Senior fellow Charles Kenny discusses the "Big Mac Theory of Development" in his latest piece for Bloomberg Businessweek, citing work by CGD senior fellow Michael Clemens.
From the article:
It’s a question richer people have about their poorer neighbors: Why are they poor? Is it circumstances, or is it some kind of moral or intellectual failing? Is it that they never had a chance to cross from the wrong side to the right side of the tracks, or that they never had the motivation to cross? The subject colors thinking about international development as well. Is poverty in Africa and Asia the result of something about individual Kenyans or Pakistanis, or is it instead something about Kenya or Pakistan? Is it about the people, or the place?
A new paper by Princeton Economist Orley Ashenfelter for the National Bureau of Economic Research sheds some light on this debate. It compares the wages earned by staff working at McDonald’s (MCD) franchises around the world. Ashenfelter studies what McDonald’s employees earn against the cost of a Big Mac in their local franchise. The Big Mac is a standard product, and the way it’s made worldwide is highly standardized. The skill level involved in making it (such as it is) is the same everywhere. And yet, depending on where they live, crew members from all parts of the world earn dramatically different amounts in terms of Big Macs per hour.
In the U.S. a McDonald’s crew member earns an average of $7.22 an hour, and a Big Mac costs an average of $3.04. So the employee earns 2.4 Big Macs per hour. In India a crew member earns 46 cents an hour while the average Big Mac costs just $1.29. Still, the employee earns just one-third of a Big Mac for each hour worked. Same job, same skills—yet Indian workers at McDonald’s earn one-seventh the real hourly wage of a U.S. worker. There’s a huge “place premium” to working in America rather than India.
The place premium is not limited to low-end service jobs. Economist Michael Clemens, a colleague of mine at the Center for Global Development, studied (PDF) a group of Indians working at an India-based international software firm doing the same job on the same projects for the same pay. All of them applied for a temporary work visa to the U.S. but were separated by one fact—some of them won the lottery by which the visas were issued; others lost. The workers—still employed by the same firm and still doing the same type of job on the same projects—suddenly became very different in terms of their pay. The ones who moved to the U.S. started earning double what their colleagues back in India were earning (adjusted for purchasing power). They earned more not because they were different from the colleagues they left behind—selection was random, not based on education, talent, or drive—but because they were in the U.S. rather than India. And once they returned to India they went back to earning pretty much the same as their colleagues who had never left.
Clemens concludes that location alone—the place premium—accounts for three-quarters of the difference in average pay levels between software workers in the U.S. and India. Differences in production technology, education levels, and levels of effort account for, at most, one-quarter of the difference in earnings between the two groups.
Why do people in the U.S. earn so much more doing the exact same jobs as people in India? One reason is infrastructure: physical infrastructure such as (comparatively) good road and electricity networks, alongside economic infrastructure including a (somewhat) robust banking system. Institutions such as a (passable) set of commercial laws and (not completely capricious) regulatory regimes are another factor. The higher quality of these public goods allows the same amount of effort by the same quality employee to create considerably more value in the U.S. than in India.
So the overwhelming explanation for who is rich and who is poor on a global scale isn’t about who you are; it’s about where you are. The same applies to quality-of-life measures from health to education. And that suggests something about international development efforts: If there’s one simple answer to the challenge of global poverty, it isn’t more aid or removing trade and investment barriers (though those can all help). It’s removing barriers to migration. Harvard economist Lant Pritchett estimates that increasing the labor force of the OECD club of rich countries by just 3 percent through migration from the rest of the world would benefit people in poor countries to the tune of $305 billion a year. Compare that with an $86 billion annual payoff from the removal of all remaining trade barriers or the $125 billion the rich world already spends on aid to developing countries. The fastest and most foolproof way to make poor people in poor countries richer and healthier is to let them move to a rich country.
Of course, there’s the concern that if rich countries are flooded with poor people, those countries will just become poor, too. But that’s based on a misunderstanding of what makes rich countries rich. It isn’t scarce labor that makes Americans wealthy. It’s those better-functioning institutions and networks which allow people with the same skills to get paid so much more here than in India. That’s why the evidence suggests even unskilled immigration to the U.S. actually increases overall domestic wages and employment—to say nothing of skilled immigration, where the benefits are even greater.
Unfortunately, politicians don’t seem to care about whether people born on the wrong side of the tracks have the motivation to cross over, or how much the planet benefits when they do. Instead we’ve erected a huge electrified fence to keep people out. The evidence on the place premium suggests immigration restrictions are probably the greatest preventable cause of global suffering known to man.
Read it here.