The Balassa-Samuelson (B-S) hypothesis relies on the productivity differentials between tradable and non-tradable sectors to explain deviations in purchasing power parity. Within this framework, the relative productivity differences in tradable vis-à-vis non-tradable sectors between two countries will determine the long-run changes in the real exchange rate. However, Lopcu, Burgaç and Dülger, (2012) found that the relationship between the real effective exchange rate and productivity is not supported for the post 2001 era in Turkey. By testing the cointegration relationship between the real effective exchange rate, relative productivity differentials, real interest rate differentials and net foreign assets, using recently developed techniques with multiple structural breaks, the authors reported that support could not be found for the standard B-S hypothesis between Turkey and 27 countries of the European Union (EU-27), particularly after 2001. MacDonald and Ricci (2005) investigated the long run impact of the distribution sector on the real exchange rate and found that increases in productivity and product market competition of the distribution sector vis-à-vis the rest of the world lead to appreciation of the domestic currency. Although the distribution sector typically would be considered part of the non-tradable sector, they indicated that the use of services from the distribution sector in the tradable sector could be a potential explanation for the appreciation of the real exchange rate. In particular, they pointed out that if the distribution sector plays a bigger role in delivering goods in the tradable sector rather than to consumers, this would tend to reduce the price of tradable goods, raising relative wages and, hence lead to the appreciation of the real exchange rate. Thus, in this study, following MacDonald and Ricci, we include the distribution sector in the analysis to determine whether the tendency of the Turkish lira to appreciate could be explained by the B-S hypothesis taking into account the potential productivity increases in the distribution sector for the post-financial liberalization era.
Topics in Middle Eastern and North African Economies, electronic journal, Volume 15, Middle East Economic Association and Loyola University Chicago, May, 2013, http://www.luc.edu/orgs/meea/
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