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.
This description is from the OECD website:
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.
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.
History
What is now called the “Gerschenkron effect” have first appeared in 1947 and was further explained and used in a study A Dollar Index of Soviet Machinery Output in 1951 by Alexander Gerschenkron. Using actual data of United States machinery output in different years, it, empirically, showed that the substantial economic growth of the Soviet Union was due to index number bias; a Laspeyres index calculated on basis of 1926-27 had overstated the real expansion. It was shown for an industrial production index, however, it would be the same for price indices with differently weighted volume indices. That finding proved Soviet economic growth in the first half of 20th century to be subject to inappropriate technique, rather than false statistics. Which had a great political importance at that time as it deflated the economic growth of the biggest communist economy at that time.
The “Gerschenkron effect” can be observed throughout the history. It is, however, connected with technological growth; e.g. industrial revolution. Because of tremendous technological development, thus, disproportional change in prices for different goods, the “Gerschenkron effect” has become even more pronounced in the second half of 20th century. Meaning, that the true economic growth was massively overstated if older prices were taken as base of the index. Therefore, both cross-country and cross-time comparisons has become rather challenging. Considering concurrent economic growth, especially of high-tech companies, the challenge will become greater. According to Gerschenkron, a country that experiences the industrialization process late progresses faster than the countries that industrialize early when it makes its industrialization move. The success and thus the speed of late industrialized countries have been possible with the use of modern technology. The late industrialized countries, which had the chance to compete with the early industrializing countries through modern technology and managed to have a large share in the world markets, adopted a strategy of concentrating on industries where technology is important in order to reach these countries. For example; In the second half of the 19th century, the technologies used in heavy industries in Russia and Germany developed rapidly and as the developing technology required large-scale enterprises, the scale of the factories in these countries also increased. Alexander Gerschenkron emphasized that the later a country industrializes, the larger the factory scale and capital-output ratio required.