Prices in Developing Countries

Research in this area includes work by Fadi Hassan

The celebrated Penn-Balassa-Samuelson effect states that, even if accounting for PPPs, the price level is higher in richer countries. Current PhD student with the CEP’s Macro Programme, Fadi Hassan takes a closer look at the relationship especially in the bottom part of the world income distribution. A quick look at the scatter of price levels and incomes in the full sample of 149 countries hints at the presence of nonlinearities in the relationship between the two variables, hence the need a non-parametric estimation technique, named LOWESS (locally weighted scatter plot), in the work. The study explores the issue in the cross sectional, panel and time series dimensions.

In the cross section the estimation suggests that the Penn-Balassa-Samuelson effect does not hold in the poorest 25% of countries in the sample, where the relationship is actually downward sloping. The minimum point of the fitted curve corresponds to an income level of around 1350 PPP $, which is equivalent to the income of Senegal in the year 1990. In the panel, which extends from 1950 to 1990, the minimum is located at 1600 PPP $ per-capita (2005 prices), which corresponds to the income of Nigeria in the year 2005. Time-series analysis on selected countries supports the finding that the development process of low-income countries presents a negative relationship between price and income, whereas in developed countries this relationship is positive.

These pieces of evidence thus contrast with the prediction arising from the Penn-Balassa-Samuelson effect, but they could be rationalized in a number of frameworks advanced in theoretical works addressed to issues of economic development. Fadi is currently working on the theoretical explanation of this new evidence.

For further reading please see

• "The Penn-Belassa-Samuelson Effect in Developing Countries: Price and Income Revisited"[Full document in Adobe PDF] (Fadi Hassan), CEP Discussion Paper No 1056 June 2011