Balassa-Samuelson Effect

The Balassa-Samuelson Effect explains why countries with higher productivity in their tradable sectors (like manufacturing) tend to have higher wages and, consequently, higher prices for non-tradable goods and services (like healthcare or restaurants). When productivity improves in these sectors, wages rise, making non-tradable services more expensive. This leads to overall higher price levels in the country. Essentially, faster productivity growth in key industries pushes up wages and living costs, often causing the country's currency to appreciate relative to others with slower productivity growth.