So, some prices vary wildly from country to country, and some prices don't. What's the difference?



THE NANNY EFFECT

If the answer is obvious to you, then you just might be smarter than some of the 20th century's most brilliant economists, who spent decades building a framework for finding out why some prices between countries (and even between cities in the same country) differ so dramatically. The most elegant of these theories is known, less elegantly, as the Balassa-Samuelson Effect, after two economists Béla Balassa and Paul Samuelson. The Balassa-Samuelson Effect is a mouthful. Let's call it the "Nanny Effect."

In a nutshell, the Nanny Effect says that the price of some goods -- e.g.: Picasso paintings, barrels of oil, bricks of gold, and company stock -- shouldn't vary much by location, because it would create opportunities for arbitrage. If you bought a gold brick for $10 in Peru and sold it for $100 in the United States, Lima sellers would raise their price toward $100.



But most services aren't like gold bars. They're delivered locally and consumed locally. You're not hiring a Bangalore nanny to look after your kids, and you're not flying to Shenzhen for a haircut. From the dry-cleaner, to the restaurant, to the hairdresser, most of the jobs in a service economy have a local clientele. In cities where incomes are high, average price levels for these services are typically high. Where incomes are low, average price levels are low.

But how do incomes go from low to high? Balassa and Samuelson said it must come down to workers' productivity, especially in the sectors that can "trade" their goods and services abroad. If a country gets better at making cars it can sell to foreigners for money, it gets richer. As income and investment flows into a country, incomes rise and prices rise across the board -- even for the haircuts and the nannies.



WHY IS INDIA SO CHEAP? ... AND WHY IS ZURICH SO EXPENSIVE?

On Tuesday, and my roommate Shyam emailed from Mumbai to brag about the cheap food. Ordering "a full lunch of a rice, naan and three curries for, oh, about $1 is pretty great." It sure is, Shyam. But if he had visited ten years ago, it might have been closer to 50 cents. As India has become more productive over the last few decades, wages in the tradable sector (IT) rose, pulling up wages in the nontradable sector (waiters), and the currency has appreciated. There is a still a major price difference D.C. and Delhi. One dollar will pay for much less stuff in America than its equivalent in rupees will buy in India. But as Indian exports continue to grow, one should expect Shyam's lunch to get more and more expensive.

There is much more to price levels than the Nanny Effect. Much, much, much more. Restrictive urban policy raises the price of rent in similarly productive cities. Energy policies and levies raise or lower the price of gas. Tariffs raise the price of imports. On a nation-by-nation basis, taxes restrain demand and subsidies increase supply on an idiosyncratic basis.

