how fast is the world economy growing? How important is China as an engine of growth? How much richer are ordinary Americans than ordinary China people? The answers to these huge questions depend heavily on how you convert the output of different countries into the same currency. It is misleading to convert a country's gross domestic product into dollars at the market exchange rate. In poor economies, prices are often lower than
, so, for example, the value of a dollar spent in China is much higher than that of a dollar spent in the United States. A more appropriate method is to use purchasing-power parity (PPP) considering price differences.
purchasing power parity theory says that in the long run, the exchange rate should change to a ratio that can make the price of the same package of goods and services in any two countries equal. This is the thinking behind
The Economist's Big Mac index. This index was invented in 1986 as a convenient guide to measure whether the currency is at the "correct" level, and our "package" is McDonald's large hamburgers produced locally in about 12 countries.
the purchasing power parity of large hamburgers is the exchange rate that enables a hamburger eater in any country to spend at the price of
the United States. The first column of our table converts the local price of a hamburger into RMB at the current exchange rate. In four American cities, the average price of a hamburger is $2.9 (including tax). In the table, hamburgers are the cheapest in the Philippines (US$ 1.23) and the most expensive in Switzerland (US$ 4.9). In other words, the Philippine peso is the most undervalued currency in the world, while the Swiss franc is the most overvalued currency in the world.
The second column of the table calculates the purchasing power parity of large hamburgers by dividing the local currency price by the American price. For example, in Japan, a large hamburger costs 262 yen. Divide this price by US$ 2.9, and the purchasing power parity of US$ 1 is equivalent to 9 yen. At present, US$ 1 is equivalent to 113 yen, which indicates that the value of Japanese yen is undervalued by 2%. On the contrary, the value of the euro (based on the weighted average price of large hamburgers in the euro zone) is overvalued by 13%. Perhaps the most interesting finding, however, is that the currencies of all emerging markets are undervalued against the US dollar. China, which has been talked about in recent months, seems to be underestimated. r 57% o
We have no intention to use the large hamburger index as an accurate forecasting tool. Hamburgers are not traded internationally as required by purchasing power parity theory; Prices are distorted by the prices of non-tradable goods and services such as rent.
However, it is these defects themselves that make the large hamburger index useful, because in another way, this index can help measure the different living expenses of different countries. The fact that hamburgers are cheap in China does not prove that the China dollar is seriously lower than its fair value as claimed by many American politicians. In poorer countries, it is natural that the average price is low, so it is natural that their currencies are cheap.
the prices of tradable goods will tend to be similar to those of developed countries. However, the prices of non-tradable products such as housing and labor-intensive services are generally much lower. For example, a haircut is much cheaper in Beijing than in new york.
a significant implication of lower prices is that converting the gross domestic product of a poor country into US dollars at the market exchange rate will seriously underestimate the true size of the country's economy and the true level of living standards. If we use the large hamburger index to convert China's GDP into US dollars, China's GDP will be nearly 1.5 times higher if it is converted into US dollars at the market exchange rate. Richer and more complex estimates of purchasing power parity, such as those used by the International Monetary Fund, indicate that more adjustments are needed.