest that for most of the countries, there is either amplification or attenuation, implying that any increase in the open sector's productivity feeds onto changes in the relative price of non-tradables either imperfectly or in an over-proportionate manner. With these results as a background, the size of the Balassa-Samuelson effect is derived. For this purpose, a number of different sectoral classification schemes are used to group sectors into open and closed sectors, which makes a difference for some of the countries. The Balassa-Samuelson effect is found to play only a limited role for inflation and real exchange rate determination, and it seems to be roughly in line with earlier findings for the eight new EU member states of Central and Eastern Europe.

JEL Classification: E31, O11, P17

Keywords: Balassa-Samuelson effect, productivity, inflation, real exchange rate, transition, South Eastern Europe, CIS, Turkey

(ProQuest Information and Learning: ... denotes formulae omitted.)

1. Introduction

The prospect of joining the EU and the actual accession of eight countries from Central and Eastern Europe to the European Union in May 2004 have triggered a lot of research related to the Balassa-Samuelson (B-S) effect. A first round of studies, mainly from the late 1990s and early 2000s, suggested that one of the major determinants of high inflation observed at that time in the CEECs was the Balassa-Samuelson effect. Sinn and Reutter (2001) came up with figures up to 6.7% inflation a year due to the B-S effect, and Golinelli and Orsi (2002) and Rosati (2002) followed suit, reporting numbers of the same order of magnitude. The straightforward policy consequence of these results was, as forcefully argued in Buiter and Grafe (2002) and Szapáry (2003), that countries then at the door of the EU were expected to be unable to fulfil the Maastricht criterion on inflation and exchange rate stability because of high structural inflation fuelled by rapid economic catching-up.

A second wave of studies watered down these results considerably and pointed out that the B-S effect may not be all that important for the new EU member states after all.2 For instance, Kovács (2002), Flek et al. (2002), Burgess et al. (2003), Égert et al. (2003) and Mihaljek and Klau (2004) estimated the inflation differential towards the EU-15 to vary, on average, from 0% to 1% a year, with 2% being the highest figure.

Having said this, however, there are very few papers, which analyze the importance of the B-S effect for countries other than the eight new EU member states of Central and Eastern Europe. As a matter of fact, countries involved in future enlargement of the EU and the CIS are badly neglected in the literature in that no country-specific investigation was carried out for them. Most of the time, these countries are included in a panel and very general conclusions are advanced for the panel as a whole3. An exception is Nenovsky and Dimitrova (2002) who looked at the case of Bulgaria, but used a brief time span of only five years or so, and Égert et al. (2003) and Dubravko and Klau (2004) who analyze Croatia.

This motivates us to take a closer look at this group of countries. More specifically, we analyze the case of two acceding countries (Bulgaria and Romania), two accession countries (Croatia and Turkey4) and two CIS countries (Russia and Ukraine). These are indeed the countries for which data are readily available, on the basis of which not only a narrative analysis but also an econometric investigation can be carried out. …

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