Your dirhams are more powerful than you thought

Purchasing power is all relative, with money stretching further in one location than another.

Congratulations, residents of the UAE – you’re almost twice as rich as you thought you were.

That’s the upshot of a minor technical change to a bit of international survey methodology, which occurs, like a lunar eclipse, once every five years or so.

The International Comparison Program’s (ICP) statistical database of global expenditures, supported by the World Bank, was published at the end of last month. It is the most comprehensive study of relative price levels ever conducted. It gives us the best idea possible about how much an income in one country is worth in another.

Like a lunar eclipse, it makes everything look a little bit different.

According to the ICP, per capita purchasing power in the UAE has been revised up from US$34,800 to $60,866. That is a significant jump, and it reflects a trend across the survey – the income of individuals in developed countries has been overstated, while lower price levels in developing countries mean that the quality of life is better than previously thought.

The basic idea is this. Your welfare is not just a function of how much you earn, it’s a function of how much things cost. And the cost of the same product – a hamburger, say, can vary wildly between countries.

The Economist has its Big Mac Index to illustrate this point. McDonald's sells its notorious meat product in political jurisdictions from Fiji to the Democratic Republic of the Congo.

By expressing the price in dollars, we get a rough and ready idea of how a basic product varies in price across a number of places in the world.

A Big Mac cost $4.62 in the United States in January this year, while in China it cost $2.74.

The real value of a unit of income in one country expressed in terms of the value of the goods and services that can be bought in another country is called Purchasing Power Parity (PPP).

You can’t just look at another country’s prices in exchange rates, because these can fluctuate wildly as hot money flows circulate from economy to economy in pursuit of higher rates of return.

But major questions, from the wealth of nations to the persistence of poverty, require us to get a clear picture of relative prices. An oft-cited definition of poverty is the percentage of the population living on less than $2 per day, but this is almost meaningless without a clear idea of the goods and services $2 can buy. Price levels in poorer countries are lower: measuring $2 in currency terms will capture those who are able to make do in one country and those who struggle to survive in another.

If different economies have different price levels, so too do subsets of those economies. What happens to prices in Dubai Marina doesn’t also happen to prices in Musaffah. The baskets of goods that different sections of society buy differ: the city’s restaurants, where dishes range from Dh25 to Dh250, illustrate this clearly. These subsets may well have different inflation rates, and it’s not difficult to see that different parts of the economy can foster different standards of life.

The ICP figures should be taken with some caution – they say nothing about relative price levels within economies, which may well be significant, especially when income inequality is high. They’re from 2011 – a testament to the monumental data collection effort involved – so things have changed a bit since then. Plus it’s not really possible to get a complete picture of the price differences between countries, since some products don’t exist in others, and it would be an endless task collecting data about every single trade that took place in a territorial area, the prices paid and the quantities exchanged.

But the ICP represents the state of the art when it comes to PPP measurement – it gives us the most accurate picture we have so far of relative prices.

Of course, it’s not especially gratifying to discover that your salary is worth more than you thought if it hasn’t changed in nominal terms. But that just illustrates a behavioural fact of the kind that makes economics a very difficult discipline – individuals overemphasise losses while undervaluing gains. Decoupling subjectivity from measurements of human welfare is a mammoth task, and we haven’t managed it yet.

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