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    Jul 25 • Businesses, Developing Economies, International Trade and Finance • 283 Views

    The Big Mac Index is out again. Not much has changed. Norway’s Big Macs are most expensive and Chinese Big Macs are cheap.

    What do Big Mac prices tell us? Starting with an average U.S. price of $3.73 (based on 4 cities), we can determine whether other currencies are over valued or undervalued in comparison to the dollar. So, when we see that a euro based Big Mac will cost $4.33, we know the euro is overvalued. Rather interestingly, a Brazilian Big Mac, at $4.91 is also more while Argentina’s Big Mac is very inexpensive at $1.78.

    I wondered, though, whether a low price would be inexpensive domestically and discovered that we can also look at the Big Mac Index from an average net wage perspective. In March, 2009, someone buying a Big Mac in Chicago, Tokyo, or Toronto would have needed 12 minutes of work time. By contrast, workers in Nairobi, Mexico City, and Jakarta worked longer than 2 hours. The global average, based on 73 cities, was just below 40 minutes.   

    The Economic Lesson

    As economists, the Big Mac Index takes us to purchasing power parity. A 2 page St. Louis Fed paper clearly and briefly connects the Big Mac Index to economics. Starting with a “one price” theory, they explain that price deviations can vary because of local productivity. If workers producing exports have higher wages, other workers benefit, and prices move up. Looking at supply and demand, Big Mac prices relate to the cost of local labor and the amount consumers are willing and able to spend. Does export activity relate to Brazil’s position on the list?


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    Institutionalized Trust

    Jul 24 • Economic History, Economic Thinkers, Macroeconomic Measurement, Thinking Economically • 246 Views

    The production path of a pair of Levi’s stonewashed 501 jeans could have started in a Mississippi Delta cotton farm, continued with a North Carolina fabric weaver, and included the Dominican Republic and Haiti for cutting, sewing, and finishing. Then, the jeans would have returned to the U.S. to one of countless retail outlets, to a consumer, and maybe even to a recycled life afterwards in some other country.

    Commenting on these “production paths” economist Tim Harford  says they ultimately lead to economic growth but only if the path is preserved by trust. The trust he refers to is primarily an institutionalized trust. We “trust” that money will have a certain value. We “trust” that a contract will be enforced. We “trust” transactions that involve Visa and American Express. We “trust” that we will receive a package that we order from Amazon.

    Correspondingly, in economies where corruption and bribery abound, economic development is constrained. Explaining why Haiti has made little progress rebuilding its main harbor, the Miami Herald points out that the project is “mired in cronyism, waste, scandal, and inertia. They could also have said that there was no institutional trust.   

    The Economic Lesson

    Secretary of the Treasury Alexander Hamilton realized that the sanctity of contracts was essential for U.S. economic development. As a result, when he had to decide who owned Revolutionary War bonds, the benevolent patriots who had sold the bonds at a discount or the ruthless speculators who bought them, he chose the speculators. Why? Government has to enforce a legal contract. A nation has to have “institutional trust.”

    Contemporary economists have researched the role of trust in the market system. You might want to look at “Adam Smith’s Essentials: On Trust, Faith, and Free Markets,” and “Trust and Growth“. 


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    Green Jeans

    Jul 23 • Businesses, Environment • 247 Views

    Reading about a new Eco Index started me thinking about competition. The Eco Index is somewhat comparable to the Energy Star rating created by the EPA in 1992. For appliances, Energy Star ratings convey energy efficiency information. For apparel, the Eco Index provides a green score.

    As described in a WSJ article, the Eco Index is composed of questions that relate to environmental and labor practices. Using information about the entire, “… life of a product, from raw-material production to manufacturing, shipping, and even disposal,” a score is assigned. Levi’s, for example, elevated its Eco Index score for stonewashed 501 jeans by rerouting trucks to save carbon emissions and suggesting cold water washing. 

    Having started during the 1850s with a basic, utilitarian pair of Levi Strauss jeans, now the jeans market involves many firms, many designs, many price points. So, when I saw the Eco Index, I perceived it as a way for firms to differentiate themselves. 

    The Economic Lesson

    Levi’s and other jeans makers compete in a monopolistically competitive market. The characteristics of monopolistic competition include many sellers with a similar product, sellers creating an individual unique identity, and sellers having some control over price. The Eco Index will enable certain sellers to convey this unique identity.

    From most competitive to least competitive, the four basic competitive market structures are perfect competition, monopolistic competition, oligopoly, and monopoly. 

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    Wages and Floors

    Jul 22 • Businesses, Demand, Supply, and Markets, Economic Debates, Labor, Regulation • 234 Views

    A writer for The Baltimore Sun recently said that, “A ‘new living wage’ will make Baltimore City no more livable than stilettos will make Sen. Barbara Mikulski a forward for the WNBA.” Meanwhile, in New York City, Mayor Bloomberg was said to have “scoffed” at a similar idea. These opponents of “living wage” legislation believe businesses will flee and unemployment will climb because of a mandated higher wage.  

    On the other side, proponents say that workers deserve a fair wage. Laborers should be able to afford to live in the city in which they work. In New York, supporters of a $10.00 living wage say that the current $7.25 state minimum is inadequate.

    The “living wage” is a municipally mandated minimum for all subsidized jobs. For example, any business receiving a tax break, which could include most retailers, would have to observe the pay minimum. Living wage mandates tend to cluster between $10 and $11 an hour. Close to 140 municipalities, including Los Angeles, CA and Santa Fe, NM have living wage laws. Each time one is proposed, the same dilemmas resurface. The graph described below conveys the basic dilemma.

    The Economic Lesson

    Please imagine for a moment a supply and demand graph. Price is the y-axis and quantity is the x-axis.

    Thinking of wages, the supply curve represents labor and the demand curve is the business side of the market. The point at which demand and supply meet, called equilibrium, is the wage (the price of labor) determined by the market.

    Government, however, can say that it believes the market determined wage is too low. It then mandates a higher wage that can be depicted as a horizontal line placed above equilibrium. Economists call this horizontal line a “floor” because it stops wages from moving lower to their natural market price. 

    And therein lies the dilemma. A higher wage or more jobs? Floors create surpluses. At the new, higher wage, the number of jobs laborers want is more than the number of jobs businesses are willing and able to offer. So, we have a higher wage but fewer jobs.

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    China’s Wages

    Jul 21 • Developing Economies, Economic Debates, International Trade and Finance, Labor • 257 Views

    Because I am still reading Peter Hessler’s Country Driving A Journey Through China, I related a recent NY Times article to his wonderful descriptions of an expanding transportation infrastructure, villagers migrating to cities, and more affluence. Saying that textile jobs were shifting to Bangladesh, Vietnam, and Cambodia, the NY Times article focussed on higher Chinese wages for unskilled labor. Then, combining all of this with other articles on striking workers at auto plants, I assumed that Chinese wages were rising. 

    But it is never that easy.

    I checked further and discovered that not everyone agrees on the status of Chinese wages. In a rather interesting debate at The Economist, several experts present different perspectives. One Peking University professor said that although wages have been rising, demographic data indicate that the era of “cheap” unskilled labour has not ended. Similarly, Morgan Stanley’s Stephen Roach says that “Chinese wage convergence” has a long way to go. A third commentator looks at a shift that has begun and economist Tyler Cowen says that instead, we can focus on Chinese productivity.

    The Economic Lesson

    I guess all of this returns me to, “It’s complicated.” Involving a huge work force, many businesses, and a powerful government, a changing Chinese economy requires a closer look when someone states a clear and logical conclusion.

    Also I will let you know more when I finish the “factory half” of the Hessler book. I am looking forward to it. 

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