The index reveals that, at market exchange rates, the price of the same McDonald’s (MCD) burger can vary vastly from country to country. The Big Mac costs $1.67 in India, $4.37 in the U.S., and $7.84 in Norway?
Ryan Avent, chief economist at The Economist, tells The Daily Ticker burgernomics is also a fun and loose way to gauge changes in worker wages/productivity globally and to see if currencies are at the right level.
“When you look at a country like India or Mexico, labor there is much cheaper than it is in the U.S. or in Europe,” Avent says. “And that really has to do with productivity differences…so one thing we’re measuring is productivity gaps between different countries and how far along these places are in terms of development and growth with the richest countries.”
In general, Avent notes, the Big Mac Index shows emerging markets have caught up a bit in terms of wages over the past five to 10 years. And interestingly, through burgers he could even detect the impact of the eurozone crisis on developing countries.
The fast-food sandwich also tells us a bit about what currencies ought to do.
For example, if a Big Mac in Switzerland is more expensive than in the U.S. and these are similar products in rich countries, Avent says, “we can say the Swiss franc (CHFUSD=X) is probably overvalued relative to the dollar (^USDOLLAR). We should expect over time the Swiss franc will lose value relative to the dollar, or the dollar will gain value relative to the Swiss franc.”
Avent says you can also do a calculation to take into account differences in income and if you apply that to Big Mac prices, he says China’s currency is actually pretty much close to fair value, despite all of the talk we hear of “currency manipulation.”
On the flip side, Avent says the Brazilian currency is way overvalued, even taking labor into account. This is noteworthy because Brazil’s finance minister Guido Mantega was the first official to seriously raise the issue of currency wars in 2010. He spoke out against advanced countries seeking to devalue their currencies and improve export competitiveness. Meanwhile, low interest rates in the developed world were prompting investors to pour cash into Brazil (putting pressure on the currency to rise). Brazil's government has tried to stem the real's appreciation since.
The Big Mac index is based on an economic theory called purchasing-power parity (PPP), which indicates that over a long enough time exchange rates should adjust so similar goods cost the same across countries.
In reality, with many central banks actively working to prop up or devalue their currencies along with the volatility of financial markets, Avent doesn’t think that Big Macs will ever really cost the same everywhere.
“The text books just don’t quite capture all the variability that we see in the real world,” according to Avent.
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