Fifty fifty purchasing power parity and the Big Mac index -Dr Sandeep Goyal
While presenting the 2nd Suresh Tendulkar Memorial Lecture on Big Data and Measurement: From Inflation to Discrimination in September 2018 at the Reserve Bank of India, Professor Roberto Rigobon of MIT Sloan dwelt on the topic measurement of the real exchange rate or purchase spreads. parity of power in the world. “There are two standards in PPP measurement,” he said. “One is a massive effort by the World Bank (WB) bringing together 105 statistical offices to produce the PPP-adjusted measures. And then we have The Economist’s Big Mac index which is probably the most ever created. Unfortunately, for the World Bank, the Big Mac is as good as the PPP. There is a lot to criticize about the Big Mac Index. Regardless of what you think of it, there is something brilliant in its simplicity. It’s an identical item all over the world. I know, no one consumes it anymore, but it’s the same item. WB data has a big problem matching identical items. The advantage of WB is that it has more than one element, but its cost and complexity make it more difficult to interpret, and the worst part is that it can make it irrelevant”.
Last month the Big Mac Index was back with a nice animation of the Big Mac price evolution over two decades doing the rounds on Whatsapp, also capturing the cross currency valuation of countries based on the price of the burger in different countries, and thus achieve purchasing power parity between nations. The Big Mac Index was introduced by Pam Woodall in The Economist in September 1956 as an illustration of purchasing power, and is now published by the newspaper annually.
The Big Mac itself was created in 1967 by Jim Delligati, owner of a McDonald’s franchise in Pennsylvania. It was then launched in the United States the following year, and today you can buy one in over 70 countries. For the record, Mc Donald’s, the brand itself, was launched on September 15, 1955 in San Bernardino, California. The Big Mac is therefore almost as old as the parent. The price you pay for a Big Mac varies depending on where you are, as evidenced by the Big Mac Index.
The Big Mac index is intended to be a lightweight way to demonstrate the concept of purchasing power parity. This helps illustrate the idea that market exchange rates between countries can be “unbalanced” relative to the cost of buying the same basket of goods and services in those places. Since McDonald’s is one of the largest companies in the world and the Big Mac is widely available around the world, this means that the famous burger can be used as a commodity comparison between most countries. It also has the advantage of having the same inputs and distribution system, with some minor changes (like chicken patties in India instead of beef). And yes, India which does not have the Big Mac on the McDonald’s menu, and instead has a Maharaja Mac is not featured in the Index.
Using the price of a Big Mac in two countries, the index can also indicate whether a currency is overvalued or undervalued. A Big Mac costs ¥24.40 in China and $5.81 in the United States. Comparing the implied exchange rate to the actual exchange rate, the yuan is actually undervalued by 34%.
Switzerland, Norway and Sweden have taken the cake most years for the most expensive Big Macs. But these countries have relatively high price levels, perhaps due to higher wages compared to other OECD countries. Venezuela has also come to the top in some years. Venezuela, in fact, has seen the biggest increase in hamburger prices, with the cost of a Big Mac soaring almost 250% since 2004. The country, we all know, has been plagued by hyperinflation since years, so it is not surprising to see high prices. fluctuations in country data. The price of a Big Mac has actually gone down in Turkey. This may be the case because the index prices are all denominated in US dollars and the new Turkish lira has depreciated over 90% against the US dollar since its introduction in 2005. in the country of origin, the United States, for the Big Mac galloped 100%, and soared 129% in neighboring Canada. Russia, during the review period, had the cheapest Big Mac, reflecting the country’s relatively low price levels.
The biggest criticism of the Big Mac Index is that it lacks diversity. The index is composed of a single element: the Big Mac. For this reason, it does not include other economic measures such as the consumer price index. But then Professor Rigobon loved it just for that very simplicity.
But still, Rigobon has teamed up with Alberto Cavallo to try another more inclusive index. They gleaned item IDs from two of the best web pages in the world – in terms of transparency – Zara and H&M. So, for men, they took fast fashion – young denim jackets and similar items from stores in two different countries – the UK and the US. They removed the taxes and calculated the price ratio. This is the implied nominal exchange rate for the H&M jacket. After doing this for each item, the professors pulled thousands of those products, weighted them into each category, and produced an index for the country. The Big Mac Index on steroids? Well, maybe. Maybe not.
This Rigobon-Cavallo index had several characteristics. It had no services, no non-tradable products, and almost all goods were traded internationally. Plus, these were actually items that people were buying. They included electronics, clothing, personal care, gasoline, etc. for a more representative comparison.
But was their index higher than the Big Mac Index? No!
The Big Mac index can represent the over-the-counter price of a single hamburger. But the price of a Big Mac is itself the result of many local economic factors, such as the price of ingredients, local wages, and the cost of putting up billboards and buying TV ads. . My vote for The Big Mac Index is not my usual 50:50 but a clear 100:0 in its favour!
Dr. Sandeep Goyal is managing director of advertising agency Rediffusion. He also heads the Indian Institute of Human Brands (IIHB). Dr. Goyal is a prolific writer with 8 books to his credit, including bestsellers The Dum Dum Bullet, Point Blank, Konjo – The Fighting Spirit and Japan Made Easy.
Warning: The views expressed in the article above are those of the authors and do not necessarily represent or reflect the views of this publishing house. Unless otherwise indicated, the author writes in a personal capacity. They are not intended and should not be taken to represent the official ideas, attitudes or policies of any agency or institution.