poverty

LBTL day 2 – Understanding Purchasing Power Parity

When I talk about extreme poverty with friends, one of the most common responses is an excuse: in poorer countries, things are cheaper and money goes further. I’ve heard it a couple of times now in reaction to the Live Below the Line challenge. A lot of people seem to assume that living on £1 a day, or $1.25, is a whole lot easier in poor countries than it is here. That’s a mistake, and it’s an important one. It makes us think that serious poverty isn’t so bad after all.

The root of the problem is a misunderstanding of how that $1.25 figure is presented. That’s the global benchmark for extreme poverty, as set by the World Bank. Obviously that amount of money means different things in different countries, so the figure has been adjusted for Purchasing Power Parity, or PPP.

What that means is that local prices have been factored in and balanced out to give us a measure of spending power, rather than just an amount of currency that might mean different things in different places. Whatever currency and whatever amount of it that theoretical poor person might actually earn per day, it has the equivalent spending power that $1.25 has in the United States. Or when you read that 1.4 billion people live on £1 a day, that £1 figure has been balanced out to reflect the same amount of stuff you could buy for £1 in Britain. IE not very much.

So a PPP adjusted figure is both more simple and more complex than you might think. It’s more complicated because there’s a whole lot of maths behind it, compiling and averaging price indices and so on. It’s more simple because it’s a number that can be taken at face value.

So when you read that someone in India might be earning £3,000 a year and that hasn’t been adjusted for PPP, perhaps it would actually have the spending power of £4,500 if you factored in local prices. But if you read that someone earns £1 a day and that PPP has been calculated, then we really are talking about £1. If you were genuinely living below the extreme poverty line in Britain, you would have just £1 a day.

Can you really live on so little? Yes. Somehow 1 in 4 of the world’s people do.

(Here’s how the World Bank puts it if you want a more technical description: “A purchasing power parity between two countries, A and B, is the ratio of the number of units of country A’s currency needed to purchase in country A the same quantity of a specific good or service as one unit of country B’s currency will purchase in country B.

3 comments

  1. A corollary to this is the distinction between tradeable and non tradeable goods. In a globalised world, with free trade, and low cost bulk shipping a good with a reasonably high labour component -for example a cotton tea shirt – can only be economically manufactured in a low wage area and can be sold very cheaply in more prosperous parts of the world. So the cost of mass produced goods tends to fall to the lowest level consistent with profit.

    Non tradeable goods, for example a haircut, or a cup of coffee in a particular location, are not subject to globalised competition.

    While this complicates the issue of purchasing power parity t Shirt same price in India as here, haircut much more expensive here than in India, it also clearly raises big issues regarding wealth and poverty, and inequality.

    1. Good points, yes. It only really works with ‘baskets’ of commodities, and even those are notoriously difficult to compile unless a country keeps a formal Consumer Price Index of some kind. It’s not a complete picture, but it does allow for more accurate comparisons than GDP per capita on its own.

    2. David, Did you have any specific big issues in mind regarding wealth and poverty, and inequality, or are you merely speaking generally? I’m interested to learn, if you’ve more to offer. Thanks,

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