Wednesday, 26 May 2010

The joys of market value exchange rates and purchasing power parity

Apologies all but this post is in a more serious vein than usual. I'm intending to get a bit of a mix going between humour/satire and some looks at other issues regarding development/economics and suchlike. So here goes:

There was a BBC on-line article on Sunday (link) regarding an area that Oasis India does a lot of work in, that namely of street children. Now whilst I haven't finished digesting the article fully yet and intend to return to it at a later date I did want to comment on one section as it concerns something that crops up with regularity, that of daily earnings.

For those who are keen economists this will probably be both an unnecessary and inadequate comment but I've been getting a bit frustrated with some of the figures that are bandied around. Now it may be done in some cases for simplicities sake but I think it can be quite misleading.

What I refer to in the aforementioned article is the reference to the children earning between $1 (60 pence) and $6 (£4.16) per day.

The World Bank stated that the international poverty line is to be measured at roughly $1 a day (although that was subsequently revised up in 2008 to $1.25 at 2005's purchasing power parity).

Most people in the West will hear the figure of $1 a day and be shocked, especially by the fact that there are millions who live below this line. This was also the line I used to take.

It's true and it is shocking that people are existing on so low a figure but it does lead to a slightly inaccurate view of the extent of the poverty. I finished the novel Shantaram in March and there were several statements that demonstrated the sort of thinking I mean. At one point, fairly early on in the book, the author gets on a train to go to a village in Maharashtra. His guide hires a man to help them board for the sum of 40 rupees. The effort of boarded involves a great amount of physical strain and the author (it is a partly autobiographical book) is in disbelief that the cost of this job was a mere $2.

Now technically that is true, at market exchange rates at least. Herein lies the issue. Market exchange rates give an inaccurate idea regarding the value of a currency (and is why the World Bank figure is given at PPP). As of this moment £1 will purchase 68 rupees, but £1 in terms of goods bought in the UK is not equivalent to 68 rupees of goods bought in India. For example £1 in the UK would probably buy you one bottle of water. In India a bottle of water will cost between 12 and 15 rupees. Therefore for one bottle of water in the UK you could purchase around five bottles in India.

This fact is largely overlooked by people. They will talk about how cheap it is in India but that is because they are experience the market exchange rate rather than PPP. Whilst teaching at Blue Edge many of the students will ask me how much various clothes or personal items cost. My shoes for instance cost about £25. In Indian rupees that's 1700 units of their currency. 1700 rupees is a hefty sum here. In theory the national average wage in Indian is about 3000 rupees per month. My shoes cost over half an average Indian's monthly salary! This contributes to us Westerners appearing ridiculously wealthy but it is a skewed conception. My average monthly wage post-tax in my previous job was £1100. That means my shoes cost 2.3% of my average monthly earnings. A far more manageable sum.

It goes a bit deeper than that though. Just because my shoes cost £25 here it doesn't mean that they will cost Rs 1700 in India. In fact a similar pair of shoes will cost around Rs 500 and that is inflated because of the branding and taxes. If I reply to one of the students with the figure of Rs 1700 I am misleading them because the shoes will only cost Rs 1700 if they come to the UK and buy them. Therefore it is actually more exact to give a figure that is revised down. I worked out that for the goods that I buy in India we are looking at roughly one fifth of the cost. So if someone asks the cost of my shoes for instance I divide 25 by five and then covert that number (£5) by the current exchange rate. In this case we have Rs 340.

The way I worked this out is fairly arbitrary but I find it roughly works out. To illustrate this further, each month I receive £280 to live on. If I was to receive £280 a month in the UK to live on, then, depending on my location, I would be living a very frugal existence. Even in a cheaper area such as Swansea it would only just cover rent. In Indian rupees that £280 amounts to 19,040. If I use the five-times rule it would mean the equivalent of living on £1400 post-tax in the UK. Which is more or less correct. It's a comfortable lifestyle and monetarily my standard of living here is higher than before I came out.

To go back to the poverty line of a dollar a day this means that you could be led to believe that people are even worse off than they really are. $1 at the moment will buy 47 rupees and 47 rupees will buy you a lot more in India than $1 in the USA. 47 rupees in fact could stretch to three meals a day. So rather than being able to buy absolutely nothing people can survive on this amount.

But that is the real issue: surviving. 47 rupees might buy you food for a day but that's it. It won't pay for accommodation, utilities, transport or entertainment. And what is also crucial is that the poverty line is described as people living on less than $1 a day. In Bombay you can buy a wadapow (a sort of fried potato burger) for six rupees. But living on a couple of these everyday would be neither a healthy or balanced diet.

I recently tried to live on 100 rupees a day to see how it would be like (ignoring things like rent as that is paid for in advance). It was definitely possible but it did mean having only one proper meal a day if I was to pay for transport to work (my bus ticket costs 20 rupees a day). What's more I had the option of going back home and relaxing to pass the time. For most of the poor the reality will be that if they live on 100 rupees a day it will be 100 rupees that they have spent the day earning and at the end of that day they will probably end up sleeping on the street.

Therefore when talking about the scale of poverty in somewhere like India then raising the living standard to $10 a day is actually a huge difference. A cursory glance could come to the conclusion that $300 a month to live on and pay for rent and utilities is still shockingly low, but in reality it would lead to quite a comfortable existence over here and those 14,100 rupees a month would mean an individual could lead a relatively affluent lifestyle.

So there we have it, a brief (though it may not feel like it!) overview of exchange-rate economics. It misses off things such as the factors behind the rates of exchange and differences between the currencies (the Indian rupee is restricted for example which means it cannot be bought or sold outside of the country unlike the pound sterling) but it hopefully highlights some of the reasons for why we are viewed as so wealthy and clears up any misunderstandings.

For more a in-depth look at some of the issues see the UN's Millennium Development Goals and the indicators of how they measure poverty.

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