What Is the Starbucks Index?
The term Starbucks Index refers to a measure of purchasing power parity (PPP) that compares the cost of a tall latte in local currency against the U.S. dollar in 16 countries. Its purpose is to show the purchasing power of each national currency represented, which is reflected in the cost of a latte in that country in U.S. dollars.
For instance, a latte that costs significantly less in one country suggests an undervalued currency. The index was created by The Economist in 2004. There are other similar indexes, including the Wall Street Journal's Latte Index and the Big Mac Index, which was also started by The Economist. Online publication Finder also has a Starbucks Index.
- The Starbucks Index is a measure of purchasing power parity comparing the relative prices of a tall latte coffee in 16 different countries.
- PPP states that because of the market for currency exchange rates, the prices of like goods in one country should be equivalent when valued in another country's currency.
- According to the index, a currency is overvalued when a tall latte costs more in U.S. dollars in one country and is undervalued when it costs less in U.S. dollars.
- Originally created by The Economist, other publications also use their own version of the index.
- The index is relatively simple in its approach because it doesn't take certain factors into account, such as economic conditions in each country.
How the Starbucks Index Works
Purchasing power parity is a popular macroeconomic analysis metric used to compare economic productivity and standards of living between countries. It compares different currencies through a basket of goods approach. It implies that two currencies are in equilibrium, known as the currencies being at par, when a basket of goods is priced the same in both countries and taking the exchange rates between the two currencies into account.
Purchase power parity lets you compare pricing between countries with differing currencies, although it's not a perfect measurement metric.
As stated above, the index was first created by The Economist, a global publication printed every week. Like every other major publication, it also has an online presence. It was based on its Big Mac Index, which was described as “a lighthearted guide to whether currencies are at their 'correct' level."
The Starbucks Index provides insight into what currency exchange rates should be based on the price of a tall latte. The Starbucks Index does this by comparing the price in 16 different countries in U.S. dollars. The theory suggests that a tall latte in one country should cost the same in another country once the exchange rate is applied.
This means that two currencies are at par when lattes have the same value in both countries. A currency is considered overvalued if the cost of a latte is more than the price paid by a U.S. consumer in U.S. dollars and undervalued if it costs less. Let's say a tall latte in the U.S. costs $3.50, $4.00 in China, and $1.50 in Thailand. Using this theory, the Chinese renminbi is overvalued compared to the U.S. dollar while the Thai baht is deemed undervalued.
Applying this comparison as a viable measure is often deemed to be challenging. That's because it's very simplistic in its approach, as it doesn't take certain factors into account when comparing currencies. These factors include differences in product quality, consumer attitudes, and economic conditions in each country.
Relative purchase power parity (RPPP) may be a more accurate metric. This measure considers the difference between two countries’ rates of inflation in driving changes in the exchange rate between the two countries over time. RPPP expands on the idea of purchase power parity, and complements the theory of absolute purchase power parity.
The Starbucks Index vs. Other Latte Indexes
There are other, similar indexes that have used the price of a tall Starbucks latte to measure PPP. The Wall Street Journal compared prices in U.S. dollars in more than a dozen major cities across the world with its own latte index based on prices at Starbucks locations. Online publication Finder also has its own Starbucks Index, which calculates latte prices in U.S. dollars in 76 different countries. The last time it published its findings were in 2019.
The Starbucks Index vs. The Big Mac Index
The Starbucks Index is closely related to The Economist's Big Mac Index or the Big Mac PPP. It is used to measure the purchasing power parity between nations using the price of a McDonald's Big Mac as the benchmark.
The Big Mac Index works the same way as the publication's latte index, replacing the basket of goods with the Big Mac. It suggests that exchange rate changes between currencies should affect the price consumers pay for a Big Mac in a particular nation.
Something the index fails to take into consideration is that while the inputs of the Big Mac and the way it is manufactured and distributed is uniform across all countries, there may be differences in the following:
- The costs associated with the labor to staff the stores
- The cost of the storefront
- Additional costs within the franchise license to operate the McDonald's restaurant
- Costs to import and acquire the inputs
These factors may sway the price of the Big Mac and throw off the ratio relative to the cost of the U.S. version.