The Economist has upgraded to a “gourmet” version of its Big Mac index, and the results are likely to be less satisfying for critics of China’s exchange rate policy.

The magazine has always described the famous burger indicator as a “light-hearted” guide to exchange rate economics, as the theory it is based on has well-known flaws in describing appropriate exchange rate levels.

“It was never intended as a precise gauge of currency misalignment,” the Economist said in an article on Friday. Yet to the magazine’s dismay, “American politicians have even cited the index in their demands for a big appreciation of the Chinese yuan.”

The index is based on the theory of purchasing power parity (PPP), essentially the idea that goods should cost the same in markets around the world no matter what currency they are priced in. Since Big Macs sell for 44% less in China than the U.S., the yuan is therefore figured to be 44% undervalued against the dollar.

But PPP only applies to tradable goods that are easily exchanged across borders, like commodities or electronics. Other, less mobile goods like labor and land may well cost different amounts in different markets, and in particular in developing countries where productivity and wages are much lower. Since labor and land are important inputs into the production of Big Macs, these differential costs feed through into the final cost of the burger.

Hence the new Big Mac index, which adjusts for GDP per capita, and thus takes into account the lower costs in poorer countries. As the magazine notes, China’s average income is one-tenth what it is in the U.S., meaning China’s burgers really ought to be substantially cheaper.

New York Senator and prominent yuan critic Chuck Schumer might want to make sure he’s sitting down before he checks out the Economist’s results, which show that on this basis the yuan is actually overvalued against the dollar by 3%. Against a group of various currencies, the yuan is still figured to be undervalued by 7%. which the Economist says is “hardly grounds for a trade war.”

– Aaron Back. Follow him on Twitter @AaronBack

China’s economy during the past 30 years has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy.

One demographic consequence of the “one child” policy is that China is now one of the most rapidly aging countries in the world.

China has emphasized raising personal income and consumption and introducing new management systems to help increase productivity.

The restructuring of the economy and resulting efficiency gains have contributed to a more than tenfold increase in GDP since 1978.

Technology, labor productivity, and incomes have advanced much more rapidly in industry than in agriculture.

China has acquired some highly sophisticated production facilities through trade and also has built a number of advanced engineering plants capable of manufacturing an increasing range of sophisticated equipment, including nuclear weapons and satellites, but most of its industrial output still comes from relatively ill-equipped factories.

Over the years, large subsidies were built into the price structure, and these subsidies grew substantially in the late 1970s and 1980s.

China now ranks as the fifth largest global investor in outbound direct investment (ODI) with a total volume of $56.5 billion, compared to a ranking of 12th in 2008, the Ministry of Commerce said on Sunday.

But “this is just a beginning.

It also aims to sell more than 15 million of the most fuel-efficient vehicles in the world each year by then.

China’s challenge in the early 21st century will be to balance its highly centralized political system with an increasingly decentralized economic system.

Agriculture is by far the leading occupation, involving over 50% of the population, although extensive rough, high terrain and large arid areas – especially in the west and north – limit cultivation to only about 10% of the land surface.

China is the world’s largest producer of rice and wheat and a major producer of sweet potatoes, sorghum, millet, barley, peanuts, corn, soybeans, and potatoes.

Sheep, cattle, and goats are the most common types of livestock.

Coal is the most abundant mineral (China ranks first in coal production); high-quality, easily mined coal is found throughout the country, but especially in the north and northeast.

There are large deposits of uranium in the northwest, especially in Xinjiang; there are also mines in Jiangxi and Guangdong provs.

Major industrial products are textiles, chemicals, fertilizers, machinery (especially for agriculture), processed foods, iron and steel, building materials, plastics, toys, and electronics.

Other leading ports are rail termini, such as Lüshun (formerly Port Arthur, the port of Dalian), on the South Manchuria RR; and Qingdao, on the line from Jinan.

Continued here:
Chew on This, Yuan Critics: New and Improved Big Mac Index