Big Mac index still shows dislocations

The Economist Big Mac index has been again produced and shows some major dislocations in exchange rates especially for Latin America. This is even after adjusting for GDP per person. The Economist has tried to eliminate some of the bias in the data through taking into account the fact that for a good that cannot be traded across borders. The local labor market will effect prices. Average prices will be cheaper in poor countries than in rich countries because labor costs are lower. Rich countries will have higher productivity and higher wages in traded goods. This productivity will also push up labor costs for non-traded goods. This is the Balassa-Samuelson effect. Hence, burgers should be cheaper in poor countries than in rich countries and thus exchange rates should be below the long-term PPP. PPP adjustments will be bigger for poor countries.

What is amazing is that the Big Mac index has survived for 25 years and still does a reasonable job of identifying over and undervalued currencies.