Monday, March 27, 2006

Part 7 - Hyperwage Theory: Labor as Unit of Currency


Table of Contents

Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Part 8
Part 9
Part 10

Part 12
Part 13
Part 14
Part 15
Part 16
Part 17
Part 18
Part 19
Part 20

Part 22
Part 23
Part 24
Part 25
Part 26
Part 27
Part 28
Part 29
Part 30
Part 32
Part 33

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The Misadventures of the Street Strategist Vol 1 to 13


Hyperwage Theory Part 07

Hyperwage Theory Part 7

Chapter 7: Labor as
Unit of Currency

The Hyperwage Theory could be the source of extreme ridicule or, the same could be the source of supreme honor for the Street Strategist in the annals of intellectual history.

There’s no room for half-lives within the spectrum of extremes.

Before we proceed, I have constantly made you aware of my limited talents and minimal wealth. Therefore, I don’t have the expertise, the fame and the fortune to enhance my credibility. After all, truth and logic alone are not sufficient to form faith and belief.

If you are not convinced that the Hyperwage Theory is a concrete, actionable, elegant single-stroke solution to the Third World poverty, what can I do?

At least, you will never look at economics the same way again. This is probably the only contribution of the Hyperwage Theory to the world.
All these and more, courtesy of the Street Strategist, a one-man thinking machine of limited talents and unlimited imagination.

In Part 1 (Strategy of Poverty), I revealed the strategy of poverty unwittingly perpetrated by Third World governments and their economists.

In Part 2 (Hyperwage Theory Unveiled), I unveiled Hyperwage Theory with the surprise feature that the solution to a Third World country’s poverty rests on the country’s valuation of the labor of the poorest of the poor. I argued that domestic helpers should be covered by the minimum wage law, and that they should be paid wages with actual purchasing power.

In Part 3 (Paradigms), I laid out the paradigms needed to appreciate the Hyperwage Theory, and attempted to illustrate that it comes as a direct natural logical and elegant consequence of the same.

In Part 4 (Aimless Strategies), I disparaged the aimless strategies of the World Bank and government economists with their “beating around the bush” solutions and their insistence on an inflation-centric First World economic theory for Third World countries.

In Part 5 (The End of Modern Theory), I described the helplessness of modern economic theory in solving both the economic and non-economic problems of the Third World.

In Part 6 (The Wealth of the Nation), I argued that the wealth of the nation depends on the valuation of its lowliest worker and not on the accumulation of excessive profits by a privileged few.

In this part, I will discuss the World Bank’s purchasing power parity (PPP) and why I consider this an ineffective measure.
PPP and Exchange Rates

Let me quote the World Bank. Understanding the factors that affect levels of economic and social development in countries, and monitoring poverty reduction at the global level requires measures that convert indicators such as GDP and other economic statistics measured in national currencies, into a common accounting unit, typically the United States Dollar. Because market exchange rates are based on short-term factors and are subject to substantial distortions from speculative movements and government interventions, comparisons based on exchange rates, even when averaged over a period of time such as a year, yield unreliable and misleading results.

The problems associated with comparing indicators of social and economic development across countries have been known for some time, as have the shortcomings associated with the use of exchange rate conversion factors. Indeed it was the recognition of these problems by the international community in the sixties that first gave rise to the ICP, with a view to generating PPP data. By establishing purchasing power equivalence, where one dollar purchases the same quantity of goods and services in all countries, PPP conversions allow cross-country comparisons of economic aggregates on the basis of physical levels of output, free of price and exchange rate distortions.

I would like to quote from the ICP Handbook. The International Comparison Program (ICP) of the World Bank calculates Purchasing Power Parities (PPPs) in order to make comparisons of the volumes of Gross Domestic Product (GDP) between different countries. The PPPs are based on a global survey of prices. Volume comparisons can also be made between other expenditure aggregates, such as household consumption, in order to compare living standards and poverty incidence.
In international comparisons, however, the ratio of the values of the GDPs in two different countries splits into three components:
• the exchange rate;
• the volume ratio; and
• the price ratio.
The exchange rate simply converts the GDPs into the same currency units. Even when valued in the same currency unit, the ratios of GDPs in different countries still have to be split into their volume and price components.

As its name suggests, a Purchasing Power Parity is the rate of currency conversion at which a given amount of currency will purchase the same volume of goods and services in two countries. Another way of looking at a PPP is to note that when it is used as a currency converter, the price levels are the same in both countries.

The inter-relationships between the PPPs, exchange rates, volume indices, and price indices for GDP or other expenditure aggregates such as household consumption can be summarized as follows:
1. GDP or expenditure ratio = exchange rate x volume index x price index
2. GDP or expenditure ratio = volume index x PPP (by definition of PPP)
3. PPP = exchange rate x the price index

Not price index
PPPs are not price indices. They are not ratios or pure numbers that measure the percentage by which one flow, or level, exceeds another. Their dimensions are different as they measure ratios of currencies. Their values depend on the units in which the currencies themselves are measured. However, it can be seen from above that PPPs can easily be transformed into price indices by dividing them by the corresponding exchange rates.

Two common fallacies
Many users of the data assume that GDPs converted at exchange rates provide volume comparisons directly. There is immense confusion on this point among many economists and other users of the data including the press, politicians and the general public. This fallacy leads to faulty analysis and inappropriate policy recommendations.

Because exchange rate converted GDPs are expressed in the same currency unit, such as the dollar, it often seems to be tacitly assumed that they must be valued at the same price levels. However, no one would commit the same fallacy when comparing the current dollar values of US GDP, for example, in two different time periods. Yet, the evidence clearly shows that the differences in price levels between developed and developing countries, for example, can be much greater than the changes in the price levels between successive time periods in the same country.

Another common fallacy is that PPPs are calculated because they provide estimates of underlying equilibrium exchange rates. There are no assumptions whatsoever about exchange rates, or their determination, underlying the ICP other than that, in general, exchange rates are different from PPPs.

The calculation of PPPs
The PPP between two countries is defined as the rate at which the currency of one country needs to be converted into that of a second country to ensure that a given amount of the first country’s currency will purchase the same volume of goods and services in the second country as it does in the first.

The concept of a PPP is clear and simple at the level of a single good or service. For example, consider salt. If the price of a kilo of a salt in country A is PA units of currency and the price in country B is PB units of currency, the PPPAB for salt is defined as the ratio PB /PA . The ratio is usually normalized by setting PA equal to one, so that the PPP can be expressed as a certain number of units of currency B per unit of currency A.

If a given amount of A’s currency is converted into B’s currency at the salt PPP rate of PB/PA it must, by definition of the PPP, purchase the same quantity of salt in B as it can in A: hence, the name ‘purchasing power parity’. However, the measurement of PPPs runs into traditional index number problems of the kind encountered in inter-temporal price indices as soon as more than one good or service is involved.

In practice, the relative prices of different kinds of good and services vary from country to country because demand and supply conditions differ between countries. The greater the variation in relative prices between a pair of countries, the greater the variation in the individual PPPs for different goods and services. In order to obtain a comprehensive PPP covering a wide range of different goods and services, such as the consumption goods and services purchased by households, it is necessary to take some kind of average of the individual PPPs. They also have to be weighted in order to reflect the relative importance of different kinds of goods and services.

The individual products whose prices are compared between countries must obviously be the same. The prices in the numerators and denominators of the ratios that are fed into the calculation of the elementary PPPs must refer to exactly the same product. As the price collectors cannot observe the products that price collectors in other countries are pricing, each price collector must be given a very precise or tight specification of the product, including a picture where possible. The specification should be so precise that the same product can easily be identified in different countries.

In fact the international survey covered prices of such products as milk, garlic, mushroom, belts, dwellings and many basic commodities and services.

New terminologies
Gross national income (GNI) (formerly gross national product, or GNP) is the sum of gross value added by all resident producers plus any product taxes (less subsidies) that are not included in the valuation of output plus net receipts of income from abroad.
Gross national income in PPP terms (GNI PPP) is gross national income converted to international dollars using purchasing power parity rates.

An international dollar has the same purchasing power over GNI as the U.S. dollar in the United States.
The Atlas conversion factor for any year is the average of a country’s exchange rate (or alternative conversion factor) for that year and its exchange rates for the two preceding years, adjusted for the difference between the rate of inflation in the country. A country’s inflation rate is measured by the change in its GDP deflator.

Income groups
Economies are divided according to 2003 GNI per capita, calculated using the World Bank Atlas method. The groups are: low income, $765 or less; lower middle income, $766 - $3,035; upper middle income, $3,036 - $9,385; and high income, $9,386 or more.
The Philippines is classified as “Lower-middle-income economies” one of the 56 in this group which includes Albania, Guatemala, Armenia, Russian Federation, Azerbaijan, South Africa, Iraq, Sri Lanka, Brazil, China, and Thailand.

GNI Ranking
As released in April 2005, here is the Total GNI 2003 Ranking, using the Atlas method as described above.
Exhibit 2 Ranking (US dollars, millions)
1 United States 11,012,597
2 Japan 4,360,824
3 Germany 2,085,464
4 United Kingdom 1,680,069
5 France 1,521,613 a
6 China 1,416,751
7 Italy 1,243,168
8 Canada 773,943
9 Spain 700,475
10 Mexico 637,159
11 Korea, Rep. 576,426
12 India 570,760
13 Brazil 479,515
14 Australia 436,470
15 Netherlands 425,556
16 Russian Federation 374,810
17 Switzerland 298,975
18 Belgium 267,250
19 Sweden 258,882
20 Austria 216,903
21 Saudi Arabia 208,089
22 Poland 201,660
23 Norway 197,991
24 Turkey 197,788
25 Denmark 180,859
Source: World Bank
PPP Ranking

But the PPP ranking is different. In April 2005, The World Bank released the PPP GDP 2003 ranking of economies. Here are the top 25 countries. China is number 2 and the Philippines is number 24.

Exhibit 3 Ranking (international dollars, millions)
1 United States 10,923,376
2 China 6,446,033 a
3 Japan 3,567,804
4 India 3,078,024 b
5 Germany 2,291,007
6 France 1,654,018
7 United Kingdom 1,610,579
8 Italy 1,563,332
9 Brazil 1,375,756
10 Russian Federation 1,323,839
11 Canada 970,326
12 Mexico 937,836
13 Spain 920,292
14 Korea, Rep. 861,042
15 Indonesia 721,533
16 Australia 589,116
17 Turkey 478,891
18 Netherlands 476,454
19 South Africa 474,137 b
20 Thailand 470,992
21 Iran, Islamic Rep. 464,394
22 Argentina 445,148
23 Poland 434,626
24 Philippines 352,191
25 Pakistan 311,258
Source: World Bank

Skewed ranking
The World Bank and the member governments spent tens of millions of dollars to conduct this survey and calculate the PPP of each country.
But I have a favorite question: Of what value is that information? Does it lead us to rank economies in a useful manner?

Based on the PPP ranking, the purchasing power parity ranking of China is No. 2, the Philippines is No. 24, and Pakistan is No. 25.
World Bank, are you telling me that it is better to live in Pakistan or China than Hongkong (No. 40) and Singapore (No. 54) and New Zealand (No. 57)?

By just looking at this ranking, immediately, any ordinary person in the street may conclude that there must be something wrong with this ranking.

After all, it is a basic reality that we have a shortage of doctors, nurses, and teachers because the only way to remain alive as a citizen of this country is to leave this country. We leave to survive.

Sin of omission
Now, guys, do you have to be a PhD to realize that it is a waste of tens of millions of dollars for the World Bank to come up with a parameter than does not reflect the economic situation of the country?

This is equivalent to using the size of the thumb to rank phallic sizes. Wait a minute, at least the rule of the thumb actually makes sense.

Can you blame me if I call their strategies aimless? Can you blame me or declaring at the start of the series that the World Bank, the ADB are world-class failures?

You mean to say that the World Bank spent millions of dollars and wasted precious years to come up with a useless parameter?

Where did the geniuses of the World Bank go wrong? How can they arrive at a parameter that does little to understand the reality of economic conditions?

I have a minor theory for this monumental failure: Analysis paralysis. The economists are so enamored with academic mathematical theory that they failed to recognize certain simple basic truths.

In fact, probably, it is their PhDs that’s their downfall. Why? Because they have been brainwashed to think along the same lines. Overdose of Laspeyres and Paasche indices.

They have less time for original thought, or they probably are brainwashed into thinking that there’s no original economic thought left undiscovered.

Let me go back to the question: What is the defect of the PPP ranking? For me, inherently, PPP is a good data to have, it’s nice to have. But the moment you use it for ranking economies, the PPP becomes an instrument of confusion.

Why? The error lies in what the PPP ranking tells you and what it does not tell you. The PPP tells you that the Third World countries such as
the Philippines are cheaper countries. That’s good.

However, it does not tell you this: The prices are cheap but the people have no money to buy.
Yes, that’s the error of the ranking. It is the omission not the commission that is the source of the fault.
Of what use are cheap prices if there’s no money to buy? If the people have no purchasing power?
Have you read that expat survey wherein Manila is the most favorite of the expats? Because the expats are given their home country’s purchasing power and pay only Third World prices for services in Manila.

I think it’s high time for the Street Strategist to take over the economic thought of the World Bank and its member countries.
Here’s my proposal. Instead of an international dollar such as the PPP, I propose to use a new unit of currency, and that is labor hours.

Therefore, the questions is not PPP international dollars to buy a certain basket of goods. Rather, how long does it take for a worker to buy such a basket?

Of course, labor hours are paid differently by skills, therefore inappropriate.

But why not use the minimum wage worker as the basis of the unit of currency? Since we are after the reduction of poverty, let’s focus on the least of our brothers and sisters.

How long does it take for a minimum wage worker to pay for one kilowatt-hour of electricity, for one Big Mac, for a can of 330-ml Coke, or a liter of gasoline in their respective countries?

That’s the topic for the part of this series.

For the moment, suffice it to say, labor-hours is a better parameter to determine purchasing power parity, and that is why the Hyperwage Theory rests heavily on labor economics.

Excited? As I said, you will never look at economics the same way again. Labor as a unit of currency, yes, I think that sounds exciting. Don’t you?
(Thads Bentulan, June 16, 2005)
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