Purchasing Power Parity And The Big Mac Index
While delivering the 2nd Suresh Tendulkar Memorial Lecture on Big Data and Measurement: From Inflation to Discrimination in September 2018 at the Reserve Bank of India, Prof Roberto Rigobon of MIT Sloan dwelt on the topic of trying to measure the real exchange rate or deviations on purchasing power parity worldwide. “There are two standards in the measurement of PPP”, he said. “One is a massive effort by the World Bank (WB) that puts 105 statistical offices together to produce the PPP adjusted measures. And then we have the Big Mac Index from The Economist that is probably the simplest statistic ever created. Sadly, for the World Bank, the Big Mac is just as good as the PPP. There are many things to criticise about the Big Mac Index. Regardless of what you think about it, there is something brilliant in its simplicity. It is an identical item around the world. I know, nobody consumes it anymore, but it is the same item. The WB data has a big problem matching identical items. The advantage of the WB is that it has more than one item. But its cost and complexity makes it harder to interpret; and what is worse is that, it can render it irrelevant”.
Last month The Big Mac Index was back in focus with a cute animation on change in prices of the Big Mac over two decades doing the rounds on Whatsapp, also capturing cross-valuation of country currencies based on the price of the burger in different countries, and thereby arriving at purchasing power parity across 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 paper annually.
The Big Mac itself was created in 1967 by Jim Delligati, a McDonald’s franchise owner in Pennsylvania. It was then launched throughout the U.S. the following year, and today you can buy one in more than 70 countries. For the record, Mc Donald’s, the brand itself, was launched on 15 September, 1955 in San Bernardino, California. The Big Mac, therefore, is almost as old as the parent. The price you pay for a Big Mac varies based on where you are, as evidenced by the Big Mac Index.
The Big Mac Index is intended to be a lighthearted way to demonstrate the concept of purchasing power parity. It helps illustrate the idea that market exchange rates between countries may be “out of whack” when compared to the cost of buying the same basket of goods and services in those places. Given that McDonald’s is one of the biggest companies in the world and the Big Mac is widely available globally, it means that the famous burger can be used as a basic goods comparison between most countries. It also has the advantage of having the same inputs and distribution system, with a few minor modifications (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 give an indication as to whether a currency is over or undervalued. A Big Mac costs ¥24.40 in China and $5.81 in the United States. By comparing the implied exchange rate to the actual exchange rate, the Yuan is actually undervalued by 34%.
Switzerland, Norway and Sweden took the cake in most years for the priciest Big Macs. But then these countries have relatively high price levels perhaps because of higher wages when compared to other OECD countries. Venezuela too did pop onto the top in some years. Venezuela, in fact, saw the largest jump in burger prices, with the cost of a Big Mac climbing nearly 250% since 2004. The country, we all know, has been plagued by hyperinflation for years, so it’s no surprise to see large price swings in the country’s data. The price of a Big Mac actually decreased in Turkey. This maybe so because the prices in the Index are all denominated in U.S. dollars and the new Turkish lira has depreciated against the U.S. dollar more than 90% since it was introduced in 2005. Prices in home country United States for the Big Mac galloped up by 100%, and climbed 129% in neighbouring Canada. Russia, in the period under review, had the cheapest Big Mac, reflecting the country’s comparatively lower price levels.
The Big Mac Index’s biggest criticism is that it lacks diversity. The index is made up of just one item: the Big Mac. Because of this, it lacks the inclusivity of other economic metrics such as the Consumer Price Index. But then Prof. Rigobon loved it just for this very simplicity.
But still, Rigobon partnered Alberto Cavallo to try another more inclusive index. They gleaned item IDs from two of the best webpages on earth – in terms of their transparency – Zara and H&M. So, for men, they took fast fashion – young-jackets-denim, and similar items in stores in two different countries – UK and US. They took taxes out and computed the ratio of the prices. That 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 within 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 at all, it had not a single non-tradable product, and almost all the goods were traded internationally. Furthermore, these were actually items people purchased. They included electronics, clothing, personal care, gasoline, etc. for a more representative comparison.
But was their Index superior to The Big Mac Index? Naw!
The Big Mac Index may represent the over-the-counter price of just one burger. But then the price of a Big Mac is itself the result of many local economic factors, such as the price of the ingredients, local wages, and how much it costs to put up billboards and buy 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 ad 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 best-sellers The Dum Dum Bullet, Point Blank, Konjo – The Fighting Spirit and Japan Made Easy.
