HOMEWORK ASSIGNMENT: FACTORS FOR DIFFERENCE BETWEEN STARTING WAGE

OF COLLEGE GRADUATED STUDENT IN UNITED STATES AND VIETNAM

1. Introduction
Introduced in the 1920s by Gustav Castel, the Purchasing Power Parity (PPP) is
a method used to determine the exchange rate between countries. PPP theory is basically
based on considering the connection between exchange rates and the local-currency prices
of an individual commodity in different countries, also known as law of one price.
However, there are several problems arise in reality that question the validity of law of one
price and furthermore PPP method. One of typical question that we will analyze in the next
part of this assignment is the difference between the starting salary of students in US and in
Vietnam graduate in the same major. For instance, a Vietnamese Bachelor of Arts in
Economics after graduate normally receive 4,000,000, which is roughly around
$200/month, while in United Sates the number is about that tenfold, $2000/month.
According to the law of one price, the salary per month of people in different location their
labors price should be the same. Thus, what causes this deviation to happen?
2. Analysis
In his textbook International Finance (2005), Maurice D. Levi stated 2 reasons for
departures from PPP. Both of them is based on flaws in assumption of the law of one price.
In order to work, the law of one price assumes that all of there are people who buy in one
market and sell in another
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the commodity arbitragers. These people take advantages of
free trade to buy a commodity with cheap price and sell them in markets where its price is
higher. In reality, however, the aforementioned assumption is not always true due to
restrictions on movement of goods and labor is a non-tradable good. Later on this
part, I will point out 2 additional reasons why law of one price cannot hold in the starting
wage problem, which is because of the Balassa-Samuelson effect & cost of living and
differences in human capital.
2.1. Restrictions on movement of goods and the difficulty in equalize the price of
non- tradable goods
The law of one price states that when there is a price differential in locations around
the world, rational people will arbitrage goods across countries. This allows them to make
profit by buying cheap and sell at higher price. In short term, this phenomena will not likely
to create a remarkable effect. But when we consider in the long term, these commodity
arbitragers will increase the demand in the country that has the low-priced goods (we
assume as A) and increase the supply in the country they sell goods at higher price (country
B). This will ultimately increase the price in country A and lower the price in country B, and
in other words, narrow the gap between their price. The movement of tradable goods in
those countries is the key factor that helps equalize prices difference.
However, such movement might be difficult to exist in real world. Even with the
visible goods, governments nowadays tend to protect their countries domestic markets by
creating trade barriers like import tariffs, quota and technical standards. These policies and

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Maurice Levi (2005), International Finance, fourth edition, p. 143
also transportation cost will make arbitraging goods across countries harder because they
increase the price of commodity before they enter those countries.
Furthermore, in our problem, the good mentioned is labor a non-tradable good. We
can only help our people settle in foreign countries, encourage them to live and work there,
but cannot arbitrage their labor. That means the law of one price will not work, since there
is no real arbitrager in labor market.
2.2. Balassa- Samuelson effect
Bela Balassa and Paul Samuelson both points out some important propositions in
their independent work in 1964, which part of them is:
The greater are productivity differentials in the production of tradable goods
between countries, the larger will be differences in wages [in those countries] []
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If international productivity differences are greater in the production of tradable
goods than in the production of non-tradable goods, the currency of the country with
the higher productivity will appear to be overvalued in terms of purchasing power
parity.
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These proposition is a part of an effect that economists nowadays often call the
Balassa-Samuelson effect. While its economic model is somewhat complicated and I have
not fully understood yet, the theory basically states that price level in developed countries is
higher than developing countries. Because there are differences in price level, it also exists
the wage level differences between these countries since wage is the price of labor. Besides,
workers in developed countries produce more productivity, their currency will likely to be
overvalued in terms of purchasing power parity, which also results in the wage level
differences between United States and Vietnam.
Ultimately, because of the price level in United States is higher than in Vietnam, it
leads to a gap between cost of living in these two nations. The result is US firms usually
offer higher wage for people living in here to maintain their more expensive daily life than in
Vietnam.
2.3. Differences in human capital
Gregory Mankiw (2011) defines human capital as the accumulation of
investments in people.
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Also, he states that [] workers with more human capital on
average earn more than those with less human capital and the most important type of
human capital is education
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. This provides us one more factors explain the differences in
wage level between nations. Since the quality of education system on United States are far
more excellent than in Vietnam, graduated American students will have more human capital
than Vietnamese students . Firms are willing to pay more for people have higher education
quality, because they will likely to produce higher marginal products.

2
Bela Balassa (1964), The Purchasing Power Parity Doctrine: A Reappraisal.
3
Bela Balassa (1964), The Purchasing Power Parity Doctrine: A Reappraisal.
4
Gregory Mankiw (2011), Principle of Economics, 6
th
edition. p. 399
5
Gregory Mankiw (2011), Principle of Economics, 6
th
edition. p. 399
Another factor is also worth mentioning is the cost of studying. If we only consider
the cost for studying in higher education (college, university and beyond), the average
annual cost for a student in United States is about $60,000
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. Although there is no official
statistics in Vietnam yet, we can assume it was around $1500 per year (30,000,000).
While this relate more to price level and cost of living, we assume that students expect to
receive the salary that equal to the cost and effort they spend on their education. Because
studying in United States costs higher, graduated students in the country will demand a
higher salary than those in Vietnam.
3. Suggestion
Providing detailed solutions to narrow the gap between wage level in United States
and Vietnam is virtually impossible in this assignment. It would require a deep knowledge
not only in law of one price and purchasing power parity, but also in many branches of
economics and finance like labor economics, international economics, interest rate, inflation,
etc. Moreover, it is likely that resolving the issue of trade barrier and restriction will be
difficult, due to the fact that it depends on both side of Vietnamese and United States.
Because United States government has the right to adopt policies that suit their needs, and
their benefit will be different to Vietnam, it might not be effective if we focus on solutions
that depend on both sides to work. Hence, I will only propose two brief suggestions that
might be feasible to work in Vietnam.
The easiest solution should be concentrate on improving our average productivity. As
Balassa and Samuelson concluded, an increase in productivity can help us raise our living
standard, and while it might create other bad effects (e.g. high inflation), it is worth to
trade-off. Ways to improve productivity include adopting new technology from foreign
countries, increasing funds on research and development activities and optimizing education
system. Improving education quality itself is the second solution. Vietnam government, by
doing this, will vastly improve its work forces ability. We can study the education system
Japan, one of the leading nations in Asia, which have many similarities with Vietnam in
culture. Invest money on education, ultimately, is a good long-term investment.
4. Conclusion
In this answer of assigned problem, I have provided some factors affect the
difference between starting salary of graduated student in United States and in Vietnam.
Although some factors related to the limit of law of one price and purchasing power parity
theory, one of them (education quality) is mostly not, and there should be some other
unrelated reasons that I did not mention above. Consequently, these factors have pointed
out the fact that law of one price does not always work, and the PPP index is not always a
reliable index.
Also, I would like to address specially thanks to Prof. Le The Binh for providing a
problem that was seemed to be simple at the beginning, but in fact took me hours to revise
my economics knowledge and research to answer.


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http://www.forbes.com/sites/steveodland/2012/03/24/college-costs-are-soaring/
References
1. Levi, Maurice (2005). International Finance, fourth edition. Routledge.
2. Mankiw, Gregory (2011). Principle of Economics, 6
th
edition. Cengage Learning.
2. Balassa, Bela (1964). The Purchasing Power Parity Doctrine: A Reappraisal. Journal of
Political Economy.
3. Asea, Patrick; Corden, Max (1994). The Balassa-Samuelson Model: An Overview.
Review of International Economics.
4. Forbes.com (2012). http://www.forbes.com/sites/steveodland/2012/03/24/college-costs-
are-soaring/