Gerschenkron effect information

The Gerschenkron effect, developed by Alexander Gerschenkron, claims that changing the base year for an index determines the growth rate of the index. This effect is applicable only to aggregation method using reference price structure (meaning, each country’s quantities are valued by uniform set of prices to obtain volume) or reference volume structure (meaning, obtaining Purchasing power parity via valuation of uniform set of quantities by each country’s price). However, if production is measured by "real" tearms, this effect does not exist. ^[1]

This description is from the OECD website:^[2]

The Gerschenkron effect can arise with aggregation methods that use either a reference price structure or a reference volume structure to compare countries. For methods employing a reference price structure, a country's share of total GDP (that is the total for the group of countries being compared) will rise as the reference price structure becomes less characteristic of its own price structure. For methods employing a reference volume structure, a country's share of total GDP will fall as the reference volume structure becomes less characteristic of its own volume structure. The Gerschenkron effect arises because of the negative correlation between prices and volumes. In other words, expenditure patterns change in response to changes in relative prices because consumers switch their expenditure towards relatively cheap products.

Simply, put the “Gerschenkron effect” measures the difference between Paasche and Laspeyres indices. That means that “early-weighted” aggregate will grow faster than “late-weighted.” Negative correlation is due to relatively rapid technical progress and falling relative price benefit from cost-reducing substitution. Or it can be vice versa; slow technical progress, increasing relative price suffer from cost-reducing substitution. In other words, this effect arises when activities whose relative prices are falling tend to increase their volume shares of total production and vice versa. Which is exactly what happened during industrial revolution when manufacturing expanded is produced volume. ^[1]

After revision by Jonas and Sardy in 1970, properties of the Gerschenkron effect were further developed. In addition to originally stated upward bias of base-year indices and reasoning behind that, it was shown that the movement in relative quantities is usually larger than the movement in relative prices and that the weighted correlation of those effects decreases over time with further development. ^[3]