25:
1047:, and might make the non-traded sector look relatively less productive than it had been when demand was lower; if service quality (rather than quantity) follows diminishing returns to labour input, a general demand for a higher service quality automatically produces a reduction in per-capita productivity.
271:
In each country, under the assumption of competition in the labor market the wage ends up being equal to the value of the marginal product, or the sector's price times MPL. (Note that this is not necessary, just sufficient, to produce the Penn effect. What is needed is that wages are at least related
799:
in favour of the
Balassa–Samuelson hypothesis, since supermarket beer is an easily transportable, traded good. (Although pub beer is transportable, the pub itself is not.) The BS-hypothesis explanation for the price differentials is that the 'productivity' of pub employees (in pints served per hour)
808:
in the north). Although the employees of southern pubs are not significantly more productive than their counterparts in the north, southern pubs must pay wages comparable to those offered by other southern firms in order to keep their staff. This results in southern pubs incurring a higher labour
187:
The simplest model which generates a
Balassa–Samuelson effect has two countries, two goods (one tradable, and a country-specific nontradable) and one factor of production, labor. For simplicity assume that productivity, as measured by marginal product (in terms of goods produced) of labor, in the
859:
The vast majority of the evidence supports the HBS model. A deeper analysis of the empirical evidence shows that the strength of the results is strongly influenced by the nature of the tests and set of countries analyzed. Almost all cross-section tests confirm the model, while panel data results
833:
Over time, the testing of the HBS model has evolved quite dramatically. Panel data and time series techniques have crowded out old cross-section tests, demand side and terms of trade variables have emerged as explanatory variables, new econometric methodologies have replaced old ones, and recent
909:
problems with testing the BS-hypothesis, and the lack of strong evidence for it between modern economies may not refute it, or even imply that it produces a small effect. For instance, other effects of exchange rate movements might mask the long-term BS-hypothesis mechanism (making it harder to
817:
Evidence for the Penn effect is well established in today's world (and is readily observable when traveling internationally). However, the
Balassa–Samuelson (BS) hypothesis implies that countries with rapidly expanding economies should tend to have more rapidly appreciating exchange rates (for
829:
In total, since it was (re)discovered in 1964, according to Tica and Druzic (2006) the HBS theory "has been tested 60 times in 98 countries in time series or panel analyses and in 142 countries in cross-country analyses. In these analyzed estimates, country specific HBS coefficients have been
1250:
policy. (Lu & Yu 1999). Other mechanisms through which RERs can affect productivity growth have been advanced, such as the idea that structural transitions caused by exchange rate volatility have a disruptive effect on the real economy. There is some econometric evidence that the
1093:
it produces. However, this reasoning is slightly different from the pure BS-hypothesis, because the goods being produced are 'traded-goods', even though protectionist measures mean that they are more expensive on the domestic market than the international market, so they will not be
830:
estimated 166 times in total, and at least once for 65 different countries". Many papers have been published since then. Bahmani-Oskooee and Abm (2005) & Egert, Halpern and McDonald (2006) also provide quite interesting surveys of empirical evidence on BS effect.
1319:
it may be harder to increase the productivity in the service sector as rapidly as in mass-production, so if money exchange rates are still based on the output of mass production the differentials in price level could still be caused by the
Balassa–Samuelson
1848:
but says even countries undergoing very rapid traded-goods productivity growth only experience inflationary pressure in the 1-2% range, and inflation sources other than
Balassa–Samuelson have proven more significant for past Euro converge candidates like
1237:
says that currency depreciations can reduce growth, and that 'overvalued' currencies can contribute to domestic productivity growth by 'forcing' efficiency improvements in the tradables sector (by exposing it to international competition at unfavourable
1310:
domestic producers import barriers are raised, allowing the local price for the traded good to rise beyond the international price. If this were a common phenomenon then one of the key assumptions of the BS-hypothesis (that traded-goods follow the
950:
An increase in the productivity and competitiveness of the distribution sector with respect to foreign countries leads to an appreciation of the real exchange rate, similarly to what a relative increase in the domestic productivity of tradables
981:
In this model, there has been no change in real economy productivities, but money price productivity in traded goods has been exogenously lowered through currency appreciation. Since capital inflow is associated with high-income states (e.g.
910:
detect if it exists). Exchange rate movements are believed by some to affect productivity; if this is true then regressing RER movements on differential productivity growth will be 'polluted' by a totally different relationship between the
864:
between relative productivity and relative prices within a country and between countries, while the interpretation of evidence for cointegration between real exchange rate and relative productivity has been much more controversial.
712:
Since money exchange rates will vary fully with tradable goods productivity, but average productivity varies to a lesser extent, the (real goods) productivity differential is less than the productivity differential in money
1008:
has appreciated 14% (during the 1990s). The export sector of the Cape Verde economy suffered a similar fall in productivity during the same period, which was caused entirely by capital flows and not by the BS-effect.
1293:, Bourdet & Falck found that the export sector strengthened during the 1990s period of currency appreciation, which might support the theory of "Competitive Appreciation" mentioned in the footnote above
687:
with the (highly productive) Zürich engineers, Zürich fast food employees must be paid more than Moscow fast food employees, even though the burger production rate per employee is an international constant.
507:
Where the subscript "t" denotes the tradables sector. Note that the lack of a country specific subscript on the price of tradables means that tradable goods prices are equalized between the two countries.
171:), and many manufactured goods such as furniture have high transportation costs or, conversely, low value-to-weight or low value-to-bulk ratios, which makes deviations from the law of one price, known as
946:
working paper
Macdonald & Ricci accept that relative productivity changes produce PPP-deviations, but argue that this is not confined to tradables versus non-tradable sectors. Quoting the abstract:
740:(which is always 1 for areas sharing the same currency). Looking at the price level distribution within a country gives a clearer picture of the effect, because this removes some complicating factors:
503:
387:
1054:
countries have a higher ratio of service-sector to traded-goods-sector employment than low-GDP countries. If the traded/non-traded consumption ratio is also correlated with the price level, the
1229:
There may be a causal link from exchange rates to productivity, as well as (or instead of) the opposite direction of causation (from productivity to RERs) given by the BS-hypothesis model.
897:"A possible explanation of the BS empirical rejection may simply be that there are additional long-run real exchange determinants that have to be considered." Drine & Rault conclude.
264:
575:
637:
860:
confirm the model for the majority of countries included in the tests. Although some negative results have been returned, there has been strong support for the predictions of a
1629:
Kravis, Irving B. & Lipsey, Robert E. (1991), "The
International Comparison Program: Current Status and Problems", in Hooper, Peter & Richardson, J. David (eds.),
642:
So with a same (world) price for tradable goods, the price of nontradable goods will be lower in the less productive country, resulting in an overall lower price level.
1020:(1998) and others say that income rises can change the ratio of demand for goods and services (tradable and non-tradable sectors). This is because services tend to be
1362:
800:
is more uniform than the 'productivity' (in foreign currency earned per year) of people working in the dominant tradable sector in each region of the country (
719:
This is equivalent to saying that the money exchange rate exaggerates the real income, or that the price level is higher in more productive, richer, economies.
1906:
as the traded goods' productivity gap has declined. They argue that in practise, border barriers mean that tradables appreciate with productivity, and say:
868:
Therefore, most of the contemporary authors (e.g.: Egert, Halpern and McDonald (2006); Drine & Rault (2002)) analyze main BS assumptions separately:
769:
effects, and exchange rate movements can affect the real economy and complicate the picture, a problem eliminated if comparing regions that use the same
1551:
121:
between developed and less developed countries in the traded goods' sectors which in turn affects wages and prices in the non-tradable goods sectors.
1881:'s Product Price Differences across Countries (2004) traces the history of the qualitative description given by the Balassa–Samuelson effect back to
1895:- Cincibuch & Podpiera (2004) studied the RER appreciation to explain why it exceeds the Balassa–Samuelson prediction in the case of bilateral
1874:
Useful summary of the different
Exchange Rate Equilibrium models, including Balassa–Samuelson, as models for estimating a stable Koruna/Euro level
1590:Égert, Balázs; Halpern, László & MacDonald, Ronald (2006), "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues",
1089:
This explanation is similar to the BS-effect, since an industry needing protection must be measurably less productive in the world market of the
1581:
989:
1856:
1412:
Bahmani-Oskooee, Mohsen & Rhee, Hyun-Jae (1996), "Time-series
Support for Balassa's Productivity-bias Hypothesis: Evidence from Korea",
1547:
993:
1165:
findings have been mixed, and partly to differentiate the model from its conclusion, modern papers tend to refer to the
Balassa–Samuelson
672:
The fixed-productivity sectors are also the ones producing non-transportable goods (for instance haircuts) – this must be the case or the
848:
has become a benchmark for empirical tests. Consensus has been reached on the testing of internal and external HBS effects (vis a vis a
1259:
978:. As the RER appreciates, the competitiveness of the traded-goods sectors falls (in terms of the international price of traded goods).
1693:
MacDonald, R. & Ricci, L. (2005), "The real exchange rate and the Balassa Samuelson Effect: The Role of the Distribution Sector",
1873:
1555:
1383:
Bahmani-Oskooee, Mohsen & Nasir, Abm (2005), "Productivity Bias Hypothesis and the Purchasing Power Parity: A Review Article",
1176:
175:
or PPP-deviations, persistent. The Penn effect is that PPP-deviations usually occur in the same direction: where incomes are high,
728:
The average asking price for a house in a prosperous city can be ten times that of an identical house in a depressed area of the
709:) so that tradable goods follow PPP (purchasing power parity). The assumption that PPP holds only for tradable goods is testable.
393:
277:
1761:
1638:
1508:
1651:& Swedenborg, Birgitta (1996), "The High Cost of Eating: Causes of International Differences in Consumer Food Prices",
872:
The differential of productivities between the traded and non-traded sector and relative prices are positively correlated.
661:
Certain labour-intensive jobs are less responsive to productivity innovations than others. For instance, a highly skilled
1359:
1315:-hypothesis) would be invalid. However, the essence of the Balassa–Samuelson mechanism would still remain: Even without
1188:
1888:
68:
46:
1058:
would still be observed with labour productivity rising equally fast (in identical technologies) between countries.
39:
1132:
does not lead to as much of an improvement in the living standard as an equal GDP increase in the non-traded sector
1122:, when compared with treating the sectors equally. The Balassa–Samuelson effect might be one reason to oppose this
885:
As a consequence of 1, 2, & 3, there is a long-run relationship between productivity differentials and the RER.
1285:
The BS-hypothesis would still explain the Cape Verde price index rise in its own terms if the incomes from rising
1257:
Strauss, Jack (1999), "Productivity Differentials, the Relative Price of Nontradables and Real Exchange Rates",
658:
than in others. This is the ultimate source of the income differential. (Also expressed as productivity growth.)
1732:
Officer, Lawrence H. (1976), "The Productivity Bias in Purchasing Power Parity: An Econometric Investigation",
1913:"Real appreciation is also observed in tradables and often accounts for the bulk in the overall appreciation".
756:
noise. (This noise would be an econometric problem, even assuming that the exchange rate volatility is a pure
1255:
from exchange rates to productivity is more significant than the reverse, i.e. the BS-effect. (For instance,
193:
763:
There may be some real economy border effects between countries which limit the flow of tradables or people.
516:
1924:
1633:, National Bureau of Economic Research Studies in Income and Wealth, Chicago: University of Chicago Press,
1438:
584:
943:
757:
1944:
1306:, is that domestic productivity of some tradable-good is below international productivity. In order to
1000:
remittances on the traded-goods sector. They find that, as local incomes have risen with a doubling of
1893:
to traded goods; so that the pure Balassa–Samuelson effect is an underestimate of likely RER changes
1840:
Widely cited examination of the relationship between distribution-sector productivity and the effect
1707:
1604:
889:
Refinements to the econometric techniques and debate about alternative models are continuing in the
779:
are very different in many countries, whereas in a same country taxes are usually equal or similar.
106:
33:
1134:. (This is due to the effect's prediction that the CPI will increase by more in the former case.)
1110:(and others) have argued that raising international competitiveness through policies that promote
1312:
890:
876:
853:
749:
172:
94:
1928:
1921:
A breakdown of the demand and supply side effects on the exchange rate from rising productivity
1878:
1845:
1702:
1599:
1206:
1083:
1051:
931:
911:
50:
1289:'s remittances were counted as local traded-goods 'productivity' increases. In their study of
1768:
1107:
511:
Suppose that country 2 is the more productive, and hence, the wealthier one. This means that
1672:
Lu, Ding & Yu, Qiao (1999), "Hong Kong's exchange rate regime: Lessons from Singapore",
1866:"results do not show supportive evidence for the Balassa–Samuelson effect in the long run."
1071:
1044:
176:
98:
8:
1197:
1040:
835:
669:
counterpart (in burger/hour) but these jobs are services which must be performed locally.
164:
102:
1564:
1824:
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1737:
1720:
1664:
1617:
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1455:
1425:
1400:
1119:
801:
796:
733:
716:
Productivity becomes income, so the real income varies less than the money income does.
1685:
1467:
David, Paul A. (1972), "Just How Misleading are Official Exchange Rate Conversions?",
1272:
109:. This observation about the systematic differences in consumer prices is called the "
1757:
1749:
1716:
1634:
1613:
1575:
1504:
1404:
1396:
1230:
1201:
1151:
1075:
819:
693:
local goods (which in richer countries are more expensive relative to tradables), and
1724:
1621:
1459:
131:
independently proposed the causal mechanism for the Penn effect in the early 1960s.
16:
Tendency for consumer prices to be systematically higher in more developed countries
1820:
1791:
1712:
1681:
1660:
1648:
1609:
1476:
1447:
1421:
1392:
1268:
706:
673:
152:
1532:
1158:(1939, pp. 71–77), but this portion was not included in subsequent editions.
901:
The next section lists some of the alternative proposals to an explanation of the
139:
The Balassa–Samuelson effect depends on inter-country differences in the relative
1920:
1631:
International Economic Transactions: Issues in Measurement and Empirical Research
1366:
1342:
1114:
sectors' productivity (at the expense of other sectors) will increase a nation's
268:
where "nt" denotes the nontradable sector and 1 and 2 indexes the two countries.
1433:
1143:
124:
1901:
1839:
1779:
1496:
1303:
1239:
1147:
1066:
Lipsey and Swedenborg (1996) show a strong correlation between the barriers to
1028:
1021:
1017:
128:
1082:
on agricultural imports) we should expect to see a correlation between rising
1938:
1882:
1772:
1307:
1074:. If wealthy countries feel more able to protect their native producers than
1032:
1005:
961:
861:
845:
805:
753:
702:
1846:
The European Central Bank defines BS-effect from the inflation point of view
882:
The RER and relative prices of non-tradable goods are positively correlated.
650:
A typical discussion of this argument would include the following features:
1811:
Samuelson, P. A. (1994), "Facets of Balassa-Samuelson Thirty Years Later",
1736:, vol. 23, no. 3, Palgrave Macmillan Journals, pp. 545–579,
1210:
1129:
1123:
1111:
745:
655:
168:
140:
118:
1142:
The Balassa–Samuelson effect model was developed independently in 1964 by
849:
117:
is the proposition that this can be explained by the greater variation in
1086:
and rising prices (for goods in protected industries - especially food).
1055:
1036:
967:
927:
906:
902:
838:
823:
110:
917:
1803:
1741:
1518:
1488:
1316:
1290:
1193:
1167:
1067:
1001:
997:
723:
677:
1150:. The effect had previously been hypothesized in the first edition of
1533:"The Harrod–Balassa–Samuelson Effect: A Survey of Empirical Evidence"
1343:"The Harrod-Balassa-Samuelson Effect: A Survey of Empirical Evidence"
1252:
1243:
1162:
1090:
1024:, which are consumed proportionately more heavily at higher incomes.
812:
188:
nontradable sector is equal between countries and normalized to one.
160:
1795:
1480:
1246:
gave "Competitive Appreciation" as the official reason for the high
662:
1451:
1286:
971:
770:
766:
156:
159:
goods cannot vary greatly in price by location because buyers can
1897:
788:
1879:
The International Association for Research in Income and Wealth
1850:
1436:(1964), "The Purchasing Power Parity Doctrine: A Reappraisal",
1095:
1079:
983:
666:
1842:
with links to the academic Balassa–Samuelson effect discussion
975:
844:
The sector approach combined with panel data analysis and/or
776:
1647:
792:
91:
Ricardo–Viner–Harrod–Balassa–Samuelson–Penn–Bhagwati effect
1247:
1177:
A panel data analysis of the Balassa-Samuelson hypothesis
1115:
986:) this could explain part of the RER/Income correlation.
784:
498:{\displaystyle w_{2}=p_{nt,2}*MPL_{nt,2}=p_{t}*MPL_{t,2}}
382:{\displaystyle w_{1}=p_{nt,1}*MPL_{nt,1}=p_{t}*MPL_{t,1}}
1557:
Panel data analysis of the Balassa–Samuelson hypothesis
93:(Samuelson 1994, p. 201), or productivity biased
1589:
918:
Alternative, and additional causes of the Penn effect
736:-deviation exists independent of what happens to the
587:
519:
396:
280:
196:
1382:
724:
Equivalent Balassa–Samuelson effect within a country
146:
1411:
926:model has some merit. However other sources of the
813:Empirical evidence on the Balassa–Samuelson effect
631:
569:
497:
381:
258:
1012:
1936:
1931:and C. Wojcik of the Warsaw School of Economics.
1857:An Empirical test of Balassa–Samuelson from 2000
1503:(Reprint ed.), London: Palgrave Macmillan,
841:have provided direction for future researchers.
826:tests yield mixed findings for this prediction.
795:prices are very similar. This may be treated as
787:beer is famously more expensive in the south of
1782:(1964), "Theoretical Notes on Trade Problems",
1039:to include proportionately more expenditure on
852:country) with a strong reservation against the
696:tradables, which have the same price everywhere
1692:
1341:Tica, Josip; Družić, Ivo (13 September 2006).
665:burger flipper is no more productive than his
1050:A typical labour market pattern is that high-
922:Most professional economists accept that the
1628:
1101:
182:
1580:: CS1 maint: location missing publisher (
1546:
1530:
1340:
1260:Journal of International Money and Finance
879:assumption is verified for tradable goods.
143:of the tradable and non-tradable sectors.
1810:
1778:
1706:
1603:
1495:
97:(PPP) (Officer 1976) is the tendency for
69:Learn how and when to remove this message
1889:Paper disputes the applicability of the
1501:The New Palgrave Dictionary of Economics
1360:Emigrants' Remittances And Dutch Disease
32:This article includes a list of general
1731:
1432:
1256:
1035:can change the make-up of the consumer
259:{\displaystyle MPL_{nt,1}=MPL_{nt,2}=1}
1937:
1748:
1517:
937:
654:Workers in some countries have higher
570:{\displaystyle MPL_{t,1}<MPL_{t,2}}
1563:, Sorbonne University, archived from
1466:
1302:A typical reason for, and result of,
1754:The Competitive Advantage of Nations
1671:
1525:, London: Cambridge University Press
1235:The Competitive Advantage of Nations
1171:, rather than the Balassa–Samuelson
632:{\displaystyle p_{nt,1}<p_{nt,2}}
101:to be systematically higher in more
18:
1499:(1988), "Purchasing Power Parity",
856:assumption in the tradable sector.
13:
1825:10.1111/j.1467-9396.1994.tb00041.x
1784:Review of Economics and Statistics
1771:as well as the productivity—
1665:10.1111/j.1475-4991.1996.tb00165.x
1531:Tica, J. & Druzic, I. (2006),
1426:10.1111/j.1467-9396.1996.tb00110.x
1375:
1189:List of international trade topics
38:it lacks sufficient corresponding
14:
1956:
1833:
1813:Review of International Economics
1414:Review of International Economics
934:relationship have been proposed:
1717:10.1111/j.1468-0106.2005.00259.x
1614:10.1111/j.0950-0804.2006.00281.x
1397:10.1111/j.0950-0804.2005.00261.x
1061:
974:appreciation through demand for
955:
791:than the north, but supermarket
167:must be delivered locally (e.g.
23:
752:(PPP) tests are complicated by
87:Harrod–Balassa–Samuelson effect
1540:EFZG Working Paper Series 0607
1353:
1334:
1296:
1279:
1223:
1027:A shift in preferences at the
1013:Services are a 'superior good'
89:(Kravis and Lipsey 1983), the
1:
1686:10.1016/S1043-951X(99)00009-7
1327:
1273:10.1016/S0261-5606(99)85003-7
1439:Journal of Political Economy
1349:– via ideas.repec.org.
1126:, because it predicts that:
1004:from abroad, the Cape Verde
966:Capital inflows (say to the
905:, but there are significant
115:Balassa–Samuelson hypothesis
7:
1653:Review of Income and Wealth
1592:Journal of Economic Surveys
1385:Journal of Economic Surveys
1182:
1043:. This alone may shift the
996:have studied the effect of
944:International Monetary Fund
161:source from the lowest cost
10:
1961:
1347:Efzg Working Papers Series
1137:
959:
685:equalize local wage levels
645:
1102:Trade theory implications
893:community. For instance:
804:in the south of England,
134:
1216:
924:Balassa–Samuelson effect
183:Basic form of the effect
163:location. However, most
107:less developed countries
83:Balassa–Samuelson effect
1756:, Toronto: Free Press,
1695:Pacific Economic Review
1523:International Economics
1179:", referred to above.)
1156:International Economics
891:International economics
877:purchasing power parity
854:purchasing power parity
750:purchasing power parity
690:The CPI is made up of:
173:purchasing power parity
147:Empirical "Penn Effect"
95:purchasing power parity
53:more precise citations.
1929:Strathclyde University
1207:Mathematical economics
1175:. (See for instance: "
1108:supply-side economists
953:
809:cost per pint served.
633:
571:
499:
383:
260:
1769:comparative advantage
1674:China Economic Review
1365:May 13, 2005, at the
960:Further information:
948:
754:nominal exchange rate
738:nominal exchange rate
676:work would have been
634:
572:
500:
384:
261:
1767:(Discusses national
1469:The Economic Journal
1118:, and increase its
1045:consumer price index
1031:level, caused by an
585:
517:
394:
278:
194:
179:are typically high.
177:average price levels
1198:economic inequality
938:Distribution sector
579:which implies that
103:developed countries
1734:IMF Staff Paper 23
1120:standard of living
1098:" internationally
1076:developing nations
834:improvements with
802:financial services
797:anecdotal evidence
705:is pegged (by the
629:
567:
495:
379:
272:to productivity.)
256:
1945:Economics effects
1763:978-0-684-84147-2
1649:Lipsey, Robert E.
1640:978-0-226-35135-3
1510:978-1-56159-197-8
1231:Michael E. Porter
1202:per capita income
1152:Roy Forbes Harrod
1070:and the domestic
820:Four Asian Tigers
732:. Therefore, the
79:
78:
71:
1952:
1925:Ronald MacDonald
1902:Central European
1891:law of one price
1827:
1806:
1780:Samuelson, P. A.
1766:
1744:
1727:
1710:
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1607:
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1513:
1491:
1475:(327): 979–990,
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1369:
1357:
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1350:
1338:
1321:
1300:
1294:
1283:
1277:
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1227:
970:) may stimulate
822:); conventional
707:law of one price
674:labour intensive
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153:law of one price
85:, also known as
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63:
60:
54:
49:this article by
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928:Penn effect
907:econometric
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839:tradability
824:econometric
701:The (real)
155:, entirely
111:Penn effect
51:introducing
1328:References
1317:Free trade
1291:Cape Verde
1194:Free trade
1168:hypothesis
1068:free trade
998:Cape Verde
994:Hans Falck
942:In a 2001
836:endogenous
783:A pint of
758:error term
678:off-shored
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1703:CiteSeerX
1600:CiteSeerX
1552:Rault, C.
1548:Drine, I.
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1576:citation
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105:than in
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