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Why Some Countries and Cities Are So Much More Expensive Than
Others
By Derek Thompson
The Atlantic Magazine
Our special report on the world of prices wouldnt be complete
without asking, and trying to answer, a big, and surprisingly
complex, question: How do pricey countries get that way?
Reuters
Zenaide Muneton is a nanny in New York City. Last year, she
made more than $200,000, Planet Money reports. Yes, with five
zeros.
How in the world can Manhattan nannies be worth $200,000 a
year? One answer is that theyre more talented than your typical
babysitter. The highest-paid nannies can cook four-course
macrobiotic meals and know their way around a Zamboni (those are
actual examples of nanny skills). But the number-one reason why
nannies in Manhattan can get paid $200,000 is very simple. Rich
families can afford it. And in the market for locally-delivered
services, like caring for a child, prices rise as high as the
clientele can afford to pay.
What $200,000 nannies have to do with the price of tea in
China
Six-figure nannies dont rule the world, but they help explain
the world of prices. On a global scale, the price of
locally-delivered services, such as nannies and barbers, fluctuate
wildly from country to country. A simple haircut in Uzbekistan is
much, much cheaper than a simple haircut in Beverly Hills. But lots
of goods can be bought and enjoyed thousands of miles away from
where theyre made, like automobiles and paintings. If youre in the
market for an original Picasso, it wont matter whether you buy the
painting in China or in the United States. It will cost the same
price anywhere, because the painting can be “consumed” anywhere.
So, some prices vary wildly from country to country, and some
prices dont. Whats the difference?
THE NANNY EFFECT
If the answer is obvious to you, then you just might be
smarter than some of the 20th centurys most brilliant economists,
who spent decades building a framework for finding out why some
prices between countries (and even between cities in the same
country) differ so dramatically. The most elegant of these theories
is known, less elegantly, as the Balassa-Samuelson Effect, after
two economists Béla Balassa and Paul Samuelson. The
Balassa-Samuelson Effect is a mouthful. Lets call it the “Nanny
Effect.”
In a nutshell, the Nanny Effect says that the price of some
goods — e.g.: Picasso paintings, barrels of oil, bricks of gold,
and company stock — shouldnt vary much by location, because it
would create opportunities for arbitrage. If you bought a gold
brick for $10 in Peru and sold it for $100 in the United States,
Lima sellers would raise their price toward $100.
But most services arent like gold bars. Theyre delivered
locally and consumed locally. Youre not hiring a Bangalore nanny to
look after your kids, and youre not flying to Shenzhen for a
haircut. From the dry-cleaner, to the restaurant, to the
hairdresser, most of the jobs in a service economy have a local
clientele. In cities where incomes are high, average price levels
for these services are typically high. Where incomes are low,
average price levels are low.
But how do incomes go from low to high? Balassa and Samuelson
said it must come down to workers productivity, especially in the
sectors that can “trade” their goods and services abroad. If a
country gets better at making cars it can sell to foreigners for
money, it gets richer. As income and investment flows into a
country, incomes rise and prices rise across the board — even for
the haircuts and the nannies.
WHY IS INDIA SO CHEAP? … AND WHY IS ZURICH SO EXPENSIVE?
On Tuesday, and my roommate Shyam emailed from Mumbai to brag
about the cheap food. Ordering “a full lunch of a rice, naan and
three curries for, oh, about $1 is pretty great.” It sure is,
Shyam. But if he had visited ten years ago, it might have been
closer to 50 cents. As India has become more productive over the
last few decades, wages in the tradable sector (IT) rose, pulling
up wages in the nontradable sector (waiters), and the currency has
appreciated. There is a still a major price difference D.C. and
Delhi. One dollar will pay for much less stuff in America than its
equivalent in rupees will buy in India. But as Indian exports
continue to grow, one should expect Shyams lunch to get more and
more expensive.
There is much more to price levels than the Nanny Effect.
Much, much, much more. Restrictive urban policy raises the price of
rent in similarly productive cities. Energy policies and levies
raise or lower the price of gas. Tariffs raise the price of
imports. On a nation-by-nation basis, taxes restrain demand and
subsidies increase supply on an idiosyncratic basis.
But perhaps the easiest way to mess with Balassa and
Samuelson is for a government to manipulate foreign exchange rates.
China, for example, is famous for pegging its currency to the U.S.
dollar to make its exports more competitive. As a result, services
in China are probably cheaper than they would be if the government
werent actively trying to depreciate the currency. If youre happily
wondering “Why is China so cheap?” you should thank Beijing.
“The B-S Effect [er, Nanny Effect!] explains why on average,
prices vary across countries, but in the short to medium run, the
exchange rate will also determine how cheap or expensive different
countries are,” economist Arvind Subramanian told me.
Another way to see this in action is to read the Economists
latest cost-of-living index for cities, an sample of which are in
the graph below. The top of the list was dominated by Switzerland
(and, to a lesser extent, Japan and Australia). Why
Switzerland?
Blame Greece and Germany. The debt crisis sweeping Europe has
created a flight to safety to Swiss Francs, which are considered
safer. As the Franc appreciated, prices have gone up compared to
the euro and the dollar. Japan and Australia have also seen strong
currency appreciation over the last few years, which made it
relatively expensive for foreigners.
LAND AND RICHES
Even within a country, prices vary dramatically. The same
beer might cost more downtown than in the suburbs. A barber might
cost more in San Francisco than Detroit. Lets conclude with another
fundamental ingredient in prices. Land.
“Land is the key non-tradable good” in cities, Subramanian
told me. Its adheres to the Nanny Effect even more than nannies. If
rents are going down in El Paso, you cant take advantage of that
fact while youre living in Boston. Thats why housing rentals vary
by thousands of percent among cities in different parts of the
world. Rents rise when demand to live in an area goes up, and they
fall when the supply of rental units outpace that demand. The price
of real estate has a way of showing up in price tags all over the
city. Ice cream shops, massage parlors, and architects charge more
in cities with higher rental prices.
The unique case of Zenaide Muneton, our superstar nanny, is a
story about land, to a degree, but its more a story about people.
Manhattan has $200,000 nannies because thats the little island
where some of the richest and most talented people work and can
afford the richest and most talented caretakers for their kids. If
we had to boil all this — Balassa-Samuelson, Nanny Effect,exchange
rates, urban policy — down to a sentence, it might be this: All
things equal, prices rise fastest in the places where rich,
talented people want to be.
This article available online at:
https://allaplusessays.com/order
Copyright © 2012 by The Atlantic Monthly Group. All Rights Reserved.
Laura Tyson
Laura Tyson, a former chair of the US Presidents Council of
Economic Advisers, is a professor at the Haas School of Business at
the University of California, Berkeley.
Are US Multinationals Abandoning America?
03 April 2012
BERKELEY – At a recent conference in Washington, DC, former
Treasury Secretary Larry Summers said that US policymakers should
focus on productive activities that take place in the United States
and employ American workers, not on corporations that are legally
registered in the US but locate production elsewhere. He cited
research by former Labor Secretary Robert Reich, who, more than 20
years ago, warned that as US multinational companies shifted
employment and production abroad, their interests were diverging
from the countrys economic interests.
It is easy to agree with Summers and Reich that national
economic policy should concentrate on US competitiveness, not on
the well-being of particular companies. But their sharp distinction
between the countrys economic interests and the interests of US
multinational companies is misleading.
In 2009, the latest year for which comprehensive data are
available, there were just 2,226 US multinationals out of
approximately 30 million businesses operating in the US. Americas
multinationals tend to be large, capital-intensive,
research-intensive, and trade-intensive, and they are responsible
for a substantial and disproportionate share of US economic
activity.
Indeed, in 2009, US multinationals accounted for 23% of value
added in the American economys private (non-bank) sector, along
with 30% of capital investment, 69% of research & development,
25% of employee compensation, 20% of employment, 51% of exports,
and 42% of imports. In that year, the average compensation of the
22.2 million US workers employed by US multinationals was $68,118 –
about 25% higher than the economy-wide average.
Equally important, the US operations of these firms accounted
for 63% of their global sales, 68% of their global employment, 70%
of their global capital investment, 77% of their total employee
compensation, and 84% of their global R&D. The particularly
high domestic shares for R&D and compensation indicate that US
multinationals have strong incentives to keep their high-wage,
research-intensive activities in the US – good news for Americas
skilled workers and the countrys capacity for innovation.
Nonetheless, the data also reveal worrisome trends. First,
although US multinationals shares of private-sector R&D and
compensation were unchanged between 1999 and 2009, their shares of
value added, capital investment, and employment declined. Moreover,
their exports grew more slowly than total exports, their imports
grew more quickly than total imports, and the multinational sector
as a whole moved from a net trade surplus in 1999 to a net trade
deficit in 2009.
Second, during the 2000s, US multinationals expanded abroad
more quickly than they did at home. As a result, from 1999 to 2009,
the US share of their global operations fell by roughly 7-8
percentage points in value added, capital investment, and
employment, and by about 3-4 percentage points in R&D and
compensation. The shrinking domestic share of their total
employment – a share that also fell by four percentage points in
the 1990s – has fueled concerns that they have been relocating jobs
to their foreign subsidiaries.
But the data tell a more complicated story. From 1999 to
2009, US multinationals in manufacturing cut their US employment by
2.1 million, or 23.5%, but increased employment in their foreign
subsidiaries by only 230,000 (5.3%) – not nearly enough to explain
the much larger decline in their US employment.
Moreover, US manufacturing companies that were not
multinationals slashed their employment by 3.3 million, or 52%,
during the same period. A growing body of research concludes that
labor-saving technological change and outsourcing to foreign
contract manufacturers were important factors behind the
significant cyclically-adjusted decline in US manufacturing
employment by both multinationals and other US companies in the
2000s.
So, while US multinationals may not have been shifting jobs
to their foreign subsidiaries, they, like other US companies, were
probably outsourcing more of their production to foreign
contractors in which they held no equity stake. Indeed, it is
possible that such arms-length outsourcing was a significant factor
behind the 84% increase in imports by US multinationals and the 52%
increase in private-sector imports that occurred between 1999 and
2009.
To understand domestic and foreign employment trends by US
multinationals, it is also important to look at services. And here
the data say something else. From 1999 to 2009, employment in US
multinationals foreign subsidiaries increased by 2.8 million, or
36.2%. But manufacturing accounted for only 8% of this increase,
while services accounted for the lions share. Moreover, US
multinationals in services increased their employment both at home
and abroad – by almost 1.2 million workers in their domestic
operations and more than twice as many in their foreign
subsidiaries.
During the 2000s, rapid growth in emerging markets boosted
business and consumer demand for many services in which US
multinationals are strongly competitive. Since many of these
services require face-to-face interaction with customers, US
multinationals had to expand their foreign employment to satisfy
demand in these markets. At the same time, their growing sales
abroad boosted their US employment in such activities as
advertising, design, R&D, and management.
Previous research has found that increases in employment in
US multinationals foreign subsidiaries are positively correlated
with increases in employment in their US operations: in other
words, employment abroad complements employment at home, rather
than substituting for it.
Facts, not perceptions, should guide policymaking where
multinationals are concerned. And the facts indicate that, despite
decades of globalization, US multinationals continue to make
significant contributions to US competitiveness – and to locate
most of their economic activity at home, not abroad. What
policymakers should really worry about are indications that the US
may be losing its competitiveness as a location for this activity.
This article draws on “A Warning Sign from Global Companies,”
co-authored with Matt Slaughter, Harvard Business Review (March
2012).
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