Revisiting the Balassa-Samuelson Model with Markup Variations

Romain Restout ()

Recherches économiques de Louvain, 2013, vol. 79, issue 3, 25-69

Abstract: This paper addresses the role of markup variations in the transmission process of cross-sectoral productivity differential shocks and government spending shocks to the relative price of nontradables. The Balassa-Samuelson model based on frictionless goods markets predicts that a rise in the sectoral productivity ratio by 1% raises the relative price by 1% while government spending changes leave the relative price unaffected. Using panel cointegration and unit root tests applied to a panel of fifteen OECD economies, our empirical evidence does not support these implications. We find that a rise in relative productivity by 1% raises the relative price of nontradables by only 0.70% and that an increase in government spending by 1% of GDP drives up the relative price by around 1%. This paper shows that these items of evidence can be successfully explained by a two-sector open economy model in which variations in the composition of demand for nontradables give rise to endogenous changes in the markups. JEL Classification: E20, E62, F31, F41.

Keywords: Balassa-Samuelson model; markups; productivity; government expenditure (search for similar items in EconPapers)
JEL-codes: E20 E62 F31 F41 (search for similar items in EconPapers)
Date: 2013
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