Expatriate pay and floated currency

| 139 Comments

Some good news and some bad news, good news first:

I'm going to Edinburgh and I'll be working for ThruPoint. Still. My resignation was refused. This is a good thing.

The bad news is that it will take longer for me to get there than I had originally thought, perhaps as long as a month.

Now on to the meat of the discussion.

How to attract and compensate expatriate talent has become a topic of increased concern as local companies develop a global reach or as global companies develop a local touch. There are a wide variety of opinions about whether or not to compete globally and how to do so; a large number of companies feel that their managers must have some overseas experience in order to become executives in a global company.

There are many questions to be answered when attracting overseas talent or relocating personnel. Of chief concern to the individual being relocated is compensation. Constructing a compensation package that everyone can live with is difficult enough - constructing one that incents the employee, meets the budget constraints of your company's bottom line as well as your personnel goals can be monumental.

To that end, I'm going to explain a single tool that can be used to assist in calculating an equitable equivalent salary between countries using a tried and tested method of performing currency arbitrage: purchasing power parity.

Purchasing power parity is a way of measuring the difference in purchasing power between two countries after accounting for the exchange rate. A brief example might help to illustrate:

An Apple iPod, a popular music player, sells for $299US in the United States at an Apple outlet. It sells for 248 in the UK. The exchange rate between these two coutnries is $1.83 to 1. To purchase an iPod in the UK using US dollars, you would need $453.84. The ratio of these prices is the purchasing power parity for the market in iPods. This number is 1.52. It implies that Americans have one and a half times the iPod purchasing power of Scots.

The HR director of your firm isn't concerned with the purchasing power parity for iPods, of course, but instead will want to look at a more representative index. The best known purchasing power parity index is the Big Mac index. The Big Mac is a standard product available nearly everywhere. Since McDonald's supply chain management is standardized, the price of a Big Mac includes the cost of using local infrastructure, securing local labor, fighting local bureaucracy and a host of other costs that will affect an employee who moves to the area. The Economist maintains the Big Mac index and it can be found at The Economist website. It happens to be one of the most accurate measures of purchasing power parity (PPP) around.

In order to apply PPP practically to salaries of expatriates, use this formula:

1. Find the exchange rate from the home country to the new country.
2. Calculate the difference in purchasing power parity.
3. Apply the difference in purchasing power parity to the exchange rate.
4. Use the resulting number as a multiple for the initial salary.

Here's an example:

Frieda works in the U.S. and wants to work in London. What sort of salary should she look for to enjoy the same standard of living, before taking tax into account?

First, her existing salary is $100,000.

Second, the exchange rate between the countries is 1.83.

Third, the PPP between the U.K. and U.S. is 1.23. In other words, a dollar of U.S. salary only buys 1/1.23 of a dollar of stuff in London, or about 81 cents. So she'll need a salary of $123,000, which is 67,213.

Frieda will have to take other things into account - she won't need health insurance, but British taxes will take an additional 17% bite out of her wages, for example.

What if the PPP is the same? Just use the exchange rate. Here's another example:

Bob works in the United States as an executive with a large firm. The large firm decides that he needs some experience managing a manufacturing unit in South Korea. He's open to the idea, so they work out a compensation package.

Let's say that Bob makes $248,000 in the U.S. The exchange rate from the $US to KRW (South Korean Won) is 1,201.10. The best source for this information can be found at Oanda. The Big Mac PPP between the two countries is 1; 1,201.10KRW buys $1US worth of goods in South Korea, the same as it does in Peoria, Illinois.

While there are almost certainly other concerns for the HR Director responsible for setting Bob's salary, a good baseline for ensuring that he enjoys the same standard of living in South Korea that he did in the U.S. will be 298million KRW.

Purchasing power parity provides a method of finding a baseline salary to maintain standard of living, all other things being equal. It should not be used as a golden formula that provides all answers, since other things are almost never equal.

Frieda may be able to walk to work, and thus not need a car. Bob may require extensive language training.

What purchasing power parity will do, however, is provide the starting value in a more extended calculation that HR managers can use to construct an equitable compensation plan.

-Nathan Dornbrook

139 Comments

The brand new Ipod nano seems awesome! And $149 for an 8 GB is pretty damn good. Look at the size of it! But I might go for an Ipod Touch to enjoy all the additional Iphone 4 functions.

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The Zune concentrates on being a Portable Media Player. Not a web browser. Not a game machine. Maybe in the future it'll do even better in those areas, but for now it's a fantastic way to organize and listen to your music and videos, and is without peer in that regard. The iPod's strengths are its web browsing and apps. If those sound more compelling, perhaps it is your best choice.

The new Zune browser is surprisingly good, but not as good as the iPod's. It works well, but isn't as fast as Safari, and has a clunkier interface. If you occasionally plan on using the web browser that's not an issue, but if you're planning to browse the web alot from your PMP then the iPod's larger screen and better browser may be important.

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Hands down, Apple's app store wins by a mile. It's a huge selection of all sorts of apps vs a rather sad selection of a handful for Zune. Microsoft has plans, especially in the realm of games, but I'm not sure I'd want to bet on the future if this aspect is important to you. The iPod is a much better choice in that case.

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