I searched Google for information about what nations are the cheapest for travelers, and although there is a lot of interest about this topic on blogs and discussion forums, I found no good hard data on the internet. This is a bizarre hole in the world’s collective knowledge (at least as it is revealed by Google) because it is easy to predict what countries are the cheapest to travel in for Americans using readily available data and a bit of economic theory.
In 2008, a Big Mac cost $3.57 in the US and £2.29 in the United Kingdom. Most people assume that the United Kingdom must have been cheap with such low prices.
But if you bought a British pound, each dollar only bought fifty British cents which makes Britain seem very expensive because a tourist exchanging a thousand dollars would only get five hundred pounds.
In reality, both the prices of goods like hamburgers and the exchange rate price of money are required to know if Britain is a cheap place to travel or an expensive place.
What is the Purchasing Power Parity (PPP) exchange rate and how is the Travel Cost Index calculated?
The purchasing power parity (PPP) exchange rate is simply what you get when you divide the prices of goods in one currency by the prices of the exact same goods in another currency. For example, suppose the only good that matters is the price of a hamburger (which is actually used to create the Big Mac PPP index). If an identical hamburger costs $2 in the US and €4 in Paris, then a dollar is worth €4/$2 = 2€/$. That means the purchasing power parity of a dollar is two euros.
By itself, this tells us nothing about how expensive it is to visit Paris because it doesn’t tell how many euros you can actually buy with one dollar. That is the market exchange rate. If the market exchange rate equals the PPP exchange rate, then the cost of travelling in Paris is exactly the same as the cost of travel in the US. When the two exchange rates differ, the percent difference tells you how much cheaper (or more expensive) another country will be.
That fraction produces The Travel Cost Index: the PPP exchange rate divided by the market exchange rate. For example, if the two exchange rates are equal, as in the above example, then 2€/$/2€/$=1 and both countries are equally expensive.
However, if the market exchange rate value of the dollar is more than the PPP exchange rate value, then Paris will be less expensive than America. For example, if one dollar buys 2.22 euros, then 2€/$/2.22€/$=0.90 or ninety percent. This means that France is about 10% cheaper than the US on average and that is what the World Bank data indicated for 2017. Of course, Paris is going to be more expensive than most parts of France, but the same is true of New York City compared with the rest of the USA.
The ratio of prices of a Big Mac in countries around the world gives useful information about what countries are cheap to visit if, like President Trump, you like to eat at McDonalds everywhere you go.
According to the Big Mac cost of travel index, Switzerland costs 18% more than America whereas Qatar costs 40.9% less. But that is just using one price, the price of a Big Mac, to adjust for cost of living in different countries. The World Bank estimates PPP cost of living using an index of hundreds of prices which makes it much more representative of overall costs.
The following World Bank map gives an approximate value of how expensive each nation was in 2017 (Click here for an interactive version):
The table below gives the numerical data underlying the map. The cheapest country in the world in 2017 was Egypt which is right next-door one of the most expensive, Israel. In Egypt, it only took 21 cents to buy a dollar’s worth of goods and services on average. That is like the whole country being on sale, almost 80% off! The very most expensive was Iceland where it took $1.32 to buy what normally costs only $1 in the US. The index says that 49 cents in Mexico buys as much as a dollar in the US which means that Mexico was approximately half price compared to travel in the US.
(Note: The following table is very long, so you can click here to scroll to the end and continue reading.)
|Country Name||2017 Travel Cost Index (World Bank Data)||2018 Travel Cost Index (October OECD Data)|
|Egypt, Arab Rep.||0.21|
|Iran, Islamic Rep.||0.26|
|Bosnia and Herzegovina||0.40|
|Trinidad and Tobago||0.51|
|Congo, Dem. Rep.||0.52|
|United Arab Emirates||0.55|
|Sao Tome and Principe||0.57|
|Central African Republic||0.58|
|Papua New Guinea||0.61|
|St. Vincent and the Grenadines||0.61|
|St. Kitts and Nevis||0.63|
|West Bank and Gaza||0.63|
|Antigua and Barbuda||0.64|
|Macao SAR, China||0.70|
|Hong Kong SAR, China||0.75|
|Micronesia, Fed. Sts.||0.88|
What are flaws in the Travel Cost Index?
The Travel Cost Index is only an approximate estimate of relative price levels because, first of all, PPP doesn’t just focus on the kinds of things that tourists buy. It measures a much broader ‘basket’ of all goods and services, some of which, like “200 types of equipment goods and about 15 construction projects” are completely irrelevant to tourists whereas a lot of the things that are important to tourists like tour packages are probably not measured in the PPP index at all. The PPP index only includes 3,000 consumer goods and services are included, so it leaves out a lot of things, and the kinds of things tourists buy are poorly represented.
Some countries are going to be cheaper than the Travel Cost Index indicates because some places like Thailand have an extremely efficient tourism infrastructure which brings down prices for tourism-related purchases and other countries like Iraq (probably) have not developed efficient infrastructure and achieved economies of scale for handling visitors from around the world. Similarly, some regions in every country have cheaper prices for travelers than others and if you are in an expensive region, like New York City in the US, you’ll need a very different budget than you would need in a cheap region, like West Virginia. Because the PPP index shows average prices, that means that the prices in rural areas is going to typically be lower than the PPP index (at least for the kind of purchases that rural people routinely buy), and costs in large cities are typically going to be higher.
Secondly, no traveler can get the published market exchange rate because of foreign exchange transactions costs that usually average about 3% , so every country should be about 3% more expensive on average than the Travel Cost Index shows.
Thirdly, the Travel Cost Index uses World Bank Data which is over a year out of date. This is one reason it doesn’t agree with the newer OECD data, but I’m not sure what accounts for the rest of the discrepancy. This is obviously not an exact science as explained above. In any case, the index can be made more accurate by updating it with newer price information.
PPP update formula
To update old PPP data, just get the increases in inflation, and the change in exchange rates since the old PPP data was calculated. This is how real exchange rates are calculated although most of the “real exchange rates” merely use the market exchange rate of an arbitrary year as baseline and it is more accurate to use PPP as a baseline.
Then calculate how much the foreign exchange rate has changed (in percentage) and subtract it from how much higher their inflation rate has been compared to the US rate over the same time period. For example, if the foreign inflation rate has averaged 10% over the past year and the US inflation rate has been 2%, that means that their prices have gone up 8 percentage points more than in the US. Then if their exchange rate (the value of their currency per dollar) has gone up 5%, the net change in prices is 3%, meaning that their country is 3% more expensive than it was a year ago.
10% – 2% – 5% = 3%
10% = How much their prices rose
2% = How much American prices rose
5% = How much the exchange rate value of the dollar rose
This is how PPP is updated by professional economists most of the time. Because it is expensive to gather actual PPP prices in every nation in the world, and because we have inflation data which gives similar information, the baseline PPP data is ordinarily just updated with this formula.
Vox created a “Vacation Index” which merely used this calculation to show how much cheaper each country got over the prior year instead of using the PPP measurements as a baseline. That produces an interesting index as shown for May 2016 (below), but any change in the past twelve months is usually going to be very small relative to the Travel Cost Index, although it is somewhat significant in rare examples like when countries suffer a major currency devaluation such as in Argentina and Russia at the top of the graph.
The Vox index in the graph just shows how much the Travel Cost Index changed over the past year in different countries. This is a poor measure of overall travel costs because it ignores the PPP baseline. For example, it shows the United Kingdom as being particularly cheap and Turkey as being quite expensive when the reality is just the opposite. This chart merely shows that the United Kingdom had gotten 3% cheaper than it had been the previous year and Turkey had just gotten 4% more expensive than it had been the previous year, but the UK started out a lot more expensive than Turkey (and it has been more expensive for at least a century) so the relatively small changes over the prior year weren’t significant relative to the baseline PPP. Despite falling prices in the UK and rising prices in Turkey, the UK still remained almost twice as expensive as Turkey overall according to World Bank data in the map and table above.
Of course, the index in my table is also imperfect for the reasons mentioned above, but it is the most comprehensive there is and the editors at VOX must have determined that their index isn’t very useful because they abandoned it and haven’t continued to update it with new data.
Now is a good time for Americans to travel
Most countries look relatively cheap compared with America right now because the US dollar is particularly high right now. The multilateral, real, trade-weighted value of the dollar has not been this high in about 15 years.
I don’t put much faith in the Big Mac Index, but it also shows that the US dollar is particularly strong now.
This graph shows the value of foreign currencies in dollars which is the inverse of the value of the dollar, so a falling line here means the the foreign currencies are falling which means that the US dollar is doing the opposite–it is rising.
If you want to get even more wonkish…
Another way to present this kind of data graphically can be seen on the following Gapminder graph which shows market exchange rate incomes on the vertical axis versus the PPP incomes on the horizontal axis. (Click on the link to see more detail.)
The black line shows approximately where PPP is equal to exchange rates and nations below the line are relatively cheap whereas nations above the line are relatively expensive. Poorer nations (on the left side) tend to be cheaper overall than richer nations (on the right) mainly because labor is so much cheaper in poor nations. Saudi Arabia and most of the oil exporters are the red outliers on the right side of the graph which are relatively cheap relative to the other countries that are nearby on the graph and the little red island nations which are outliers just to the left of the middle of the graph are relatively expensive compared with other circles nearby although only one of them is actually above the line.
Purchasing Power Parity (PPP) would be the same as market exchange rates if there were perfect competition and the law of one price were true. In reality, most production is non-tradeable. The biggest part of every economy are things that are too expensive to be shipped abroad like real estate and services like hair cuts and taxi rides so they are completely non-tradeable. Goods and services that are not tradeable are not subject to arbitrage and so the law of one price does not apply. This is why developing countries usually have travel costs that are between 1/4 to 1/2 the expense of developed countries mainly because services (labor) is so much cheaper in poor countries.
Generally tourists buy a lot of labor in hotels, restaurants, taxis, etc., and because wages are way lower in poor countries, services tend to be much cheaper.
For tradeable goods, the law of one price should apply in the long run in theory, but that theory doesn’t work very well in the short run mainly due to the massive scale of financial flows which largely determines spot exchange rates and which have little to do with long-run fundamentals.
According to the Bank for International Settlements, the foreign exchange market is by far the biggest market in the world in volume.
The massive flows in foreign exchange speculation results in market exchange rates that can fluctuate much more wildly than any changes in the prices of tradable goods, GDP, or anything else in the real economy. Large speculative movements in market exchange rates can persist for years.
Although tradable goods like Ipads should be close to the same price everywhere, even they can sell for radically different prices around the world. According to the Ipad index, the price varied in 2013 from $473 in Malaysia, to over $1,000 in Argentina. This is due to differences in transactions costs such as:
- Taxation (particularly tariffs). This is usually what explains most of the highest prices.
- Retail industry efficiency. The USA has one of the most efficient retail industries in the world which helps keep retail prices lower in the US than in many other countries.
- Transportation costs & information costs. Transportation is insignificant for an Ipad, but more important for heavy or bulky goods and if international traders don’t have information about potential arbitrage, they won’t be able to drive down price differentials.
- Regulations that enable multinational price discrimination schemes like the bans on importing pharmaceuticals into the US at Canadian prices or intellectual property rights which ban the sale of DVD movies intended for Asia in the US market or the importation into the US of textbooks intended for Africa.
- “Sticky prices”. Because market exchange rates fluctuate much more than other prices, an Ipad could be imported at $500 and sit on a shelf with a constant price while the exchange rate doubles which would dramatically change the deal for foreign tourists.