Balassa - Samuelson Effect In China Validation (1990 Year - 2012)

Purchasing power parity theory is that the value of a currency to another currency,decided by the amount of goods and services can be bought in domestic by the two kindsof currency. That is to say, the currency’s external value depends on its internal value,determined by the price factors. Since the theory was proposed, it has a broad internationalinfluence on both theory and practice, and now become one of the most importantexchange rate theories. But In front of the empirical test for many years, the exchange ratecalculated by the purchasing power parity (PPP) had a common deviation with the realexchange rate. In1964, Lhasa and Samuelson proposed a new theory from the perspectiveof the classification of goods and productivity in two published paper that is the famousBalassa-Samuelson effect theory. The economic sector is divided into tradable andnon-tradable sectors in the theory, and it believes that in the process of the country’sgrowth, the labor productivity of the tradable sector grow rapidly would cause the rising ofwage levels of the department. Because the labor has mobility between the two sectors,although there is no greater productivity in the non-tradable sector, in order to keep thelabor the non-tradable sector will increase workers’ wages, too. The rising of the laborcosts in the non-tradable sector would cause the rising of the price of non-traded goods,and it will cause its rise in the overall price level under the condition of tradable goodsprice invariable. The real exchange rate is the price adjustment of the nominal exchange (e=e*P^f/P),domestic prices(P) rising cause the real exchange rate (e) falling (directquotation),or due to the rising of tradable sector productivity cause the falling of domestictradable goods price, and then increase the exports. Trade surplus lead to currencyappreciation, real exchange rate will showing an appreciation trend through the prices risefaster or the nominal exchange rate strengthened. Purchasing power parity theory sufferedserious impact and challenge. Economists test the Balassa-Samuelson effect from the angleof empirical, and played a great reference and guidance role in the modern economicgrowth and the adjustment of the real exchange rate. But since the reform and opening up,China’s economy grow rapidly, the real exchange rate of RMB is not consistent with theconclusion of Balassa-Samuelson effect; this article will research and discuss thisphenomenon.Firstly, this paper will introduce the theory of purchasing power parity (PPP) and theBalassa-Samuelson effect theory, as well as its supplement and development, and evaluate it properly. Secondly, validate its applicability in China with two stages. Results show thatin the first stage, from1990to2005, Balassa-Samuelson effect does not work obviously inChina, in the second stage, from2005to2012, Balassa-Samuelson effect starts to work,then, analyze its conclusions and try to explain them. Finally, give the present policySuggestions.