Where do economists go on holiday? Unmoved by glossy travel brochures they turn straight to the concept of purchasing power parity.
I’m looking at the postcards on the mantelpiece. Perhaps it’s because the senders know I’m an economist. They mostly make the inevitable comments about the weather and go on to comment on the prices. You can learn a lot of economics if you keep your eyes open on holiday.
There is one from a pair of students, backpacking in India. They’re amazed at how cheap it is. But that’s why they go; if you can find accommodation for $10 (ý6.50) a night then a few weeks of work will pay for an extended holiday. But in India even luxury hotels are cheap by European standards.
Japan is another matter altogether. The only way to enjoy touring there is to forget about currency conversions. If you start, you’ll want to go straight back to Narita airport.
Purchasing power parity is fundamental to exchange rate economics. On a day-to-day basis, currencies are very volatile. But over an extended period, relative rates of inflation in different countries are by far the best predictor of exchange rate movements. But purchasing power parity implies that the cost of living will be the same everywhere. And every returning holidaymaker knows that isn’t true.
The cost of living is generally higher in rich countries than poor ones. Prices in Norway are very high, but Norwegians can afford it. Or so one of my postcards says. But a full explanation is more complicated. Purchasing power parity means that prices of tradeable goods – such as clothes, cars and confectionery – tend to equalise around the world. The price of services varies much more, in line with the cost of domestic labour. And these costs are higher in countries such as Norway.
The result is that rich countries tend to have higher exchange rates than would seem justified by purchasing power parity, and poor countries tend to have lower ones. If you look at the dispersion of standards of living across the world, it is much less than the dispersion of output per head calculated at market exchange rates.
Tourist expenditures contain a much higher proportion of services than day-to-day living. When you are at home, mostly you make your own bed, pour your own tea and mow your own garden. But when you travel, people do these things for you. So the tourist cost of living shows even greater divergences than the residential cost of living.
This explains why India is a good destination for backpackers. But it doesn’t explain why even Americans and Europeans find Japan so expensive, since income levels in their home countries are much the same. Japanese productivity in manufactured goods – which enter into international trade – is high relative to Japanese productivity in services, which mostly aren’t traded. So the price of services relative to goods is much higher in Japan than in Europe or the US.
The Japanese see this as a difference in quality. Not even the most expensive US hotels employ someone to bow as you enter or leave the lifts, while cooks in a steak house do not require the skills of a keisekichef.
When in Rome, you must pay for what the Romans pay for, but may not want to. Purchasing power parity is too crude to cope with these cultural differences. It may equalise the wholesale price of manufactured goods, but when you buy them in a shop you also have to pay the price of local retailing services. That’s why a Japanese camera may cost you more in Tokyo than it would in New York.
The camera is also expensive because the price of property, like the price of services, doesn’t equalise internationally. Values are highest in the most congested parts of the world, such as London and Paris, Ginza and Manhattan, Hong Kong and Monaco. Property values don’t only influence what you pay for an apartment or a hotel room. They affect the price of other goods you buy that use property – a cinema seat or a drink in a bar.
Property is cheaper where there are wide open spaces, as in Australia or the US. That is why these countries also have a higher standard of living than would seem to be justified by their output per head. Property is also cheaper where there is no single dominant city. There are few prices in Spain, Italy or Germany that match those of London, Paris, or Tokyo. And property is also cheap where there has been outward migration of population, because supply does not move as quickly as demand. A French chateau is as cheap as an English country cottage because English agricultural decline happened so much earlier. And you can buy a Georgian house in Yorkshire or Northumberland for the price of a flat in the English home counties.
So where do economists go for holidays? Some of them frequent business hotels when businesspeople are no longer on business. They respond to the advertisements that offer bargain stays in Dýsseldorf in August. These people look for countries with low incomes per head, in which services will be cheap. They seek out countries with lower productivity in manufacturing goods than in services. They enjoy empty spaces, not for their environmental attributes but for the low prices. And keep an eye out for the places where the population is moving out rather than moving in. Perhaps eastern Europe is the place to be. But there is more to life than economics. That’s why this article was written in the south of France.