Why do Western currencies have such greater purchasing power in so many developing countries?

Question

Please, I am looking for nuanced and detailed answers only. Answer to this question must use political economy and address the history of colonialism that led to the bifurcation of the "developed" and "developing" worlds we have today.

I am not looking for a simple explanation. I am a graduate student in the social sciences so I already know the simple answers. But I have yet to get a really good answer that explains just why this is.

Why I can stay in a hotel in India for $5 a night that would cost me $50-100 a night if it were in the US.

Yet, this doesn't work for everything. An iced latte at the Indian coffee chain Barrista costs about $2, compared to $4 at Starbucks in the US. For this product, the difference is only about 2 times, rather than 10-20 times for the hotel.

Other things, too, differ wildly.

Pay for an hour of work for unskilled labor in India is mere pennies.

As a tourist I've been able to take advantage of this inequality in exchange.

But it doesn't seem fair.

Answer 1

it doesn't seem fair because it's not.  the western cultures embarked on an economic warfare campaign to trash currencies around the world.  this inequality is the exact reason that politicians don't want a gold standard.  honest money has a stable exchange rate and you can't manipulate it.  read a book called Gold: the once and future money. by Nathan Lewis.

Answer 2

Well, I think there are three effects here.  I am not an international trade economist or a development economist but I am a monetary economist.  I see three effects going on here.  One of them is that your internal reference prices have given you  a sense of "fair."  You know what things should cost in the United States because you have grown used to the price structure there.  Prices reflect the marginal scarcity of some thing, but while prices are "global," in concept the cost to transport the cup of coffee from India to the United States is such that local pricing rules prevail.  Prices in India are fair, because they reflect the local changes in scarcity.

This internal reference price drives how you know in the United States if you are being "cheated."  All your reference prices are wrong now and they should fairly reflect the reference prices in India.  You might even be being cheated there and you would have no way to know.  You might even be being ripped off on the room.  I recommend you look up the Slutsky equation and if you have the calculus generalize it with added local costs and local fixed costs.

The second issue is pay.  India has a nightmare of constitution in that it is constitutionally a socialist state.  Most segments of India do not work correctly because of this, so everything in India reflects massive amounts of waste.  Socialism tends to work better after you have built up a huge economy and a little waste makes everyone a little bit more comfortable, but for a poor economy it just keeps people poor.  So prices and wages are distorted by the constitutional nature of India's government.  Pay is low because many functions of business are precluded by governmental interference.  Someone has to pay for the waste and it is often the poorest person.  If you lived in India you would find it very costly to hire a person to work for you, officially, and so the pay will have to be low to pay the huge labor expenses the government creates for employers.  The smallest part of labor costs in India are the wage.

Finally, currencies of OECD countries are claims on those nations' productive capacity.  Money is locked up savings.  While a dollar can buy you goods in both India and the United States, Indian rupees will not buy you anything in the US and if you fly to Pakistan dollars will buy goods there but rupees will not.  So OECD member countries have money which is inherently more valuable than the money of a developing nation.  In particular, dollars, euros and sterling can be used as ordinary money anywhere they have trading partners.  An Indian barrista wanting to buy coffee from Columbia will be required to pay in dollars.  Indian banks are inefficient money changers so it costs much less to get dollars from you than from Indian banks.

People in other countries hold much higher levels of savings in the form of bank notes.  Institutional savings systems like postal and savings bank systems don't work correctly in most developing countries so bank notes, and in some places postage stamps, work as ways to set aside money for future needs.  Bank notes are very inefficient savings vehicles.  Because of inflation loss, the United States government makes about 4 cents per year off each one dollar bill you give to someone in India in a hidden tax called seigniorage.  For all practical purposes, a dollar bill spent by a US soldier in Vietnam and still in circulation in Vietnam has transferred about 80 cents in hidden taxes to the American government over the years.  Americans receive several hundred billion dollars in tax money each year, in the form of seigniorage, from outside the United States.  On a per capita basis, each citizen of China will pay between thirty and fifty dollars this year in taxes to the people of the United States for the use of American currency.

On a per capita basis, and this is a back of the envelope calculation, each American receives about eight hundred dollars per year in seigniorage revenue from the people of the world.  Americans locked up their savings in the form of currency and other people bought American savings in exchange for goods and services.

While it sounds like Americans are making out like bandits, there is a second side to this story.  The use of dollars, euros and pounds reduce poverty, prevent starvation, reduce conflict and permit higher wages globally in amounts far greater than the annual US seigniorage revenue.  The reason everyone else wants this money is that they make more than we do off of it.  It makes them wealthier than they could otherwise be.

The only thing that resembles colonialism in this issue has to do with the gold standard and Bretton Woods.  Bretton Woods was an agreement on how nations would settle debts with one another in 1946.  The gold standard is the cause of the Great Depression and so when nations went off the gold standard in the 1930s they were very cautious on how to resume it.  They were not going to resume it the way they had following World War I, that lead to Hitler's rise to power.  So they came up with a two tier system of dollars or gold.  A nation could pay for obligations either in dollars or gold, but the US could only pay in gold to prevent the US from simply turning on the printing presses.  The dollar was chosen, over the ruble, the franc or the pound because money is a claim on production and all of Europe and Asia were flattened by the war and had little or no productive capacity.  Their money was a claim on nothing.  You have to get goods or services for money to hold value and the only industrial nation left standing was America.  The only nation even close would have been Argentina but the Depression knocked it out of the running.  Had Argentina paralleled America since about 1900, it would be the other major super power.  Argentina is one of the world's most interesting economic conundrums because had politicians there made slightly different choices, we would be competing with Argentina for dominance.

Bretton Woods worked until 1972 when the British Ambassador showed up at the Treasury Window to redeem gold notes.  He literally brought enough in notes to demand 1/3rd of America's gold supply and he did.  He wanted immediate transfer of 1/3 of America's gold.  The US reneged and went off gold, it had to or the American economy would have collapsed.  To prevent a collapse in the dollar a group of American investors went to Saudi Arabia to get a promise that OPEC member firms would only accept dollars in payment for oil, essentially backing the American currency in oil.  For a variety of reasons OPEC agreed to back American currency.  The promise to pay was now backed implicitly by the Middle Eastern states, Venezuela and a few other states.  They in turn got direct financial access to America's productive capacity because they were now awash in dollars.

Even during the Bretton Woods era, however, there was always a Sterling zone where the dollar did not hold sway, but that was somewhat incidental to your issue.  The reason sterling held its power was that it provided an alternative to the dollar and to gold, permitting people flexibility in their currency choices that a dollar only standard would not permit.

This isn't really a bifurcation question unless you really take Indian institutions back into their basis in the colonial era and why they work the way they do.  It is not a byproduct of colonialism but the failure to reject the political institutions which evolved after colonialism.  It is a failure in political economy to learn from your own mistakes and the mistakes of  others.

Answer 3

This is really a question about exchange rates. That is if you look at how much time an unskilled laborer must work to buy a typical meal in the two countries the difference is far less. As far as I know there is not a good explanation but it is called the Penn effect or the "Balassa-Samuelson effect"