Was the Balassa–Samuelson Effect Small? Uncaptured Quality Improvements and Japan’s Real Exchange Rate Appreciation, 1956–1970

Abstract

Japan, China, and Central and Eastern European countries experienced substantial real exchange rate appreciation during their catch-up industrialization periods. In each, the measured Balassa–Samuelson effect was small while the greatest source of long-term currency appreciation was the real appreciation in tradables, increases in tradable prices expressed in the common currency, which went counter to PPP. For Japan in the 1950s and 1960s, we suspect price mismeasurement associated with uncaptured product quality improvements in manufactures. Our findings suggest that the Balassa–Samuelson effect would account for three quarters of Japan’s real exchange rate appreciation vis-a-vis the USA then.