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The Price of Development

Fadi Hassan

IIIS Discussion Paper No. 446

The Penn-Balassa-Samuelson effect is the stylized fact about the positive correlation between cross-country price level and per-capita income. This paper provides evidence that the price-income relation is actually non-linear and turns negative in low income countries. The result is robust along both cross-section and panel dimensions. Additional robustness checks show that biases in PPP estimation and measurement error in low-income countries do not drive the result. The different stage of development between countries can explain this new finding. The paper shows that a model linking the price level to the process of structural transformation captures the non-monotonic pattern of the data.

Keywords: Balassa-Samuelson; Penn e ect; developing countries; non-parametric estimation; purchasing power parity; real exchange rate; structural transformation.
JEL Classi cations: E31, F4, O1.

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Last updated 28 August 2014 by IIIS (Email).