Pur­chas­ing power

The Pak Banker - - 4EDITORIAL - Shahid Kar­dar

ECON­O­MISTS have in­vented the con­cept of Pur­chas­ing Power Par­ity (PPP). The con­cept en­ables the es­ti­ma­tion of the ex­change rate be­tween one cur­rency (say the ru­pee) and an­other cur­rency (say the dol­lar) for the ex­change to be at par with the do­mes­tic pur­chas­ing pow­ers of th­ese two cur­ren­cies - the tech­nique helps de­ter­mine the rel­a­tive value of th­ese two cur­ren­cies.

What this means is how much of a given amount of one cur­rency has the same pur­chas­ing power to di­rectly pur­chase a mar­ket bas­ket us­ing the other cur­rency. In other words, PPP dol­lars mea­sure what peo­ple can buy from their in­comes in their own coun­tries to en­able com­par­isons with other coun­tries on stan­dards of liv­ing, by pur­chas­ing from the mar­ket the same bas­ket of goods. We all know that the Pak­istani ru­pee can buy more goods and ser­vices in Pak­istan than the US dol­lar in the USA.

Ac­cord­ing to the IMF, the In­dian and Pak­istani ru­pees are highly un­der­val­ued on the ba­sis of PPP. It ar­gues that if a bas­ket of goods is bought in In­dia and the same bas­ket is bought abroad the ex­change rate would be ap­prox­i­mately Rs17.7 while in our case the ex­change rate would be roughly Rs41.33, mak­ing the ru­pee un­der­val­ued by more than one and half times - 155 per­cent!

The ob­vi­ous ques­tion aris­ing from such a rev­e­la­tion would be: why isn't an un­der­val­u­a­tion of such pro­por­tions en­abling us to in­crease our ex­ports to lev­els that will en­able us to have a large sur- plus in our ex­ter­nal trade ac­count (ex­port earn­ings be­ing higher than our out­flows to fi­nance im­ports), whereas we have his­tor­i­cally run large trade deficits? Why is this the case?

There are sev­eral pos­si­ble ex­pla­na­tions of this phe­nom­e­non. It could be ar­gued that th­ese es­ti­mates of PPP are sim­ply in­cor­rect. PPP may be an easy con­cept to un­der­stand but not easy to es­ti­mate. Con­sumers of dif­fer­ent coun­tries earn dif­fer­ent lev­els of in­come, have dif­fer­ent de­mo­graphic struc­tures, tra­di­tions and tastes and do not con­sume the same bas­ket of goods and even within this range of goods and ser­vices con­sumed the qual­ity of goods and ser­vices could be very dif­fer­ent. Hence, it is not pos­si­ble to com­pare the two.

Then, there are the prices of some ba­sic con­sumer goods and ser­vices which are ad­min­is­tered by govern­ment and can be lower be­cause of sub­si­dies, es­pe­cially the sup­pressed price of gas. Also, a sig­nif­i­cant pro­por­tion of con­sump­tion com­prises non-trad­ables, goods and ser­vices which can­not be im­ported by an­other coun­try if they are costly at home, eg do­mes­tic bus, taxi, train and air­plane rides, price of wa­ter in your homes, fees charged by doc­tors and schools, cost of dif­fer­ent ser­vices (like hair­cuts, un­skilled labour, gen­eral re­pairs and main­te­nance ac­tiv­i­ties, etc), rental space for of­fices and homes, mem­ber­ship of clubs (es­pe­cially if the land for fa­cil­i­ties has been pro­vided by the govern­ment, as in our case, at a sub­sidised rate), etc.

The most well-known PPP in­di­ca­tor for layper­sons is The Econ­o­mist's Big Mac In­dex, re­fer­ring to a prod­uct that is lit­er­ally sim­i­lar but be­ing sold at dif­fer­ent prices world­wide. The ex­change rate would be com­puted such that it would make the price of this iden­ti­cal prod­uct the same the world over. If a Big Mac is sold for $4.79 and its cost in Pak­istan to­day is Rs350, the equiv­a­lent dol­lar price of the Big Mac in Pak­istan is 3.31 sug­gest­ing that the Pak­istani ru­pee is un­der­val­ued by 31 per­cent, giv­ing an equiv­a­lent PPP ex­change rate of Rs73. If this is in­deed the case why hasn't Pak­istan been un­able to ex­pand its ex­ports?

A ma­jor rea­son for this could be Pak­istan's weak com­pet­i­tive­ness ow­ing to mat­ters other than price. For ex­am­ple: a) govern­ment poli­cies and tax and reg­u­la­tory regimes that dis­cour­age the de­vel­op­ment of an en­vi­ron­ment for ex­port ex­pan­sion while pro­tect­ing and in­cen­tivis­ing im­port-sub­sti­tut­ing in­dus­tries; and b) the low pro­duc­tiv­ity of our labour and other fac­tors and in­puts of pro­duc­tion used per unit of out­put-our pro­duc­tiv­ity be­ing sub­stan­tially lower than that of China, etc.

An­other key fac­tor is that we con­sume far more en­ergy per unit of GDP - more than twice the world av­er­age and in ex­cess of five times as much as in coun­tries where en­ergy is highly taxed, like Bri­tain, re­quir­ing more ef­fi­cient use of en­ergy re­sources.

The govern­ment also needs to grad­u­ally elim­i­nate the sub­si­dies that it pro­vides on in­puts like wa­ter and en­ergy (par­tic­u­larly gas), etc by re­plac­ing price-sup­port with in­come-sup­port and chang­ing the way wel­fare is de­liv­ered rather than play­ing around with the amount spent on ini­tia­tives like sub­si­dies which bur­den an al­ready stressed bud­get, dis­tort price struc­tures and dis­in­cen­tivise the ef­fi­cient use of scarce re­sources.

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