Ride a cab, buy a laptop & learn some economics
In the U.S., last month, I rode a private cab from the airport to my office which cost me $100. (with which I can afford one year of 10 MBPS broadband internet service in India.)
Later, my company bought me a laptop with good technical configuration. This laptop is going to be my soul saver for at least next two years. My work depends upon it’s performance and the value it provides is very high. Well, it costed $800. (eight times the price of the cab ride)
So, the point is:- there is a cab ride which just served a logistical purpose, apparently offering less value but costing me a 100 bucks. Then there is this super efficient electronic good which is just eight times pricier than the ride.
You will get the anomaly when we see this from an Indian context. In India, a cab ride similar to what I took in the U.S. will cost close to Rs.1,400. The same laptop is priced at Rs. 66,700 and is almost 48 times costlier than the cab ride.
The Indian pricing does justice to the perceived value of both the products.
In India, the laptop’s price is 48 times higher than that of the cab ride while in U.S. it was just 8 times. Basically, in U.S. the cab ride became expensive while the laptop became cheaper.
The reason behind this is explained by an economics principle called Balassa–Samuelson effect.
What is Balassa – Samuelson effect ?
As we all know, America is a very productive nation. Automation has intervened wherever possible and humans interfere in specialized functions only. This raises the wages for those specialized jobs.
Now there are certain jobs like hair-cutting, driving etc which cannot be really automated. And we have not seen much technological innovation in these jobs. However the wage levels of such jobs do not really remain low as there is a wage-equalizing process with the highly productive jobs like engineering. Thus the labor rates, for non-tradable localized jobs with less perceived value, goes up as the productivity of the country rises.
But entirely tradable goods like laptops do not show this level of price variation across countries as they are always sourced from the lowest cost locations. In India, laptop became comparatively expensive because of logistics costs like import duties.
Balassa-Samuelson effect captures this phenomenon in a macroeconomic principle. It suggests that as the productivity of a country goes up, the price levels of non-tradable goods or services go up while those of the tradable ones remain more or less the same. This indicates a higher consumer price index and hence a higher exchange rate.
P.S.: I never knew about this principle. Learned about this only when I observed the inter-country price variations. Interesting. Isn’t it ?