As I mentioned a few days ago on my blog, using current market exchange rates, Australia now has a higher income per person than the US. Matthew Turner observed the UK passing the US a few months ago and estimated several years ago that the critical value for the Eurozone is around $1.46, which was reached in the last couple of days. I haven’t checked on the GDP comparison, but the yen and franc are also rising
Of course, it would be silly to use these numbers to support a claim that Americans are, on average, worse off than people in other developed countries. The Purchasing Power Parity indexes produced by the International Comparisons Project of the World Bank provide a much better (though far from exact) basis for comparisons of this kind, not affected by short-term exchange rate movements, and on this basis the US is near the top of the ladder.
But, for advocates of free markets who’ve used the economic performance of the US as the basis for their case, there’s a rhetorical problem here. You can, I suppose, argue along the lines “The market values the output of the average American less than that of the average European (or Australian) but analyses prepared by international bureaucrats show that Americans are actually better off, and therefore we should prefer the market to the state”. But it’s not a position I’d want to defend.
A few minor points to follow up:
First, I’ll spell out the point a little more. A dollar is a claim on the output of the US economy, just as a euro is a claim on the output of the eurozone economy (that’s, pretty much, what legal tender means). So the $/euro exchange rate is, precisely, the market price of claims on US output, relative to claims on eurozone output. Of course, for non-traded goods, you may have to travel to exercise your claims, but that doesn’t invalidate the point.
Second, it might seem as if this argument can be turned around. As a social democrat, shouldn’t I be worried that the World Bank’s numbers show the free-market US to have higher income per person? I don’t think so, because the apparent symmetry is illusory. There’s only one exchange rate, and while there are quite a few different income measures, GDP and its close relatives are the only ones that are commonly used on the market side of the debate. By contrast, there are heaps of alternatives to the ICP measures. The World Bank likes the Human Development Index, but there are lots more. There are different ways to estimate PPP index (Steve Dowrick and I had a bunch of papers on this), and you can choose whether to take account of hours worked, health and longevity outcomes and so on. On the measures that make sense for social democrats, social democracy does better.
Second, common sense and past experience suggest that the large deviation from PPP we are observing won’t last. It’s not that long ago, after all that the euro was below $1US and the $A was nearing $US0.50. Presumably the $US will recover once the trade deficit is reduced to a sustainable level.
But even weak versions of the efficient markets hypothesis are inconsistent with this expectation. Assuming equal interest rates (approximately true) the best predictor of the future exchange rate between any two currencies is the current exchange rate. I think the real problem here is with the EMH, but its defenders are free to observe that, having predicted the depreciation five years ahead of time, I failed to put my money where my mouth was, and, as a result, cannot afford the private island I’ve wanted for so long.
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P O'Neill 11.10.07 at 3:35 am
I’m not sure I buy your last paragraph — interest rate differentials are sizable. For interest, the US Fed Funds target is 4.5% but the RBA rate is 6.75%. Thus the short-term funds flow is to Australian dollar and out of US dollar, until the dollar weakens enough for an expected appreciation to offset the differential (if one takes uncovered interest parity seriously). Add in a lack of confidence in policy makers who simply repeat “strong dollar” (after a near 50 percent depreciation during their time in office), and you’ve got a prediction that the current exchange rate is most definitely not a reliable guide to the future. Granted the Eurozone and US interest rates are close, but at least until recently the expected path of the policy rates looked somewhat different, as the Eurozone seemed to be performing more strongly than the US.
Overall I think the EMH has a tough time dealing with the behavior of Gulf and Asian investors, whose tolerance for the dollar has been much higher than the model could expect.
Badger 11.10.07 at 3:44 am
I guess you mean “assuming equal inflation rates the best predictor of the future exchange rate…is the [spread between the current interest rate[s]”?
John Quiggin 11.10.07 at 3:53 am
#1, fair enough as regards $A, but the implied rate of US appreciation is only 2.25 percentage points per year, which means the divergence could last decades. Of course, I agree EMH isn’t a good description for Gulf and Asian investors, but that also means it isn’t good for Wall Street, the City of London and so on, since they should have recognised a money pump when they saw it.
#2, no the inflation rate will be reflected in the nominal interest rate, and differences in real interest rates are also relevant. As p o’neill says, this prediction of EMH is called uncovered interest parity.
Maybe an energetic reader would like to check out the relevant futures markets for arbitrage opportunities.
Badger 11.10.07 at 4:26 am
I guess I never did really get that story: The theory expects the lower-rate currency to appreciate vis-a-vis the higher-rate currency, because people holding the lower-rate currency have to have a reason for giving up the better rate in the other currency, and that reason is the expectation of a corresponding currency-rise. And somehow given the existence of futures markets, the expectation of that happening is supposed to become a reality. Am I getting warm?
Colin Danby 11.10.07 at 4:28 am
Surely comparisons of national GDPs or growth rates are crude ways to make arguments for or against free trade or social democracy or anything else (in any case the US is hardly a model of free trade). Reminds me of the question 20 years ago of what exactly S. Korea’s growth could be used as an argument for.
It’s been clear for years that the $ would fall hard but as always with these things nobody knew when, and this may not be the end of it. What’s disturbing here in the U.S. is how many people suddenly think they’re the victim of a gov’t conspiracy to take away their money. The unhinged Ron Paul (featured at the bottom of this page http://calculatedrisk.blogspot.com/ of my new favorite blog) is perhaps extreme, but there’s a lot of monetary crankery going around.
Sebastian Holsclaw 11.10.07 at 5:24 am
“It’s been clear for years that the $ would fall hard but as always with these things nobody knew when, and this may not be the end of it. What’s disturbing here in the U.S. is how many people suddenly think they’re the victim of a gov’t conspiracy to take away their money.”
Well it is, insofar as the change has taken place because of the enormous federal debt levels. Of course that would be a mostly Republican conspiracy, but still…. ;)
PK 11.10.07 at 6:06 am
Well, then we guess you mean “Assuming constant interest rates”.
How many more guesses do we get?
John Quiggin 11.10.07 at 6:08 am
D’oh! Fixed now. i’m impressed that several commenters mentally made the necessary correctin to “the current exchange rate”
a 11.10.07 at 6:41 am
“…but analyses prepared by international bureaucrats show that Americans are actually better off…”
Well you don’t need international bureaucrats to show that things are a lot cheaper in the U.S. E.g. any European who can get to New York, buys their iPods in the U.S., since in Europe they now cost 50% more.
That said (indeed as you have often argued elsewhere), “better off” isn’t just a matter of who can buy the most toys or things. There’s health care, the amount of safety net one enjoys, the living environment, and so on. Europe passed the U.S. on “better off” a long time ago, even when the dollar was much stronger.
abb1 11.10.07 at 8:16 am
any European who can get to New York, buys their iPods in the U.S., since in Europe they now cost 50% more.
Yeah, and what’s the explanation?
Here, Harry Potter book 7 at amazon.com: $19.24; same book at amazon.fr: EUR 22,89 ($33.57). More than 50% difference. And the French translation is even more expensive. OK, I suppose VAT can explain some of it, but not even close to the whole thing.
If selling Harry Potter book 7 for $19.24 is profitable, why wouldn’t some company start selling it for $19.24 in Europe?
Tom Womack 11.10.07 at 8:49 am
Harry Potter book 7 is $18.92 from amazon.co.uk at current exchange rates. I get the impression that French people are prepared to pay more for books; standard thrillers in trade-paperback in a station bookshop (OK, not a hotbed of efficient pricing) are €20.
Ordering the Harry Potter from amazon.co.uk dispatched to Paris is £4.98 = $10.48, so it’s quite likely that French people ordering Harry Potter over the Internet will do so from amazon.co.uk.
Matthew 11.10.07 at 9:11 am
The only other thing I would point out, which is trivial but worth remembering, is that UK GDP per head is not just higher than US when measured in dollars, but also in euros, pounds and every other currency in the world. So things that use market exchange rates such as imports, foreign acquistions, etc, should all reflect this shift (at least over time). This market exchange rates = international economic power is often made about China’s economy, but there what would be a major effect due to the huge disparity between market and PPP exchange rate calculations (albeit one that is fallen quite quickly) is softened by the high % of market exchange rate GDP that China trades and invests.
Jack 11.10.07 at 9:35 am
If wealth is a conundrum, what about productivity measured in domestic currency and healthcare efficiency usually compared in terms of %GDP?
Cian 11.10.07 at 11:11 am
One of the main reasons that books are cheaper in the US is that its a bigger market. This means bigger print runs and better margins on fixed costs.
abb1 11.10.07 at 11:22 am
But it’s a world-wide market. If they don’t charge more in Rhode Island than in California, why would they charge more in France?
Tim Worstall 11.10.07 at 11:52 am
Well, because books aren’t a world wide market. Publishers buy the right to publish a book in a certain market. US rights, UK rights, translation rights into various languages and so on (pick up an old Penguin, sure you’ve got one somewhere on the bookshelves. It’ll say something along the lines of “for copyright reasons this book is not for sale in the USA” if it was the UK version. There were also sometimes one version for Anglo ex-colonies, Oz, NZ and Canada, somteimes lumped in with UK, sometimes independently).
This still operates BTW. A book might come out in the US, people start ordering it in hteUK. Then a publisher buys the rights to publish the same book in the UK (adding all those ezxtra “u”s as well, although not always) and then asks Amazon.com not to ship it to the UK. And they cease doing so.
Matthew 11.10.07 at 11:59 am
I thought books were generally (perhaps not at 2.10 to a pound) cheaper in the UK than the US?
abb1 11.10.07 at 12:14 pm
OK, fair enough, what about those iPods then? Why should they be 50% more expensive in Europe (if that’s indeed the case)?
Cian 11.10.07 at 12:17 pm
Its not really a straight comparison. Hardbacks of new bestsellers tend to be cheaper in the UK due to deep discounting (1/2 RRP sometimes), however US hardbacks have a much better binding. Mass market paperbacks are much cheaper in the US, some genres (e.g. SF) particularly so. Academic text books are unbelievably expensive in the US (like 3-5 times the price for the US edition, compared to the UK edition), for no particularly good reason other than that they can charge those prices. In general for midlist books in my experience, US paper backs are a little cheaper, though not as much as they used to be (it used to be $1 -> £1, not it seems to be more like $1.50 to £1. This may have something to do with how unbelievably competitive the UK book market has become for publishers, and that way too many books are published in the UK these days.
And then there’s sales tax of course – no VAT in the UK.
Tim Worstall 11.10.07 at 1:16 pm
On iPods (and most other things) there’s a good reason why they’re expensive in the UK. The planning laws. Retail space is extremely expensive as compared to the US.
Badger 11.10.07 at 1:17 pm
“…the best predictor of the future exchange rate between any two currencies is the current exchange rate”. There is something about that I find deeply troubling
Cian 11.10.07 at 1:28 pm
Tim: doesn’t explain why they are more expensive online, or for that matter cheaper in New York, not really known for its cheap retail space. And while the cost of retail space will have an effect, it will be less significant for a small item with high margins like an iPod.
Is it just iPods? Because it might just be that Apple charges more because they can. I vaguely remember that last time I checked on laptops, once you excluded VAT, there wasn’t a significant difference in prices. Also, what about phones?
kb 11.10.07 at 1:51 pm
“OK, fair enough, what about those iPods then? Why should they be 50% more expensive in Europe (if that’s indeed the case)?”
Well it doesn’t appear to be the case.
Currently apple are selling 4gb nanos for 149 dollars in the US and £84 (ex VAT) in the UK which is roughly a 10% variance. On the french amazon site a 4g nano will set you back 148 euros so in france(and presumably all of the eurozone) Ipods appear to be significantly cheaper than in the US.
kb 11.10.07 at 1:54 pm
ah damn. I meant more expensive in the eurozone……
a 11.10.07 at 2:25 pm
Gosh, maybe people really do need international bureaucrats to tell them things are a lot cheaper in the U.S. Just look at Amazon for any number of standard products.
Toa Mahri Jaller(Lego 8911). 10.69 Usd on .com and 11 Eur on .fr.
Lego Mindstorms Nxt 250 Usd on .com and 299 Eur on .fr
canon 400d aka Digital Rebel (body only) 579 Usd on .com and 569 Eur
Standard things like cereal (Kellogg’s special K or whatever) is also a lot cheaper in a typical U.S. store compared to a typical French store.
novakant 11.10.07 at 3:44 pm
Well, some of this is just a plain and simple rip-off. I’m talking to you &*$%^!!£@ Adobe.
Since a lot of their software is purchased by downloading it and getting a license key via email, there is no reason for this exorbitant price hike. And even the shipped boxed version would never ever justify the increase.
Anyway, I don’t quite get the logic of PPP when coupled with the words “better off”. People who can afford to buy property in, say, Central London tend to be quite well off. People enjoying the low house prices in, say, Kansas City, are generally less well off. But PPP coupled with “better off” says the opposite.
Jack 11.10.07 at 4:20 pm
I’m not sure Cian is right about book prices. Until very recently books generally seemed cheaper in the UK even before the massive discounting. Also I dimly recall there being more titles published in the UK too.
Soullite 11.10.07 at 5:02 pm
Using purchasing power to judge how well off people are relative to other countries is also absurd. These are countries where college is a universal right of anyone who can get into them, where healthcare is viewed as a fundamental human right, and where the poorest off are generally well taken care of. Maybe they can buy a little less with the same amount, but they get far more than we do from life.
It is indeed very hard to argue that your average person in the US is better off than the average citizen of an average comparable nation. For the majority of Americans, they would indeed be better off raising children in any one of a dozen other countries. Only the upper class is better off in this nation, primarily because the entire system is rigged in their favor.
Sebastian Holsclaw 11.10.07 at 6:49 pm
The problem with using exchange rates as an absolute indicator of economic health is that it isn’t like a stock price where higher is always better.
Yes, you don’t want to be like Russia, but you actually aren’t always thrilled to be like the UK either. All things considered, a moderate drop in USD ‘worth’ was both necessary and good for the economy as a whole.
Tim Worstall 11.10.07 at 9:39 pm
“Tim: doesn’t explain why they are more expensive online,”
Sure it does. Most people are selling/buying within a national economy. International trade does affect this, for sure, but no one actually expects international pricing to be equal…not in the real world.
WalMart (US) online is competing with PC World (UK), sure, but not in the same way that Asda(UK) is competing with PC World (UK) in the UK.
JQ would give you the correct description of this …stickiness maybe? Transaction costs? Imperfect markets?
Jack 11.10.07 at 10:22 pm
Sebastian, on what currency related scale are Russia and the UK at opposite ends? The dollar is down against the Rouble too.
Nobody is suggesting that simple exchange rate level or even direction is in itself a measure of economic health. The question is on what basis should different indicators be compared. It is a question because arguing that the market exchange rate doesn’t capture the whole picture opens a whole can of worms.
Thankfully we have Greg Mankiw on hand to remind us that the correct basis is the one in which the US appears in the best light.
John Quiggin 11.10.07 at 10:28 pm
One problem is that most of the examples we are discussing are US products where the supplier has some degree of monopoly power, and may choose to discriminate between markets. Although it’s not necessarily the case (TV programs being a counterexample, I think) my observation is that the general pattern is to price lower in the home market than in other developed countries.
More generally, as Tim W says, there are transactions costs (including transport costs) so that prices don’t necessarily reach parity. The larger these costs, the larger and more durable the gap.
Sebastian, there’s no doubt that the depreciation of the dollar is a Good Thing. But this is precisely because it reduces the purchasing power of Americans, and therefore brings their aggregate spending back into line with their income (that is what it means to reduce the US trade deficit).
P O'Neill 11.10.07 at 11:11 pm
#22 “…the best predictor of the future exchange rate between any two currencies is the current exchange rateâ€. There is something about that I find deeply troubling
It’s well founded in theory but with some confusing intuition and quite a bit of contrary evidence. But the principle is clear. If interest rates are similar, then there could not be any expected change in the exchange rate, otherwise all the funds would flow in one direction or the other to take advantage of it (e.g. expected USD depreciation would cause outflow). And in the magical efficient markets way, such an instantaneous flow would eliminate the expected change.
As it happens, exchange rate changes are quite difficult to systematically forecast. But whether interest rate differentials play much of a role in that is another story.
a 11.11.07 at 7:07 am
“…One problem is that most of the examples we are discussing are US products…”
Mindstorms Lego is Danish.
Canon is Japanese.
Look at the Playstation 3, for another Japanese example.
Why don’t we do it the other way around? Is there any widely tradeable good that is more expensive in the U.S.? (OK local grocery products would be more expensive, because they have to bought in the home country and then shipped to the U.S.) Or do we really need international bureaucrats?
a 11.11.07 at 7:11 am
By the way my question is just about Europe vs U.S. Hong Kong is supposed to be cheap as well.
Tim Worstall 11.11.07 at 9:17 am
“It is indeed very hard to argue that your average person in the US is better off than the average citizen of an average comparable nation. For the majority of Americans, they would indeed be better off raising children in any one of a dozen other countries. Only the upper class is better off in this nation, primarily because the entire system is rigged in their favor.”
Well, there are people who will disagree there. Like Smeeding, who looked at the numbers from the Luxembourg Income Study. I’ve forgotten the exact numbers (they ended up as a chart in the EPI’s State of Working America report one year) but, at PPP, the poorest 10% in the US have the same percentage of US median income as the poorest 10% of Swedes have of US median income. That’s the after tax, after benefit number.
He does look at things like health care and university education, also notes that US food costs are lower and thinks that those are largely a wash.
Now, agreed that’s the bottom 10%, not the average person. But to say that the poor are poorer in the US in an absolute sense (as opposed to relative) seems not to be true.
John Quiggin 11.11.07 at 10:26 am
You’re stretching a bit there, Tim. To quote Smeeding
And this was in 2000, which was probably the best year ever for the poor in the US.
Cian 11.11.07 at 10:38 am
“Sure it does. Most people are selling/buying within a national economy. International trade does affect this, for sure, but no one actually expects international pricing to be equal…not in the real world.”
But Amazon UK is competing with PCWorld (UK), and is going to be far less affected by planning laws/high cost of retail space. That’s what I meant by online.
Tim Worstall 11.11.07 at 11:29 am
Figure 8D here.
http://www.stateofworkingamerica.org/swa06_ch08_international.pdf
Drawn from Smeeding and Rainwater 2001 and Smeeding 2006.
The bottom 10% of US households receive 39% of median US income.
The bottom 10% of Swedish and Finnish households receive 38% of median US income.
It’s difficult to say that, on an absolute basis (I agree that the situation is reversed for a relative measurement of poverty), it’s worse to be poor in the US.
John Quiggin 11.11.07 at 12:14 pm
You’re cherrypicking here, Tim. The US and UK are consistently near the bottom in assessments of this kind. It happens that this time Sweden and Finland are also low, but that’s a far less consistent result.
Tim Worstall 11.11.07 at 12:21 pm
I’m sorry? Cherry picking? When a left leaning think tank puts out figures, derived from the major international comparison of such, showing that the absolute standard of living of the poor in the US is the same as that in Finland and Sweden, I’m cherry picking?
Z 11.11.07 at 5:26 pm
Just to answer a possible mystery, books are more expensive in France because the prices of books are set by the state. You are not allowed to sell books below a certain price. Fixed prices are supposed to protect loca book dealers from competition against corporations. According to my cousin in the trade, it does work.
John Quiggin 11.11.07 at 9:52 pm
Tim, the same figures show that the US poor are worse off than those in France, Norway, Germany, Dennmark, the Netherlands, Belgium, Canada and Switzerland so I’d say that picking the two exceptions is picking cherries.
Jack 11.11.07 at 9:53 pm
Tim, the Smeeding figures don’t include the price or quality of many services such as education, health and public transport that might make the figure a measure of quality of life, nor of the amount of work those people are doing. and public transport. The PPP comparison assumes USDSEK = 9.2 as opposed to the markets current assessment that 6.3 is a fair swap. At the market rate Smeedings figures suggest the figure is 55% not 38%.
There is approximately one way to look at the figures that makes it look as if being poor in the US is a good as being poor in Sweden. That involves ignoring the market, positional considerations, labour, state services, security and longevity. I think that might be counted as cherry picking. The use of absolute is irritating because all the statistics actually say is that the poor have equal access to Big Macs in both places.
Tim Worstall 11.12.07 at 10:43 am
Smeeding does expressly consider health: the bottom 10% in the US are all covered by Medicaid for example. He also looks at food prices and concludes that on that basis Americans are better off.
Of course, ignoring positional considerations is exactly what I’m doing by looking at absolute rather than relative numbers. Which is the point of doing so of course, for relative measures depend upon position.
GreatZamfir 11.12.07 at 8:47 pm
On the matter of things that are cheaper in europe,
Ikea apparently is. I compared their US website with the Dutch one, and Dutch prices are significantly lower. Example: (almost) the same mattress Sultan Enebak
NL 169 Euro US 299 $
Cutting board Boholmen
NL 3.99 Euro, US 6.99 $
If you take the 19% VAT in the Netherlands into account, those are pretty big differences for the same product, from the same store, probably made and shipped from the same China.
(On a side note: the Dutch standard mattress size is apparently 11 cm taller than the US version, while the US one is 7 cm wider. I wonder what that means)
GreatZamfir 11.12.07 at 9:08 pm
Another random comparison: Dell notebook XPS M1710
NL: 1499 Euros (at current rates $2200)
US: 1999 dollar
The differences appear to be almost the VAT. ANd this for a more or less American product, specifically from the electronics category people go to New York to buy.
I suspect the VAT is really what gives people the idea that everything is cheap in the US.
Now, those people who measure PPP are probably not stupid, and probably many things, including books, are cheaper in the US, if only because of the larger market. But I wonder what part of the difference is in land pricesand other things affected by this, and reflecting the lower population density of the US
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