January 17, 2009

On the Living Costs in the Third World

Posted in Economics, Int'l Trade, Theory tagged , , , , , , at 18:27 by Matthijs Krul

It is considered an intuitively self-evident idea among most people in the developed nations, whether they are intellectuals or otherwise, that the difference in income between those nations and the underdeveloped ones can be explained away by noting that the costs of living in the Third World are lower than in the First. This is generally seen as a truism, supported by the experiences of many a tourist from the developed world when visiting popular destinations in the underdeveloped parts, such as Egypt and Mexico, and then noting the extraordinarily low prices for basic products in these countries. Surely then with such low prices, the lower incomes must have been compensated for, so that the common people in such nations are not in terms of living standards that much poorer, according to the norms they are used to?

Yet this idea is wholly false, as can be demonstrated by some simple calculations. Indeed of course the relative costs of living vary much by nation and also within nations, and incomes vary much as well; yet it is possible to give some examples that will indicate how strong in fact the difference in incomes also translates into differences in living standards, because the living costs in the underdeveloped world are in fact higher than in the developed world.

The price of bread in Ghana is 0.6 Cedi (this is the minimum price guaranteed by the state), which is $0.46. The American price of bread is $1.28 (given as average price in an article in the Boston Globe, dated 09-03-2008.). The average daily wage in Ghana is $1. The minimum hourly wage in the United States is $6.55 (federal minimum); assuming eight hours of work, we get $52.40.

Now all you need to do is calculate how many local loaves of bread one local day of work is worth, to compare. We see that one day of work buys the American minimum income worker $52.40/$1.28 = almost 41 loaves of bread (40.94). One day of work for a Ghanaian average worker buys him $1/$0.46 = a little over 2 loaves of bread (2.17). Therefore, the cost of living (expressed in bread) is much higher in Ghana than in the US.

But, it will be objected, there is more to living costs than merely food prices. Bread may in the parts of the world where this is the common staple food serve as an acceptable proxy for the costs of food, but another major expense is the costs of housing. What of this? It must first off be noted that in terms of housing comparisons are much more difficult to fairly make. Bread is bread everywhere and everywhere essentially the same, but housing costs vary enormously. Not just because of the differences in amenities common in the housing units, but also because of the differences in land prices, due to the influence of land rent. This in turn is affected by a great many variables, from effects of crime to proximity to work and urban areas, as well as environmental factors and so on.

Yet we need not despair for our analysis entirely. The LA Times fortunately has some information in their article of 26-03-2007 on the slum living of illegal immigrants near Los Angeles. They give the example of a family which earns $10.000 a year and pays $360 a month in rent. I’m not sure if this is household income, but I think so. Rent then is 43.2% of their income, monthly and yearly, for the equivalent of an illegal hovel. From Kenya we have info on slum living, assuming the source is accurate, from a Pambazuka News article of 03-07-2007 by Humphrey Sipalla. The cost of rent is here given as KES 2,693 monthly, which is at current exchange rates $34.26 (this just to give an idea). According to the article, this represents 22% of their income, I assume also applies to households. If this is accurate then, the housing cost in a Kenya slum is just under half of what it is for illegal immigrants in California (22% versus 43%). But it would have to be 1/20th, i.e. ten times as cheap, to remove the difference in living costs altogether. Of course rents account for differences in costs as mentioned, but comparing Nairobi to the Los Angeles area seems to me not so unfair as to undo that entirely.

We may conclude then from this example, comparing the expenses in major cities in the United States (for average people and poor people respectively) with the living costs in food and housing in Ghana and Kenya respectively, that the common idea of the living costs being much lower in the underdeveloped world is wholly false. Indeed it makes that appearance because the prices, when valuta are calculated according to exchange values on the market, are indeed significantly lower in the Third World – the bread in Ghana costs one-third of what it does in Boston. However, our naive friends in the developed world forget that the incomes in the underdeveloped world are so much lower than theirs, that 1/3rd of the price is for them over 20 times the relative cost.

On a final scientific note, it must be taken into account that there is good evidence that the currencies of underdeveloped nations are undervalued by exchange rates in comparison to their value in terms of purchasing power. The nominal exchange rate of 16-01-2009, which is the one that I have used, is likely (as any nominal exchange rate) to undervalue the currencies of underdeveloped nations compared to their purchasing power. This has no particular implications for the living cost comparison I have undertaken, but it does affect international trade between, say, Ghana and the United States, because it means Ghanaian wages as well as prices are undervalued compared to American ones in the exchange rate, causing the terms of trade to tilt strongly in favor of the United States. Gernot Köhler’s research, described in “The Structure of Global Money and World Tables of Unequal Exchange”, in: Journal of World-Systems Research 4:2 (Fall 1998), p. 145-168, indicates in the appendix that the estimated loss as percentage of GNP (PPP) on the part of Ghana and Kenya is respectively 30% and 35%. If currencies were equalized according to PPP, the relative value of the Cedi would be much greater, increasing the relative price of food in Ghana compared to the United States, but also increasing the relative value of the wage. This would not of itself necessarily alter the proportion between wage and food costs within Ghana (aside from changes in the market caused by changes in international trade in the longer run, which are outside the purview of this article), but it would to a significant degree remove the false impression on the part of citizens of developed nations about the low costs of living, because they would experience the local prices as much higher.

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