Determinants of Relative Sectoral Prices: The Role of Demographic Change
| Author | Max Groneck,Christoph Kaufmann |
| Published date | 01 June 2017 |
| DOI | http://doi.org/10.1111/obes.12149 |
| Date | 01 June 2017 |
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©2016 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 79, 3 (2017) 0305–9049
doi: 10.1111/obes.12149
Determinants of Relative Sectoral Prices:The Role of
Demographic Change*
Max Groneck† and Christoph Kaufmann‡
†Department of Economics, Stockholm School of Economics and Netspar, P.O. Box 6501
SE-11383, Stockholm, Sweden (e-mail: max.groneck@hhs.se)
‡Center for Macroeconomic Research (CMR), University of Cologne, Albertus-Magnus-
Platz, 50923 Cologne, Germany (e-mail: c.kaufmann@wiso.uni-koeln.de)
Abstract
Demographic change raises demand for non-tradable old-age related services relative to
tradable commodities. This demand shift increases the relative price of non-tradables and
thereby causes real exchange rates to appreciate. We claim that the change in demand
affects prices via imperfect intersectoral factor mobility. Using a sample of 15 OECD
countries, we estimate a robust increase of relative prices.According to our main estimate,
up to one fifth of the average increase in relative prices between 1970 and 2009 can be
attributed to population ageing. Further findings confirm the relevance of imperfect factor
mobility: Countries with more rigid labour markets experience stronger price effects.
I. Introduction
The relative price of non-tradable services to tradable commodities is well known to be
an important determinant of real exchange rates. According to the famous Balassa (1964)
- Samuelson (1964) hypothesis, movements in these relative sectoral prices can be at-
tributed to sectoral differences in productivity growth. Empirical studies tend to find
support in favour of the hypothesis.1Further determinants of the relative price beyond
the Balassa–Samuelson effect operate over the demand-side of the economy. The litera-
ture discusses non-homothetic preferences (Bergstrand, 1991), government demand (De
Gregorio, Giovannini and Wolf, 1994; Galstyan and Lane, 2009) and net foreign
assets (Lane and Milesi-Ferretti, 2002, 2004; Christopoulos, Gente and Le´on-Ledesma,
2012).2
JEL Classification numbers: F14, F31, J11
*We thank Oleg Badunenko,Tino Berger, Alexander Ludwig, Øivind Nilsen, Matthias Sch¨on, three anonymous
referees, as well as seminar and conference participants at Cologne, Dortmund and Paris for helpful comments. We
also thank Julie Graf for excellent research assistance.
1See, amongst others, Canzoneri, Cumby and Diba (1999), Kakkar (2003), Berka, Devereux and Engel (2014),
and Coto-Martinez and Reboredo (2014), where the latter also consider the role of imperfect competition.
2An interesting synopsizing study is conducted by Ricci, Milesi-Ferretti and Lee (2013).
320 Bulletin
AUT
BEL
CAN
DNK
FIN
FRA
ITA
JPN
KOR
NLD
NOR
PRT
ESP
GBR
USA
0 1 2 3
1.5 2. 5 3.5 4.5 5. 5
Avg. annual change of relative productivity
Avg. annual change of relative price of non−tradables
AUT
BEL
CAN
DNK
FIN
FRA
ITA
JPN
KOR
NLD
NOR
PRT
ESP
GBR
USA
0 1 2 3
.5 1.5 2.5 3.5
Avg. annual change old−age dependency ratio
Avg. annual change of relative price of non−tradables
(a) (b)
Figure 1. Cross-sectional correlations of relative price changes. (a) Relative productivity. (b) Old-age depen-
dency ratio
Notes: Average annual changes for 15 OECD countries between 1970 and 2009. Abscissa left panel: produc-
tivity in tradable relative to non-tradable sector. Abscissa right panel: old-age dependency ratio (population
aged 65+ divided by population aged 15–64). Details on the construction of all variables are given in online
Appendix A. Country codes are explained in Table 1.
In this study, we propose a country’s demographic structure as an additional eco-
nomic fundamental for the relative price of non-traded goods and we study this rela-
tionship empirically. Figure 1 highlights the importance of this deter minant. As a point
of reference, the left panel depicts the cross-sectional relation between changes in rela-
tive prices of non-tradables and productivity growth differentials between tradables and
non-tradables for a set of industrialized countries. The strong positive correlation illus-
trates the Balassa–Samuelson effect. The right panel plots relative price changes against
the average growth rates of old-age dependency ratios (hereafter named OADR), which
are defined as the fraction of population aged 65+ to the population of age 15–64. This
highlights our proposed channel: changes in the age structure of the population are posi-
tively correlated with the growth rate of the relative price of non-tradables. In par ticular,
countries with stronger growth of the OADR experience higher growth in the relative
price.
There are several mechanisms how ageing can lead to higher relative prices. In this
study, we focus on the following demand effects.We present evidence that elderly people
consume more non-traded services relative to people in working age. This implies an
increase in overall demand for those goods due to population ageing. At the same time,
the old-age population has lower saving rates than younger cohorts, such that agg regate
savings of an ageing society decline (see for instance Higgins, 1998; Yoon, Kim and Lee,
2014), while aggregate consumption increases. Likewise this rise in spending is also biased
towards non-tradable goods. If the additional demand for non-traded services of an ageing
society is not fully met by higher supply, the relative price of non-tradables increases.
We claim that persistent imperfect intersectoral mobility of production factors hampers
a reallocation of factor inputs to the non-tradable sector. Since we are concentrating on
©2016 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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