What if I tell you that every time you scarf down a burger at McDonald’s you modify the nation’s exchange rate? Granted, that is a slightly exaggerated claim, but it could prove true if a majority of a country’s population begins consuming the Big Mac burger. Devised in 1986 by The Economist, the Big Mac index was originally made as a joke to present a lighthearted comparison of international currencies. Over time, it became globally recognized and is regularly published by the British newspaper which maintains that it is a “semi-humourous” indicator to make exchange-rate theory more comprehensible.
Every Joke Has a Grain of Truth
Quirky economic indicators are not new — as evidenced by indexes based on men’s underwear, iPods, hemlines, and Starbucks’s chai latte around the world. The Big Mac index however operates on the theory of purchasing power parity (PPP) by using the relative prices of Big Macs at McDonald’s outlets, based on data from the International Monetary Fund (IMF). PPP is a popular concept applied to compare the purchasing power of currencies for an identical basket of goods and services while using this relative purchasing power to determine the exchange rate between countries. Since the ambiguity of this identical basket of goods and services is prone to errors, by assuming that the basket has only one item (the Big Mac burger), we can ensure consistency with minor local variations in ingredients (like chicken instead of beef in Maharaja Macs in India).
With McDonald’s presence in more than 100 countries, the comparison is fairly simple. Notably, The Economist releases a gourmet version of the index, while taking factors like the popularity of burgers, ingredients, rent, taxes, electricity rates, etc. into account. Base currencies include the US dollar, the Euro, and the British pound. For this calculation, the price of a Big Mac in country A’s currency is divided by the price of the same in country B’s currency. This implied exchange rate is then compared with the official exchange rate to see if a currency is overvalued or undervalued. If the implied rate is lower than the official one, the currency is undervalued and if it is higher then it is said to be overvalued. For instance, as per January 2023 data, the Big Mac costs ₹207 in India and $5.36 in the US, making the implied exchange rate 38.62. Since the actual exchange rate was 81.72, the Indian rupee was said to be 52.7% undervalued as per the raw index.
A common mistake is assuming that cheaper prices mean better currencies. Since lower labor costs in countries lead to cheaper prices and vice-versa, the GDP-adjusted index is published too by The Economist to ensure that the fair value of a currency is obtained. As per this, the Indian rupee is undervalued by 41.2% (with the US dollar as the base currency) in January 2023.
Data Churns Out Interesting Stories
Over the years, changes in Big Mac prices are reflective of various trends in exchange rates and inflationary tendencies. Switzerland wins the spot of the priciest Mac with higher wages and one of the highest GDP per capita in the world. From 2004 to 2022, Venezuela experienced a big jump (243%) in burger prices due to hyperinflation. Among the most overvalued currencies, Uruguay is followed by Switzerland and Norway while the most undervalued currency is that of Egypt. Analysis can also show how long an average person must work (based on minimum wage) to be able to afford a Big Mac. In the US, one would have to work for 48 minutes to purchase the burger while a Swiss worker would work for 17 minutes. Contrarily, a worker in Uruguay would be required to work for 258 minutes and a worker in Venezuela would need to work for 87 minutes.
One of the limited benefits of the Big Mac index when compared to other measures, is its use when data manipulation is at play and other economic measures are rendered unsuitable. For instance, amid doubts regarding Argentina’s rate of inflation published by the government between 2010 and 2011, the Big Mac index was used by The Economist. The result was that the difference between the burger inflation rate and the official inflation rate was found to be the highest among other countries, adding to the controversy regarding Argentina’s true inflation rate. However, in 2012, one of the officials further tried to distort data by drastically lowering the prices of Big Macs and even removing them from menus to keep the actual rate of inflation hidden from the media.
While the Big Mac index can be somewhat utilized by investors and tourists for planning their purchases, it suffers from several drawbacks. One of the incorrect assumptions of the index is that the demand for Big Macs is the same everywhere; this is false as seen in the case of India where burgers are still consumed as a snack item rather than a meal one and the affordability is low in smaller towns.
The prices of Big Macs are also affected by sizes, nutritional values, and whether or not basic ingredients are imported; not to mention that the prices are set differently by McDonald’s outlets as per their varied profit margin strategies. Lastly, despite being the ultimate symbol of globalization, all countries are yet to have McDonald’s outlets.
While the index is not perfect, it can still be used to compare and analyze data while being mindful of the economic realities among countries. Using a single item to measure PPP is a little too simple for complicated economies and the index mainly suffices as a good starting point for understanding exchange rates and their implications for nations in terms of trade, devaluation, revaluation, inflation rates, and cost of living.