Nova workboard

a blog from young economists at Nova SBE

The more competitive you are, the more you pay for a Big-mac

The developed countries such as Germany, Japan or Norway are characterized by their high levels of competitiveness. However, the price level in these countries is extremely high comparing with the rest of the world. It sounds a bit contradictory because a competitive country should produce the goods in a cheaper than the other. Does the theory go against the reality? Not really.

Let’s think about the example of Brazil in the last years. It is a country that is becoming more competitive, it is able to produce goods in a cheaper way for the rest of the world. As long as there are several countries producing goods (the so called tradable-goods can be exported and imported) for the international market the price is expected to be quite stable and the same or quite similar around the world. The productivity shock may be a profit opportunity for Brazilian firms and wages are expected to increase due to the fact that people is producing/creating more value per hour worked.

The shock might be followed by a stimulus in the domestic economy characterized by more consumption/demand and prices will go up in the non-tradable sector (the non exportable with no international competition) such as hair dress, cleaning services, housing construction, transportations services, etc. Another possible outcome of this shock is an appreciation of the domestic currency avoiding totally or partially the previous mechanism because the competitiveness gained by productivity would be offset by the new currency price which is higher than before. In reality both effects are taking at the same time – increasing prices and appreciation of the Real. These effects make an appreciation of the real exchange rate.

This mechanism is the Balassa-Samuelson effect: higher competiveness level made domestic prices higher. It explains the non-intuitive relation between high domestic prices and competition. As long as international markets are open and there is competition there, productivity levels in the tradable sector can be “seen” in the non-tradable price level.

One simple way of analyzing and rank competitiveness across countries is by the Big-Mac index which is simply the Big-Mac prices in relation to the U.S. price. This is a simplification of the real exchange rate/competitiveness level but it is useful because Big-Mac is related to costs such as production, transportation, wage of the seller, energy costs, etc. These costs are a sample of non-tradable goods in an economy and their prices (incorporated in the Big-Mac price) will give us a clue about whose countries are the most competitive. This index theory is not taking into account different preferences across countries however it is a useful tool to have a simple proxy of the real exchange rate across countries. Different productivity levels may make the Big-Macs cheaper or more expensive across the world and we should expect to have a more expensive Big-Mac in Brazil than before.

 

Guilherme Rodrigues

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Author: studentnovasbe

Master student in Nova Sbe

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