Big Mac Index-type readings shouldn't mislead Europe

In a recent series of Substack posts, Nobel laureate economist Paul Krugman made a counterintuitive argument to support the view that Europe is not suffering any productivity decline relative to the US.

- PHILIPPE AGHION & ANTONIN BERGEAUD

Instead, Krugman argues that Europe’s output per hour relative to America’s has stayed roughly flat for 25 years if we use current purchasing power parity (PPP).

Krugman’s argument lends support to all those who claim that no major change in European growth and innovation policy is required. The problem is that current PPP is being wrongly used to make that case.

PPP is useful for comparing purchasing power across countries at a specific point in time. But a sequence of current-PPP comparisons is not automatically a measure of real growth, because the prices used to value output change from year to year.

Since 1986, The Economist has published its ‘Big Mac’ index, which records the price of a McDonald’s Big Mac hamburger in every country and uses this data to ask whether currencies are expensive or cheap. A PPP is a form of exchange rate, built from the prices of actual goods rather than from financial markets. It is a comparison across space, frozen at one moment. The Big Mac example works because the product is unusually standardized.