The comparison of standards of living

This is still part of my course, International Financial Economics.

Usually, people will look at the country's GDP per capita to compare how poor or how rich that country is. The GDP per capita is usually in US Dollar so we can compare it between countries. As I mentioned before, according to the Balassa-Samuelson Theory, the prices of goods in rich countries are higher than that in poor countries because of the productivity of labor in rich countries is high, then their wages are higher, the production cost becomes higher and the result is the price tends to be more expensive.

Now we want to compare the GDP per capita of Indonesia and the United States. GDP per capita reflects a yearly income of a person in a country on average.
The U.S. GDP per capita in 2007 was $45,800.
Indonesia GDP per capita in 2007 was only $3,400. (source: www.indexmundi.com)
We can say that the U.S. GDP per capita is 13,47 times the GDP per capita of Indonesia.

In the class, we compared the GDP per capita between the U.S. and India which showed the U.S. GDP per capita is 59 times of India.
"Does this reflect the actual difference in standard of living between the two countries?" my professor asked us in the class, then suddenly I answered him instantaneously, "NO!".
He asked why, I replied, "it depends on the cost of living!" (actually, it was the first and maybe the last time I could think logically).
He said,"Exactly!" that made me flying to the ceiling...

I could say so because based on my experience, when I gathered with friends, we ever compared our salary and expenses in our own country. Before I came here, I thought that my scholarship would be more than enough because I just converted it to Rupiah. As time goes by, I realize that the cost of living in Indonesia much much cheaper than that in the U.S.. In Indonesia, you can buy a hamburger in Mc. Donald by 50 cents (or 5,000 Rupiahs), while in the U.S. it costs us $4 to $5. It is almost 10 times! With 50 cents, you can buy a hamburger in Mc. Donald Indonesia, but in the U.S. you need to spend $5 to buy the same thing!

I have a friend who is a rich guy from Tanzania, but in the U.S., he is poor, as poor as me. Oneday, someone asked him how much money that he got in Tanzania (He also got a scholarship from his office). He told that guy, an American guy, that his salary is around $800. That American guy was almost screaming when he said,"WHHAAAAAATTTTTT??? How could you live with that money????"
Of course it will never be enough in the U.S. but in Tanzania, with that amount of money, my friend could buy a fancy house with many rooms even though he is still single. He only needs one room to take a rest, but because he could make a lot of money in his country, he doesn't know how to waste his money. He could buy luxuries goods or anything he wants to buy. In the U.S., it means nothing.

That is why, you can not just compare the GDP per capita of your country to other country because it is not comparable. Again, it depends on the cost of living!


Urbana,
March 20th, 2009