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| Economic Competitive Growth and Determinants of the Formation Mechanism of Regional Inflation Differentials in China: Analysis of the Penn-Balassa-Samuelson Effect Based on Spatial Econometrics |
| YANG Changjiang, LI Bo
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| School of Economics, Fudan University |
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Abstract Inter-regional inflation differentials within an economy are affected by multiple factors, such as the effectiveness of monetary policy and the coordinated development of regional economies, and have been a focus of research since the establishment of the euro. The prevailing research method in this field is based on the theory of the Balassa-Samuelson effect (hereinafter referred to the BS effect), which was originally used in the dichotomy framework as the basis of a cross-border real exchange rates model. However, it remains under debate whether BS effect theory can be applied within a country, and whether there are new features within a country is also highly noteworthy.
Regional inflation differentials are particularly important for a large country like China, which has undergone rapid economic transformation and upgrading in recent decades. Moreover, inter-regional competitive growth is recognized as an important driving force of China's “economic miracle”. Thus, the Penn-BS effect paradigm based on the perspective of growth and productivity is especially relevant for analyzing the inflation differentials between regions in China. However, very few studies take this perspective, and there are also some problems that need to be clarified.
In this study, we adopt the Penn-BS effect analysis paradigm for the first time to examine the basic pattern, the fluctuation sources, and then the driving forces of inflation differentials. We use the spatial econometric model to study the mechanism of formation of medium-to long-term inflation differentials within China and find that the theoretical core of the BS effect applies to the inflation differentials within China. However, we also find that the theoretical core of the BS effect shows new characteristics, which may be related to the breaking of the original dichotomy framework under the servitization trend of manufacturing.
We begin by examining the basic pattern the regional inflation differentials in China from the perspective of economic growth and analyzing whether the Penn effect or the Kaldor effect applies to China. Based on the inflation and growth data of 28 provinces in China from 1992 to 2019, we find that the inflation differentials within China follow the basic law of the Penn effect. We adopt the amount of Jinshi in each region during the Ming and Qing dynasties as an instrumental variable and perform a robustness test, and find that the abovementioned conclusions remain unchanged.
Whether the Penn effect seen in China can be explained by BS effect theory depends on the structural sources of the inflation differentials. We adopt the variance decomposition method of Betts and Kehoe (2008) and use two indicators—variance and mean squared error—to decompose the contributions of different factors in the fluctuation sources of the inflation differentials within China. We find that deviations from the law of one price and the relative price effect are both important sources. The former is more important than the latter in most cases, and spatial adjacency also has a highly significant impact the inflation differentials. In addition, this result shows that the traditional paradigm of BS effect analysis remains necessary within an economy. Moreover, the prominent position of the deviation from the law of one price is also a paradox in the analysis of the BS effect.
Given the significant spatial correlation of inter-provincial inflation in China, we establish a spatial Durbin model to analyze whether the core of BS effect theory, namely the positive correlation between inter-departmental relative productivity and inter-departmental relative price, applies within China. For the first time, we use a spatial weight matrix that is constructed using inter-regional trade and geographic distance data. We find that relative productivity in a region has a significant and positive direct effect on the local internal real exchange rate, indicating the presence of the BS effect, but has a negative spatial spillover effect. In terms of spatial heterogeneity, the western region's relative productivity has the greatest direct effect, and negative spatial spillover effects mainly occur between regions with strong heterogeneity. We also find that the greater the division of labor markets among regions, the stronger is the BS effect, which means that the existence of obstacles to labor mobility underpin the occurrence of the BS effect within a country.
Furthermore, we find that there is a negative relationship between relative productivity and overall inflation rate, which represents another paradox. However, this finding is consistent with the domestic BS effect theory proposed by Changjiang and Sheng (2021), which holds that the dichotomy framework is no longer in line with the characteristics of modern service industries. Instead, it is necessary to divide the service industry into the productive service industry and the life service industry, and then adopt a three-sector framework. The key conclusions of this theory are confirmed in this paper and offer a preliminary explanation for the two paradoxes mentioned above. That is, these paradoxes can be considered to reflect the new characteristics of the BS effect within a country and represent the main mechanism of formation of regional inflation differentials in China.
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Published: 03 August 2023
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| Cite this article: |
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YANG Changjiang,LI Bo. Economic Competitive Growth and Determinants of the Formation Mechanism of Regional Inflation Differentials in China: Analysis of the Penn-Balassa-Samuelson Effect Based on Spatial Econometrics[J]. Journal of Financial Research,
2023, 517(7): 21-39.
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| URL: |
| http://www.jryj.org.cn/EN/ OR http://www.jryj.org.cn/EN/Y2023/V517/I7/21 |
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