The Balassa-Samuelson Effect

The Balassa-Samuelson Effect explains why richer countries tend to have higher price levels and living costs than poorer ones. It suggests that in wealthier countries, higher productivity in the manufacturing and services sectors leads to increased wages. These higher wages then raise prices for non-tradable goods and services—like housing and services—causing overall price levels to be higher. Essentially, as a country becomes more productive and developed, its cost of living tends to rise relative to less developed nations, influencing exchange rates and international competitiveness.