IV. DOLLARIZATION AND PRICE DYNAMICS
5. Balassa-Samuelson, Non-Tradables and Tradables
the only one to be found non-significant, and is the smallest in absolute value. This could be an indication that Panama’s mechanism for maintaining a long-run relationship between relative price and relative income is not as strong as is for the other countries; or it may be the result of including Panama, with its extremely low ratio of price volatility to income volatility, in a panel where the series of the other countries are fairly noisy.
It is important to mention that in the time-series analysis of this section, each country was allowed to have its own cointegrating relationship between relative price and relative income. However, this flexibility in the analysis does not drive the results. If the Error Correction terms for all countries are obtained using the same coefficients for equation (4.20) rather than country-specific coefficients, the results in Table 4.8 change only slightly and the conclusions of the analysis remain the same.96
] ) 1 ( ) )(
1 [(
] )
(
[ i i,N i * *N i i,T i * T*
i p e p p e p
q = θ − −θ + −θ − − −θ (4.21)
which after assuming that θi = θ* reduces to97: ) )(
1 ( )
( i,N i *N i i,T i T*
i
i p e p p e p
q =θ − − + −θ − − (4.22)
which can be expressed in growth terms by simply first-differencing:
) (
) 1 ( )
( i,N i *N i i,T i T*
i
i p e p p e p
q = ∆ − − + − ∆ − −
∆ θ θ (4.23)
According to equation (4.23) the growth of the real exchange rate (or we can say the relative price level) between country i and the U.S. depends on the growth of the common currency price levels of the non-tradable component, ∆(pi,N - ei - pN*), and the tradable component, ∆(pi,T - ei - pT*). However, if PPP holds for tradables, the latter term becomes zero, and the non-tradables become the driving force.
In this section, the two component terms in equations (4.22) and (4.23) are estimated using data from the Economist Intelligence Unit (EIU). The EIU provides annual domestic prices for 109 commodities, of which 24 are classified as non-tradable and 85 as tradable, for the capital cities of the 13 Latin American countries analyzed in this study and for Pittsburgh in the U.S. for the period 1990-2000. The list of commodities is shown in Appendix B.98 The EIU also provides the countries’ nominal exchange rates prevailing at the price collection time, so that all prices can be converted to U.S. dollars. Using these data, the annual series for the dollar price levels of both non-tradables, pi,N - ei, and
97 The assumption of equal CPI weights across countries for the tradable and non-tradable components is a simplifying assumption. Actually, the U.S. gives relatively greater weight to the non-tradable component than the typical Latin American country. However, the classification of a commodity as tradable or non- tradable is not as straightforward as it may seem either. In practice, no commodity is 100% of either type.
98 Utilities, rent, lodging and services in general are classified as non-tradable, and agricultural and manufactured commodities as tradable. The EIU provides prices for more than 190 commodities but the list was restricted to only those commodities with non-missing data for all countries and all years. In some cases, there are prices for the same commodity but for a different type of store. For the purposes of this section, these prices are considered as if they were for different commodities.
tradables, pi,T - ei, are calculated, for each country i, as the simple average of the log of the dollar prices of the corresponding sets of commodities j (the time subscript is ignored for simplicity):
∑
=−
=
− 24
1 , ,
, ( )
24 1
j
i j N i i
N
i e p e
p (4.24)
∑
=−
=
− 85
1 , ,
, ( )
85 1
j
i j T i i
T
i e p e
p (4.25)
For each country, Part A of Table 4.9 shows the mean and standard deviation for these price levels and their growth rates. Part B of Table 4.9 shows the same statistics for the relative price levels of the countries with respect to the U.S., calculated using the series obtained with equations (4.24) and (4.25). The relative prices for non-tradables and tradables are pi,N - ei - pN* and pi,T - ei - pT*, respectively, as shown in equation (4.22).
Because the purpose of this section of the study is to draw implications about long- run concepts such as PPP and the Balassa-Samuelson hypothesis, the focus will be on Panama. No long-run predictions can be made using a short period such as 1990-2000, unless the price series are very stable. According to the results presented in the previous sections of this chapter, only Panama meets this criterion. Table 4.9 confirms this: the standard deviation values for Panama’s series are always the lowest among the Latin American countries. Still, the short length of the series would make it difficult to statistically detect small differences even for Panama. For this reason, the conclusions from this section can only be tentative.
The statistics in Table 4.9 show certain particularities of the data used. First, the mean price level for non-tradables is higher than that for tradables, indicating that the
(Compare 3.79 to 1.43 and 3.87 to 1.71 for the average Latin American country and the U.S., respectively.)
Table 4.9. Price Level Statistics by Type of Commodity (EIU Data, Period 1990-2000)
Non-Tradable Commodities (N) Tradable Commodities (T) Part A: Price Level
Level Growth (%) Level Growth (%)
Country Mean Std Mean Std Mean Std Mean Std
Argentina 4.22 0.21 *** 6.50 12.15 1.70 0.16 *** 5.18 7.29
Brazil 4.15 0.32 *** -0.57 27.05 1.49 0.24 *** -1.41 22.91
Chile 3.89 0.27 *** 5.01 10.13 1.41 0.16 *** 3.15 7.75
Colombia 3.60 0.24 *** 2.94 15.04 1.35 0.17 *** 3.56 9.43
Costa Rica 3.49 0.14 *** 3.19 7.30 1.34 0.09 *** 1.05 5.80
Ecuador 3.32 0.33 *** 6.50 20.80 1.15 0.20 *** 5.15 17.32
Guatemala 3.78 0.32 *** 10.56 12.46 ** 1.49 0.17 *** 5.04 11.76
Mexico 4.05 0.19 *** 6.91 16.07 1.54 0.22 *** 8.10 15.88
Panama 3.90 0.10 *** 2.76 4.40 1.48 0.10 *** 3.17 3.62 **
Paraguay 3.70 0.27 *** 5.58 15.50 1.22 0.12 *** 1.52 8.16
Peru 3.80 0.23 *** 5.39 10.15 1.45 0.09 *** 0.57 7.20
Uruguay 3.82 0.20 *** 5.81 11.47 1.54 0.10 *** 2.12 6.23
Venezuela 3.56 0.39 *** 10.94 24.33 * 1.46 0.21 *** 4.83 17.10
Average: 3.79 0.25 5.50 14.37 1.43 0.16 3.23 10.80
USA 3.87 0.14 *** 4.12 2.90 *** 1.71 0.11 *** 2.84 2.41 ***
Part B: Relative Price Level
Level Growth (%) Level Growth (%)
Country Mean Std Mean Std Mean Std Mean Std
Argentina 0.35 0.13 *** 2.38 10.55 -0.01 0.10 2.34 8.44
Brazil 0.28 0.27 ** -4.68 26.28 -0.22 0.21 ** -4.25 21.26
Chile 0.02 0.16 0.89 9.09 -0.30 0.09 *** 0.31 7.38
Colombia -0.27 0.20 *** -1.17 12.90 -0.36 0.11 *** 0.72 8.84
Costa Rica -0.38 0.09 *** -0.93 5.10 -0.37 0.11 *** -1.79 6.27
Ecuador -0.55 0.26 *** 2.38 18.97 -0.56 0.18 *** 2.31 17.24
Guatemala -0.09 0.19 6.45 11.09 * -0.22 0.12 *** 2.20 11.99
Mexico 0.18 0.14 *** 2.79 14.29 -0.17 0.17 ** 5.26 16.08
Panama 0.03 0.08 -1.35 4.32 -0.23 0.04 *** 0.33 4.04
Paraguay -0.17 0.19 * 1.47 13.13 -0.49 0.09 *** -1.33 7.00
Peru -0.10 0.14 1.29 9.82 -0.27 0.06 *** -2.50 5.98
Uruguay -0.05 0.10 1.69 11.30 -0.17 0.07 *** -0.72 6.50
Venezuela -0.31 0.27 ** 6.83 23.56 -0.25 0.12 *** 1.99 16.04
Average: -0.08 0.17 1.39 13.11 -0.28 0.11 0.37 10.54
Note: (*)(**)(***) One, two and three asterisks indicate statistical significance at 10%, 5% and 1%, respectively, for a test for zero mean that uses Newey-West HAC standard errors. The "Average" values are simple column averages. These values are not tested. Price levels are averages of the log prices in dollars of a set of commodities from the Economist Intelligence Unit (EIU). Growth series are the first differences of the price level series. The statistics are obtained from the price level and growth series for the period 1990-2000 for all countries except Peru for which the 1990 data are missing. All series are annual.
Second, the mean relative price level for tradables (-0.28) is not closer to zero than for non-tradables (-0.08) for the average Latin American country. This seems to be the result of certain countries’ (Argentina, Brazil, Chile, Mexico and Panama) having a mean relative price level for non-tradables that is positive, indicating that this set of commodities is more expensive in those countries than in the U.S. The mean relative price level for tradables is negative for all countries, indicating that this set of commodities is consistently cheaper in the Latin American countries than in the U.S.
However, the cross-country spread of mean relative prices is greater for non-tradables than for tradables, just as expected.99 Third, in terms of price growth, the U.S. has a lower standard deviation of the growth rate than the average Latin American country for both groups of commodities (compare 2.90% to 14.37% and 2.41% to 10.80% between the U.S. and the average Latin American country for non-tradables and tradables, respectively.) This reflects the greater price stability of the U.S. economy. Finally, the mean growth rate of the price of non-tradables is greater than that for tradables for both the U.S. (4.12% versus 2.84%) and the average Latin American country (5.50% versus 3.23%.)
Panama’s mean growth values presented in Table 4.9 make it apparent that a
“typical” Balassa-Samuelson effect is indeed at work. First, the fairly small mean growth rate for the relative price of tradables, 0.33%, and its relatively small standard deviation, 4.04%, are both consistent with relative PPP holding for the tradable commodities.
Second, the negative growth rate for the relative price of non-tradables, -1.35%, is consistent with the long-run depreciating trend of Panama’s real exchange rate observed
in the previous sections (Refer to Table 4.2, which indicates that Panama’s real exchange rate depreciated at an average 1.68% per year during the period 1950-2000.) As predicted by the Balassa-Samuelson hypothesis, for Panama the driving force behind real exchange rate movements seems to be the relative price of non-tradables. With respect to the average Latin American country, no clear effect can be appreciated due to the high volatility of the growth values.
With respect to relative productivity between Panama and the U.S., some interesting assessments can be made. According to the Balassa-Samuelson hypothesis, the depreciating trend of the relative price of non-tradables and the resulting depreciating trend of the real exchange rate is an indication that productivity growth in the production of tradables is faster in the U.S. than in Panama. This requires the assumption that productivity growth in the production of non-tradables be roughly the same in both countries and that PPP hold for tradables. To understand this more clearly, we can express the growth of the relative price of non-tradables as100:
) (
) (
) (
)
(∆pi,N −∆p*N = ∆pi,T −∆pT* + ∆ai,T −∆aT* − ∆ai,N −∆a*N (4.26) If PPP holds for tradables and productivity in the production of non-tradables is the same in both countries, the first and third terms on the right-hand side of equation (4.26) both become zero, so that the growth of the relative price of non-tradables depends only on the growth differential in the productivity in the production of tradables between the two countries. According to the results presented in this section, for Panama, the term on the left-hand side of equation (4.26) is negative, and PPP holding for tradables seems to be a sensible approximation. However, according to Goldfajn and Olivares (2001) the
100 This is obtained by first-differencing equations (4.15) and (4.16), and then subtracting (4.16) from (4.15) and re-arranging.
third term on the right-hand side is probably not zero. The authors suggest that Panama may have become more productive than the U.S. in the production of non-tradables. This seems plausible since the results presented in Table 4.9 show that the price level of non- tradables grows slower than the price level of tradables for Panama (2.76% versus 3.17%
per year.) This is not a common occurrence. For both, the U.S. and the average Latin American country the opposite is true. If the authors’ claim is correct, then the third term on the right-hand side of equation (4.26) would be positive, reinforcing the negative trend on the relative price of non-tradables. This conclusion is in line with an argument made by Frankel (2001).