Saturday, 5 May 2012

Graph of the week: Big Mac Wages

You've surely heard of the Big Mac Index – it’s an interesting way to measure the plausibility of the law of one price, or to be more precise the purchasing power parity (PPP). It’s published by the Economist on an annual basis. Acording to the PPP theory "in the long run, exchange rates should adjust to equal the price of a basket of goods and services in different countries." 

With the Big Mac Index, they compare how much is a currency overvalued with respect to the dollar (taken as the basis currency, i.e. the basis price of a Big Mac in America). 

The Big Mac Wage Index is a bit different.

Source of graph: WSJ blog

It tells us how many minutes of work does it take for a McDonald’s employee in a given country to earn enough money to buy a Big Mac. Basically it’s a measure that compares real wages across countries. 
"A real wage rate is a nominal wage rate divided by the price of a good and is a transparent measure of how much of the good an hour of work buys. It provides an important indicator of the living standards of workers, and also of the productivity of workers."
So tells us the author of the idea to compare real wages this way, Orley Ashenfelter of Princeton University, in his new paper. To measure wages this way is credible since the objects of measurement - McDonalds employees - do the same job everywhere. This makes it easier to compare (same company, same product, same required skills) and to conclude on the huge wage gap between countries. 

Looking at the graph it would infer that the wage gap between India and the US is higher than, for example, China and the US. Does it make it more realistic this way? Not necessarily. 

First of all, I’m assuming the prices of the burgers as well as employee wages are taken as averages across the country? (Note: I didn't read the paper). There is a difference in prices of burgers based on the location of the restaurant. McDonalds operates on a franchise basis, which means that owners of different restaurants have the courtesy of determining their own prices, which cannot differ much, but can reflect the attractiveness of a location. Also, I'm wandering if the price of the Big Mac used by the author is adjusted for the Big Mac Index differential. India's currency, for example, is the most undervalued against the dollar, according to the Economist's measurement

In conclusion the Big Mac Wage index, hardly a breathtaking discovery, can only do so much to inform us on the world inequality and the widening real wage gap. It can do so in a more precise way but it’s still a proxy. Having said that, I think it’s an interesting way to look at real wage differences, just like the Big Mac Index, amid its faults, is an interesting way to look at the purchasing power parity theory. 

4 comments:

  1. This technique can also be used to show differences in real wage purchasing power over time, instead of relying on the not very good CPI

    For instance, if you look at a list of ten common household items which existed in the 1970's and still exist, you could use the average hourly wage in both time periods to show how long a person had to work to buy that item.

    In every case we are much much better off than we were in the 1970's even though some econometrics says the wages have stagnated. And that does not even count in the higher quality of goods currently available.

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    Replies
    1. Yeah, that's a good point, I agree. It's basically what the author was trying to do. He used Mcdonalds employees and wages to control for any possible selection bias.

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  3. I hear a lot on TV about how the food service industry pays low wages because the work is unskilled. I hate the word unskilled some companies in the food service Industry make hanson profits but pass little of it on to their workers. Someone thats unskiled can be worth a considerable amount of money if their productive enough. How often have you heard that one. And what about the stock market or so called stock market professionals that work for a large investment research firm and get paid lots of money to give their advise about certain stocks. Studies have shown that most of the so called expert advise on what stocks to buy is no better than the performance of the standard and poor 500 Index. I wonder what would happen if a customer thats paying lots of money for advice were told. You know what most of the advise that we give on what stocks to buy is not going to result in anymore profit for you than if you just were to buy a Index fund that tracks the performance of the standard and poors 500.

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