Growth and Structural Transformation

We illustrate the usefulness of our approach by applying it to the so called Balassa-Samuelson effect, that is, in a cross sectional sense, countries with higher ppp adjusted incomes tend to have higher aggregate price levels (in a common numeraire). We show that as the US economy develops, its aggregate price level increases for two reasons. First, services experienced smaller TFP growth than the other two sectors. Second, the consumption share of services increased. This has the interesting implication that the difference in the aggregate price level between a slow and a fast growing economy should become larger over time. In other words, the Balassa-Samuelson effect should emerge endogenously. This prediction of our work is consistent with the observation that the Balassa-Samuleson effect is a fairly recent phenomenon that has become more pronounced over time.