Jun 23, 2010

Bad Economics: The Power of PPP

Take a look at this image (courtesy of this page):

This is what I'd like to call bad economics. I checked a few of the figures and they are correct with respect to exchange rates and minimum wages, however what this image does not reflect is the differences in what economists call "purchasing power". To explain this, the magazine The Economist uses the Big Mac Index which asks, "how much does a Big Mac cost in various countries around the world?" According to their February 2009 data, it would cost you $5.79 USD to buy a Big Mac in Norway (the most expensive), while it only costs you $1.22 to buy a Big Mac in India (the cheapest). Purchasing power measures how much stuff you can buy in a country with a fixed amount of money (say $100 USD).

Let's take a more detailed look at China. For this picture I'm guessing they used China's minimum wage on Wikipedia, which is 960 RMB =~ $140.94 USD per month. This makes about $1691.29 USD per year. In order to get $15 080 USD at that wage, you'd need to work around 8.9 years. So the figure is numerically correct.

My problem with this figure is that it is misleading. Saying that it would take 8.9 years for a Chinese worker to make the same as an American worker would in one year is insinuating that Chinese workers are 8.9 times poorer than American ones. This is not correct. In China, prices are much lower than they are in the United States - this means that Chinese people have a higher purchasing power in China than Americans do in the US. If I were to take $100 USD, convert it to Chinese yuan, and buy a bunch of goods in China, that same bundle of goods would probably cost me around $200 USD if I were to buy them in the United States. That $100 USD is worth twice as much in China as it is in the US.

So the 8.9 years figure is a gross over-estimate of poverty. While it would take 8.9 years to match the American worker's salary, it would only take about 4.5 years to match his purchasing power. The real minimum wage is lower in China, but it's not as much lower as the picture there portrays.

The difference is even bigger for India, $100 USD is worth about 2.8 times as much in India as it is in the US, so the 24.3 years or so that the figure shows is actually about 8.7 years - still a really long time, but the figure certainly overestimates it.

It also goes both ways - purchasing power is lower in France than in the US, so while it may only take you 10 months to earn the equivalent of $15k USD, that money can't buy you as much in France as it would in the US. Same goes for us Canadians, as we often find out when we journey down south!

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