Friday, April 19, 2013

Why Are There Such Large Cost Of Living Differences Around The World?

Why is Switzerland so expensive? Zurich and Geneva are the top two most expensive places in the world. The most obvious reasons are the rents, the high standard of living, and high wages. But why is this the case? There are other factors involved such as restricted competition whereby prices are far higher than the real value of the commodities or services involved. Many trades in Switzerland are protected by corporations or guilds which restrict the number of people allowed to practice their particular trade, and who set high mandatory prices for their services.

Switzerland is fragmented into different cultures and different languages in different geographical areas. In comparison to most countries, people do not like to move and will remain in the same area all their life. Service providers in any given area therefore have small, well-defined mature markets where they know their competitors well. Therefore they tend to set prices high in a relatively "captive" small market. The Swiss economy has traditionally always been organized this way and because many people profit from the system there is resistance to changing to a freer economy. Bargain hunting and price negotiation are not part of Swiss culture. They are accustomed to paying high prices and do not like to question them.

Why is Tokyo no longer the most expensive place in the world? The slight decrease in the relative cost of living in Tokyo (relative to the rest of the world) is not only due to Japanese deflation and the weaker yen but it is also due to rising prices elsewhere in the world.

In terms of currency changes, while the Swiss Franc was 5% weaker against the US Dollar as at 1 April compared to the same time last year, it has been relatively volatile this year, peaking close to its 2012 high at 1.10 USD to the CHF in February and while it was at its lowest of 1.05 USD around 1 April 2013 compared to last year's low of just over 1.01 USD in late July 2012.

The Japanese Yen on the other hand has weakened by more than 20% against the US Dollar since September 2012 when 1 Japanese Yen bought around 0.0128 USD compared to 0.01062 USD around 1 April 2013.

Prices in poor countries are systemically lower than in richer ones. This is based on the assumption that if salary levels are low with high unemployment locally traded goods will be sourced from the lowest cost location. In addition services delivered locally are largely determined by prevalent salary / wage levels. So in a poor country, services such as hairdressing will tend to be cheaper than in a richer developed country where minimum wages are considerably higher. Poor countries tend to use a higher proportion of locally (and usually cheaper) manufactured goods due to high transportation costs to import such goods.

Another feature of lower cost of living / poor countries is a large informal sector with little price regulation. People who do not have jobs and face starvation will most likely move to where they have better prospects. Service providers in any given area therefore have large, informal, highly competitive markets. Therefore they tend to set prices low in order to compete. Bargain hunting and price negotiation are very much a feature in poor countries. They cannot afford to pay high prices and will shop around and bargain until they find the lowest price.

The cost of living rankings are released on a quarterly basis and measure the comparative cost of living in 780 locations across the globe.