Productivity bias hypothesis in purchasing power parity : a Swiss-South African case, 1994-2003.
Professors Bela Balassa and Paul Samuelson (1964) have made a significant contribution to the theories of exchange rate by bringing a new thinking to the most popular exchange rate model, Purchasing Power Parity (PPP). They have elucidated the contribution of productivity in the determination of PPP. Accordingly, the emphasis of this thesis is Balassa and Samuelson’s Productivity Bias Hypothesis (PBH) in Purchasing Power Parity (PPP) and the application thereof to South Africa and Switzerland for the period 1994Q1 -2003Q4. The productivity bias hypothesis that explains real exchange rate movements in terms of sectoral productivities rests on two components: firstly, it implies that the relative price of non-traded goods in each country should reflect the relative productivity of labour in the traded and non-traded goods sectors. Secondly, it assumes that purchasing power parity holds for traded goods. The deviation of PPP from the equilibrium exchange rate or the real exchange rate is directly related to the ratio of productivity in a counter country over that of the base country. With inter-country productivity differences believed to be smaller in the service sector than in the sectors producing goods and with the prices of traded goods equalised through arbitrage, the relative prices of non-traded goods (services) would be directly correlated with productivity levels in individual countries. The thesis employs stationarity and cointegration tests in order to determine the presence of long-term, equilibrium, relationship between PPP and productivity variables of the above-mentioned two countries. The overall finding of this thesis is supportive of the productivity bias hypothesis in purchasing power parity concerning the two countries, South Africa and Switzerland. Accordingly, it has been found out that the deviation from equilibrium exchange rate can be explained by differences in productivity. Though currently being challenged by the service sector, South Africa’s manufacturing sector is assuming an important place in the economy. Given the need for improved competitiveness in the manufacturing sector, it is imperative that policy analysis and formulation render increased emphasis on efficiency and costeffectiveness. Such an integrated approach may aid not only in raising productivity but also in managing the intertwined socio-economic challenges of unemployment, poverty and inequality.