A TIME-SERIES APPROACH TO TEST THE PRODUCTIVITY BIAS HYPOTHESIS IN PURCHASING POWER PARITY

It has been argued that a greater difference between productivities of two countries contributes to a larger gap between their wages. This, in turn, may contribute to a larger gap between purchasing power parity and the equilibrium exchange rate. Therefore, productivity differential is said to be one of the major factors contributing to the deviation of purchasing power parity from the equilibrium exchange rates, a phenomenon known as productivity bias hypothesis. In this paper we reexamine the productivity bias hypothesis by relying upon time series data and the new technique of cointegration. Out of four countries, France, Italy, Japan, and the U.K. for which the cointegration approach could be applied, at least for three of them (Italy, Japan, and the U.K.) the empirical results showed that there is a longrun equilibrium relation between the productivity differentials and the deviation of purchasing power parity from the equilibrium exchange rate, supporting the productivity bias hypothesis.