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A STUDY OF CULTURAL CONVERGENCE FROM PURCHASING POWER PARITY PERSPECTIVE
--- MORE EVIDENCE FROM W INDOWS VISTA INDEX
Ming Xia
INTRODUCTION When Euro was first launched on 1 January 1999, against all odds, “Big Mac Index” (BMI) created by The Economist Magazine was one of the few who predicted the depreciation of Euro. This success triggered an international applause of Big Mac Index as a light-hearted assessment to measure purchasing power parity. The index is based on the law of one-price. In this case, a basket of goods is replaced with one product – the Big Mac hamburger which is sold in 119 countries. By converting the local prices into US dollars (USD) then compared with real exchange rate, Big Mac index uncovers the arbitrage opportunities exist between a particular country and United States. However, BMI is far from perfect. One could easily assume the change in business environment since 1986. What once a good indicator of a country’s PPP may not has the same representative status in this IT age. The change in global business environment may require a product what is constantly self-updating. Low price of Big Mac with the range of US$1.42 to US$4.601 will magnify a slight price differences between countries generating a large percentage error of the BMI. The change in eating habits further complicates the issue (Sonestedt, Wirfält, Gullberg and Berglund 2007).In addition, some cultures and religions have second thoughts about cows. Therefore, a large percentage of the Muslim and Hindu communities have to be excluded from BMI. The academia has also long being doubtful about this index, particularly on the existence of non-tradable component in the production cost (Pakko and Pollard 1996) as well as apparent component (beef) cost difference in a standardized product (Li 1997). Many attempts have been made to improve the index, from the “Tall Latte Index2” created by The Economist itself, to the Apple iPod Index by the Commonwealth Bank of Australia and eventually to the Game Console Index (Cox 2008). The paradigm has shifted from food items to high-tech products. 1
Source: The Economist Lattenomics, The Economist, http://www.economist.com/finance/displaystory.cfm?story_id=E1_NPGTDSN
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However, the manufacturing cost of iPod is still considerably high (40%3), not to mention the transportation cost required. In addition, the stiff competition in the hightech electronics market in developed countries might force retailers to cut their margin. On the other hand, due to fewer brands available in the developing nations, may allow the retailers to price them at higher price. This combined effect on market availability may undervalue the developed country currencies, while overvalue developing country currencies. Software industry usually requires a massive investment in centralized R&D (In 2007, Microsoft spent $6.2 billion on R&D4), while the manufacturing and packaging cost could be effectively reduced to near zero after mass production. Furthermore, software like operating systems (OS) have little component disparity as it is the platform where other program will rely on – maximum compatibility is required. This effectively removed possibility for disparity in components. These unique factors make software products a convincing candidate for evaluating PPP and cultural convergence. This paper aims to explore the interaction between purchasing power parity and cultural convergence using of software products instead of Fast-food products in measuring global purchasing power parity. Microsoft’s Windows Vista Home Basic Operation System is chosen to represent the software products. The rationale will be discussed in the following chapter. A similar methodology to the famous “Big Mac Index” is adopted here for a fair comparison between software products with fast-food products. To ensure the validity of our analysis results for individual countries, a combination of validation methods was employed – Sensitivity analysis and Triangulation process.
METHODOLOGY The prices of Window Vista Home Basic (WV) packaged edition in each country was obtained by calling the respective customer service centers of Microsoft Company of each country within two days5. This short time frame avoids data inaccuracy due to pricing policy changes. There are X countries in our sample, Table 1 shows the detailed analysis of all countries investigated. Data on currency exchange rates used in this study was taken directly from Bloomberg and presented in indirect terms (stated values demonstrate how much of the respective currency can be bought with 1 USD6). All exchange rates were taken as the daily closing
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Ryan Block, Your $200 iPod nano costs about $90 to make, http://www.engadget.com/2005/09/23/your-200-ipod-nano-costs-about-90-to-make/ 4 http://blog.searchenginewatch.com/060602-085238 5 Two dates are 31 Dec 2008 and 1 Jan 2009. 6 To convert values into direct figures showing the amount of US dollars that can be purchased with one unit of a particular currency, a reciprocal of the numbers shown may be done.
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price at 1 Jan 2009 to investigate the latest currency valuation while allowing ample time for back-testing. The implied PPP of the dollar is calculated by dividing the local WV price against the price in United States. This Vista PPP is the exchange rate that would equate the prices of WV in America as elsewhere. The implied exchange rate is compared to the actual market exchange rate between these currencies to determine if the relevant currency is under or overvalued7, as presented in the final column. A figure of 0 indicates a fair market valuation for the respective currency in line with strict PPP, figures below 0 indicates currency undervaluation and vice-versa8. This index is the technical equivalent of BMI in that it calculates PPP exchange rates simply by comparing the local currency prices against the US prices. This hence allows a fair comparison between BMI and WVI.
RESULTS AND ANALYSIS In Appendix 1, we have listed all the countries investigated. Among them, the Peruvian Nuevo Sol is the most undervalued currency (-76.07%), followed by the Chinese RMB (63.43%), On the other hand, the most overvalued currency is the Hungarian Forint (125.02%). Generally, the currencies of developing countries are generally undervalued. On the other hand, the Euro seems overvalued, still. It is interesting to note that within geographically close regions, valuations tend to be similar, namingly Malaysia (-42.06%) and Indonesia (-52.24%), as well as US (base currency) and Canada (6.55%). This suggests the existence of certain degree of pricing and cultural convergence across the immediate boarder.
ACCURACY COMPARISON BETWEEN BIG MAC INDEX AND WINDOWS VISTA INDEX We computed the absolute difference of Vista’s valuation and Big Mac’s valuation from the actual change in the exchange rates between 1 Jan 09 and 2 Feb 09. This allows us to compare the predictivity of Vista Index as well as Big Mac Index. The last two columns
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These terms are used in the same sense as BMI, according to PPP theory which argues that in the long run, exchange rates should move towards levels that would equalize prices of an identical basket of goods between any 2 countries. Realistically however, the market exchange rates will deviate to an extent from strict PPP. Markets should be assumed to adjust exchange rates to equalize prices of individual goods or any market baskets.
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For example: Canadian dollar is overvalued by 100* [(259/200)-1.22]/1,22 = 6.55%
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indicate the absolute difference of Windows Vista Index and Big Mac Index from actual. Absolute values are taken to eliminate trend biasness.9. Table 1: Comparison between Window Vista Index and Big Mac Index in reality
G8
NICs
Country
Vista Price (USD)
Vista Index 2009-1-1
Big Mac Price (USD)
Big Mac Exchange Exchange % Index rate rate change 2009-1-1 2009-1-1 2009-2-2 of USD
US Canada Euro Japan Russia
200 213 271 299 235
Nil 6.55% 34.76% 49.29% 17.36%
3.57 4.08 5.34 2.62 2.54
Nil 14.30% 49.60% -26.60% -28.90%
Nil 1.22 90.74 29.15 0.68
Nil 1.24 89.45 36.13 0.70
UK
200
-0.19%
4.57
28.00%
0.71
0.78
Nil -2.00% -8.54% 1.44% 19.33% -2.80%
China India Mexico Brazil Malaysia Philippines Thailand Turkey South Africa
73 103 159 193 116 174 188 123 137
-63.43% -48.72% -20.65% -3.66% -42.06% -13.17% -6.20% -38.54% -31.68%
1.83 Nil 3.15 4.73 1.7 1.96 1.86 4.32 2.24
-48.70% Nil -11.76% 32.50% -52.39% -45.10% -47.90% 21.00% -37.30%
9.48 13.71 2.32 6.83 48.77 3.47 47.52 34.78 1.54
10.13 14.42 2.31 6.85 48.93 3.62 47.72 34.97 1.65
Absolute Difference from Actual Vista Big Mac Nil Nil 0.05 0.12 0.26 0.41 0.51 0.25 0.02 0.48 0.03
0.25
-0.37% -0.33% -4.87% 0.13% -4.15% -0.42% -0.54% -6.74% -6.51%
0.64 Nil 0.26 0.04 0.46 0.14 0.07 0.45 0.38
0.49 Nil 0.17 0.33 0.57 0.46 0.48 0.14 0.44
Sum
3.29
4.59
Source: Bloomberg, Microsoft Co. Big Mac index seems to agree with Vista Index on Canada dollar and Euro for their overvaluation, as well as most of NIC currencies for their undervalued status. However, they disagree on Russia, Japan, Brazil and Thailand. In general, the Microsoft Vista Index has an absolute difference from actual fact by 3.29, while Big Mac Index is 4.59. The improvement is about 39%. This improvement in accuracy could due to the superior nature of software products in terms of international trade.
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Because positive figure in valuation indicates a tendency to devaluate, therefore we uses the Vista or Big Mac valuation to plus the actual difference in exchange rate to obtain the absolute difference
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G8 VS NICS (NEWLY INDUSTRALISED COUNTRIES) Figure 1: Plot of WVI vs GDP per capita
Valuation vs GDP per capita 45,000 40,000 Japan 35,000
Canada UK
GDP Per capita
Euro Zone
30,000 25,000 20,000
Malaysia Turkey
15,000
Brazil Thailand
South Africa
China
Russia
Mexico
10,000 5,000
Philippines
India
-80.00%
-60.00%
-40.00%
-20.00%
0.00%
20.00%
40.00%
Valuation
60.00% (5,000)
Source: Bloomberg, IMF *Radius of the circle is proportional to the GDP per capita of individual country. From figure 1, it is apparent that G8 countries are concentrated on the right hand side of the valuation chart; while NICs are disperse on the left hand side. This is because under the current recessionary environment, emerging country currencies seem greatly undervalued (average: -29.79%) [See appendix 1], while developed world seems more overvalued (average: 21.55%). From macroeconomic level, this is probably due to repatriation of funds from developing countries to developed world where investors have more confidence or eminent demand for cash to clear the balance sheet. This has increased the demand for developed country currencies, which results a superior exchange rate. Most interestingly, among G8, Russia has similar level of GDP per capita as Mexico, Turkey and Malaysia. However, Russian Ruble is overvalued as other G8 country currencies by 17.36% on its own. This abnormality suggests that Russian Rouble is likely to adjust its position to reach an equilibrium state. At the beginning of 2009, Russian Ruble tumbled by 19.33% (Source: Bloomberg) just in January alone. (as indicated by the red arrow) This is probably caused by the sharp drop
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in oil price from its peak at $145.8510 per barrel to $47.7511 per barrel. As its new found might, oil has been the main thrust for economic growth in Russia for past few years. However, the deepening of financial crisis, especially in the automobile industry, has led oil price to plunge. Rouble’s new position on 2 Feb 2009 matches the level as Mexico, Turkey and Malaysia. In theory, the likelihood of Russian Rouble to stabilize at current level is high. In fact, during February 2009, Russian Rouble only depreciated by 0.12% (Source: Bloomberg). This further justifies the accuracy of our model. This classification of currency valuation and the movement of Russian Ruble suggest to us that PPP is still greatly influenced by the economic level of a country. The law of oneprice may not stand though in today’s environment. This model also suggests that the law of one-price may be modified into law of two prices, adjusting to the level of classification of GDP per capita. This could be an interesting area for further research.
CONCLUSION In this paper, we have demonstrated the use of Window Vista OS as a better choice to Big Mac in currency valuation. MVI deviates from actual rates by 3.29, compared to BMI’s 4.59, implying an improvement in accuracy of about 39%. In general, emerging country currencies seem greatly undervalued (average: -29.79%), while currencies of the developed world seems more overvalued. The greater accuracy of WVI also implies the importance of software in globalization. All the above have proven the existence of pricing arbitrage among richer countries and less developed nations. Even though one may argue that there is certain degree of cultural and pricing convergence at broad, large discrepancies still exist in countries with different economic levels. The undervaluation of emerging country currencies may enhance the competency of their products; however, on the other hand, it might be fair to their land.
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on 3 July 2008
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APPENDIX 1: EVALUATION OF WINDOWS VISTA INDEX VS ACTUAL EXCHANGE RATE Vista Index Local Currency in dollars United States Australia 299 Britain 137 Canada 260 China 499 12 Euro Area 194 India 5000 Hong Kong 1700 Hungary 84990 Indonesia 1060000 Japan 27090 Kenya 7600 Malaysia 400 New Zealand 337 Norway 1955 Peru 150 Poland 317 Pakistan 7990 Philippines 8250 Russia 6842 Saudi Arabia 619 Singapore 358 South Africa 1295 South Korea 247000 Sweden 1700 Switzerland 145 Taiwan 6890 Thailand 6514 Turkey 189 Vietnam 3100000 UAE 325 Source: Bloomberg, Microsoft Co.
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200 212 200 213 73 271 103 219 450 95 299 97 116 198 282 48 108 101 174 235 165 249 137 196 219 137 210 188 123 177 88
Implied ppp of the dollar 1.50 0.69 1.30 2.50 0.97 25.01 8.50 425.06 5301.33 135.48 38.01 2.00 1.68 9.78 0.75 1.59 39.96 41.26 34.22 3.10 1.79 6.47 1235.31 8.50 0.73 34.46 32.58 0.95 15503.88 1.63
Actual Exchange Rate 01/01/09 1.41 0.69 1.22 6.82 0.72 48.77 7.75 188.90 11100.00 90.75 78.62 3.45 1.70 6.92 3.13 2.95 79.05 47.52 29.16 3.75 1.43 9.48 1259.55 7.78 1.06 32.82 34.73 1.54 17479.00 3.67
The retail price for Euro Area is taken as the average retail price of the area.
Bliss or Misery? Contemplating the Engagement of Cultural Forms and Economic Progress
Under / over Valuation 6.05% -0.19% 6.55% -63.43% 35.40% -48.72% 9.70% 125.02% -52.24% 49.29% -51.65% -42.06% -0.96% 41.27% -76.07% -46.23% -49.45% -13.17% 17.36% -17.47% 24.78% -31.68% -1.92% 9.29% -31.70% 5.00% -6.20% -38.54% -11.30% -55.75%
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However, the manufacturing cost of iPod is still considerably high (40%3), not to mention the transportation cost required. In addition, the stiff competition in the hightech electronics market in developed countries might force retailers to cut their margin. On the other hand, due to fewer brands available in the developing nations, may allow the retailers to price them at higher price. This combined effect on market availability may undervalue the developed country currencies, while overvalue developing country currencies. Software industry usually requires a massive investment in centralized R&D (In 2007, Microsoft spent $6.2 billion on R&D4), while the manufacturing and packaging cost could be effectively reduced to near zero after mass production. Furthermore, software like operating systems (OS) have little component disparity as it is the platform where other program will rely on – maximum compatibility is required. This effectively removed possibility for disparity in components. These unique factors make software products a convincing candidate for evaluating PPP and cultural convergence. This paper aims to explore the interaction between purchasing power parity and cultural convergence using of software products instead of Fast-food products in measuring global purchasing power parity. Microsoft’s Windows Vista Home Basic Operation System is chosen to represent the software products. The rationale will be discussed in the following chapter. A similar methodology to the famous “Big Mac Index” is adopted here for a fair comparison between software products with fast-food products. To ensure the validity of our analysis results for individual countries, a combination of validation methods was employed – Sensitivity analysis and Triangulation process.
METHODOLOGY The prices of Window Vista Home Basic (WV) packaged edition in each country was obtained by calling the respective customer service centers of Microsoft Company of each country within two days5. This short time frame avoids data inaccuracy due to pricing policy changes. There are X countries in our sample, Table 1 shows the detailed analysis of all countries investigated. Data on currency exchange rates used in this study was taken directly from Bloomberg and presented in indirect terms (stated values demonstrate how much of the respective currency can be bought with 1 USD6). All exchange rates were taken as the daily closing
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Ryan Block, Your $200 iPod nano costs about $90 to make, http://www.engadget.com/2005/09/23/your-200-ipod-nano-costs-about-90-to-make/ 4 http://blog.searchenginewatch.com/060602-085238 5 Two dates are 31 Dec 2008 and 1 Jan 2009. 6 To convert values into direct figures showing the amount of US dollars that can be purchased with one unit of a particular currency, a reciprocal of the numbers shown may be done.
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REFERENCE Anon. 2000. Big MacCurrencies. The Economist (US), 9 April. Pg 91 Ong, L.L. 1998. Fast food for thought: Burgernomics and the ASEAN currency crisis. Journal of the Securities Institute of Australia, Autumn (1) : pg 15-16 Laurenceson, James & Kam, Ki Tang 2006. China’s Equilibrium Exchange Rate and Trade Balance: a Tale of Apples and Pirates. East Asia Economic Research Group. Discussion paper No.8. Available from: IDEAS. [20 February 2009] Laurenceson, J. and Qin, F. (2006) The exchange rate debate, in Economic growth, transition and globalization in China (Ed.) Y. Wu, Edward Elgar, Cheltenham, pp 199-213 Ong Lilian (1997) Burgernomics: The economics of the Big Mac standard, Journal of International Money and Finance, 16, 865-78. Parsley, David.C. & Shang, Jin Wei (2003) A Prism into the PPP Puzzles: The Microfoudnations of Big Mac Real Exchage Rates, NBER Working Papers 10074 Yang, Jiawen (2004) Nontradables and the valuation of RMB – an evaluation of the Big Mac index, China Economic Review 15, 353-5 Cox, Joe (2007), Purchasing power parity and cultural convergence: evidence form the global video games marlet, Journal of Cultural Economcis, Volume 32, Number 3 Xu, Zhenhui (2002), Purchasing power parity, price indices and exchange rate forecasts, Journal of International Money and Finance, Vol.22: 105-130. Clement W. Kenneth & Lan Yihui, A New Approach To Forecasting Exchange Rates, Economics Discussion Working Paper, The University of Western Australia, Department of Economics Hines 2004. Cnet http://management.silicon.com/itdirector/0,39024673,39124118,00.htm. \
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Story, alan 2004. Intellectual property and computer software. Story, Alan (2004), Intellectual Property and Computer Software – A Battle of Competing Use and Access Visions for Countries of The South. UNCTAD-ICTSD Project on IPRs and Sustainable Development. Internationl Centre for Trade and Sustainable Development International Trade Administration, “Computer Software Industry”. [Online] U.S. Department of Commerce, (2008), Available at: http://www.trade.gov/investamerica/computer_software.asp [Accessed 9 March 2009].
Bliss or Misery? Contemplating the Engagement of Cultural Forms and Economic Progress
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Desmond, J.P., “Innovation Alive and Well”. [Online] Software Magazine (2009), Available at: http://www.softwaremag.com/L.cfm?Doc=1175-10/2008 [Accessed 9 March 2009] Engel, C. & Rogers. J.H. (1996), How wide is the border? The American Economic Review, 86(5), 1112-1125 Engel, C. & Rogers, J.H. (2001) Deviations from purchasing power parity: Causes and welfare costs. Journal of International Economics, 55, 1242-1272. doi:10.1016/S00221996(01)00094-0 Hearn, G. and T. Mandeville (2005). How to be productive in the knowledge economy: the case of ICTs. Handbook on the knowledge economy. R. David, H. Grey and N. Abraham. Cheltenham, Edward Elgar: 255-267 Pakko, M. R. and Pollard, P.S.(1996) For here or to go? Purchasing power parity and the Big Mac. Federal Reserve Bank of St. Louis Review 78, 3-21. Desmond, J.P., “Innovation Alive and Well”. [Online] Software Magazine (2009). Available at: http://www.softwaremag.com/L.cfm?Doc=1175-10/2008 [Accessed 9 March 2009] Christensson, P., 2007. Commercial Software Definition. [Online] Available at: http://www.techterms.com/definition/commercialsoftware [Accessed 3 March 2009]. Fuller, T., “How Microsoft Warded Off Rivals”. [Online]New York: The New York Times, (2003), Available at: http://www.nytimes.com/2003/05/15/technology/15SOFT.html?ei=5007&en=a675991 e5c85fa9b&ex=1368331200&partner=USERLAND&pagewanted=all&position= [Accessed 20 February 2009]. Anon. , ‘Purchasing Power Parity and the Balassa-Samuelson Effect’. [Online] National Graduate Institute for Policy Studies , (2009). Available at: http://www.grips.ac.jp/teacher/oono/hp/lecture_F/lec05.htm [Accessed 10 March 2009]
Global Initiatives Symposium in Taiwan 2009