Editing Balassa–Samuelson effect (section)

==Empirical evidence on the Balassa–Samuelson effect==
Evidence for the Penn effect is well established in today's world (and is readily observable when traveling internationally). However, the Balassa–Samuelson (BS) hypothesis implies that countries with rapidly expanding economies should tend to have more rapidly appreciating exchange rates (for instance the [[Four Asian Tigers]]); conventional [[econometric]] tests yield mixed findings for this prediction.

In total, since it was (re)discovered in 1964, according to Tica and Druzic (2006)<ref>{{cite journal|url=https://ideas.repec.org/p/zag/wpaper/0607.html|title=The Harrod-Balassa-Samuelson Effect: A Survey of Empirical Evidence|first1=Josip|last1=Tica|first2=Ivo|last2=Družić|journal=Efzg Working Papers Series |date=13 September 2006|via=ideas.repec.org}}</ref> the HBS theory "has been tested 60 times in 98 countries in time series or panel analyses and in 142 countries in cross-country analyses. In these analyzed estimates, country specific HBS coefficients have been estimated 166 times in total, and at least once for 65 different countries". Many papers have been published since then. Bahmani-Oskooee and Abm (2005) & Egert, Halpern and McDonald (2006) also provide quite interesting surveys of empirical evidence on BS effect.

Over time, the testing of the HBS model has evolved quite dramatically. Panel data and time series techniques have crowded out old cross-section tests, demand side and terms of trade variables have emerged as explanatory variables, new econometric methodologies have replaced old ones, and recent improvements with [[endogenous variable|endogenous]] [[tradability]] have provided direction for future researchers.

The sector approach combined with panel data analysis and/or [[cointegration]] has become a benchmark for empirical tests. Consensus has been reached on the testing of internal and external HBS effects (vis a vis a [[Numéraire|numeraire]] country) with a strong reservation against the [[purchasing power parity]] assumption in the tradable sector.

The vast majority of the evidence supports the HBS model. A deeper analysis of the empirical evidence shows that the strength of the results is strongly influenced by the nature of the tests and set of countries analyzed. Almost all cross-section tests confirm the model, while panel data results confirm the model for the majority of countries included in the tests. Although some negative results have been returned, there has been strong support for the predictions of a [[cointegration]] between relative productivity and relative prices within a country and between countries, while the interpretation of evidence for cointegration between real exchange rate and relative productivity has been much more controversial.

Therefore, most of the contemporary authors (e.g.: Egert, Halpern and McDonald (2006); Drine & Rault (2002)) analyze main BS assumptions separately:
# The differential of productivities between the traded and non-traded sector and relative prices are positively correlated.
# The [[purchasing power parity]] assumption is verified for tradable goods.
# The RER and relative prices of non-tradable goods are positively correlated.
# As a consequence of 1, 2, & 3, there is a long-run relationship between productivity differentials and the RER.

Refinements to the econometric techniques and debate about alternative models are continuing in the [[International economics]] community. For instance:
:"A possible explanation of the BS empirical rejection may simply be that there are additional long-run real exchange determinants that have to be considered." Drine & Rault conclude.

The next section lists some of the alternative proposals to an explanation of the [[Penn effect]], but there are significant [[econometric]] problems with testing the BS-hypothesis, and the lack of strong evidence for it between modern economies may not refute it, or even imply that it produces a small effect. For instance, other effects of exchange rate movements might mask the long-term BS-hypothesis mechanism (making it harder to detect if it exists). Exchange rate movements are believed by some to affect productivity; if this is true then regressing RER movements on differential productivity growth will be 'polluted' by a totally different relationship between the [[Variable (mathematics)|variables]]<sup id="Footnote_1">[[#Footnotes|1]]</sup>.