Bela Balassa worked for the World Bank from 1966 till his death in 1991. Luckily, his insights on international integration, revealed comparative advantages, trade diversion, and natural progress toward political integration have outlived him.
And what Bela is best-known for—and rightfully so—is the Balassa-Samuelson effect.
Put simply, this effect explains why a haircut or a restaurant meal is much cheaper in poor countries than in rich countries whereas the price tag for a car or a television is almost the same everywhere.
What’s behind this phenomenon is simple and can be summed up in three parts.
First, international competition equalizes the price of tradable goods like televisions across countries.
Second, the prices of non-tradable goods like haircuts can differ.
And third, the difference in productivity across countries is much more significant in tradable goods than in non-tradable goods. For example, a barber in Dhaka needs roughly the same amount of time as a barber in New York to cut my hair.
But manufacturers or farmers in Nepal need more labor to produce the same output than their counterparts in Germany.
Countries tend to be poor because their level of productivity in tradable goods is low.
Sure, these countries can still produce tradable goods, but because of the uniform global price of these goods and low productivity, wages in this sector will remain low. This leads to low wages for barbers and, in turn, to cheap haircuts.
A country can develop and grow its economy if it improves the productivity in its tradable goods—let’s call it productivity catch-up. This leads to higher wages and higher prices in non-tradable sectors.
By the same token, an emerging economy will rise fast because its higher productivity triggers a larger production output volume and increase the relative price of non-tradable goods and services.
So, how can countries achieve catch up on their productivity? By integrating into global markets.
Competitive pressures in these markets lead to greater efficiency. Interactions with foreign competitors and foreign consumers facilitate knowledge transfers.
A case in point can be found in our recent study Exports to Jobs, which shows that districts in South Asia more exposed to exports experience higher wage growth in the short-run.
Following the same logic, poor countries don’t thrive because of their non-tradable sector as few productivity gains can be achieved there.
Therefore, it is worrisome that our latest South Asia Economic Focus, Exports Wanted shows that in the last couple of years, growth in South Asia was mainly driven by non-tradable sectors.
In fact, South Asian countries’ exports are only one-third of what they should be, had they mirrored the experience of economies with similar characteristics.
And without further integration into global markets, South Asia will not sustain its growth.
Therefore, countries must be relentless in removing barriers to trade, whether they come from trade policies, rigidities in labor markets, lack of skills necessary to compete in international markets, poor business climates, or any other reason.
