Estimating Comparable Income Numbers Using Exchange Rates

The simplest way to measure income in a common currency is by using an official exchange rate. Per capita GNI1 in US$ is equal to Per capita GNI in local currency divided by the exchange rate of local currency to US$.

The exchange rates used are annual average market (or official) exchange rates, published monthly by the International Monetary Fund (IMF) in the International Finance Statistics (IFS).

Example;If GNI per capita in local currency is 5.000 pesos, and the exchange rate is 2 pesos per US$, then the GNI per capita would be 2.500 US$.

Is it appropriate to use exchange rates as conversion factors when measuring and comparing income levels per capita?
If there were free trade, stable exchange rates, small transportation costs, and no market imperfections, the use of exchange rates to convert income measures from a national to a common currency would result in comparable estimates across countries. However, market imperfections exist, and it is generally agreed that conversion using exchange rates might be misleading. In theory, changes in exchange rates are caused by changes in relative price-levels between countries. In practice, however, exchange rates are also affected by capital flows, speculation and market intervention by governments or central banks. Thus, what one US$ buys in US does not necessarily correspond with the amount of goods and services that one US$ converted into another currency (using the exchange rate) buys in another country.

Example; A haircut costs 30 US$ in the US. The same haircut (the same service) costs 400 NOK in Norway. The exchange rate is 7,5 NOK per US$. Thus, the price of the haircut in Norway is more than 53 US$.

This means that one US$, or its equivalent NOK, does not buy the same quantity of haircut in the two countries. Thus, this simple example shows that using exchange rates as a conversion factor might be misleading. Using exchange rates to estimate comparable income numbers will in general make countries with a high price level too well off, and countries with a low price level too poor.

1Gross National Income (GNI) is adopted in the System of National Accounts 1993 (93SNA), replacing the term Gross National Product (GNP) which was used in earlier versions of the SNA and World Bank documents.


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