Musings On Labour Arbitrage and Cost Parity

The indie film that kicked this train of thought off

Last week I visited Montreal for the first time. It was the first time I was leaving the GTA since my arrival last year. The city was beautiful and a breath of fresh air; I absolutely loved it! Reminded me of my childhood in the UK. Prior to the trip, my friend and I watched the indie film Mile End Kicks which is primarily set in the city. One of the earliest shots in the film has the protagonist visit a bagel shop, St-Viateur Bagel.

Similar to the protagonist of the film, my friend and I decided to have a stop at the same bagel shop. I sometimes tend to be sentimental, and it just feels nice to recreate a movie scene. Apparently Montreal bagels are famous and well-liked. It was my first time having a proper bagel that wasn't just store-bought and actually fresh. The store also served it alongside cream cheese among other options.

The Iranian Barbari bread, often topped with sesame seeds

I take my bite, it's really good; but also oddly familiar. Hang on... this tastes and has the same texture as one of my home country's primary fresh breads: the barbari bread! It got me thinking. Something considered banal and even "low-class" food for the working class in Iran is considered a delicacy here. To be fair, bagels and barbari bread aren't quite exactly the same. The form factor of a bagel is better suited to have a one-of much easier, while a barbari bread is quite large and is thus meant to be eaten either in a group of people or across the course of a few days. The smaller size of the bagel also gives it a proportionally higher crust to fluffy interior ratio.

Molecular gastronomy aside, it is remarkable just how similar these two are to each other (which comes as no surprise with how they are consumed: alongside white cheese). So that got me thinking on another matter, which is the extreme price differential between these two. Back when I was in Iran, a single barbari bread at unsubsidized prices was roughly $0.10. A single bagel at St-Viateur Bagel was $1.40. That puts the Montreal-baked bagel at a cost of fourteen times that of an Iranian barbari bread. But wait, the bagel is also significantly smaller than a barbari bread. Factoring in the weight difference the bagel costs approximately 70 times that of a barbari bread.

Is the minute difference in form factor and texture worth 70 times the price? Of course not. Is wheat 70 times more expensive in Canada? While it is more expensive for sure, wheat is traded as a global commodity so whatever difference there is, it can't account for that gap. No, the primary difference is the cost of labour. It's the labour cost that is an order of magnitude higher.

Top Countries by GDP adjusted for PPP in USD

Why is the labour cost higher? Good question. Similar to the difference between the bagel and the barbari, it is not something that can be attributed to a difference in quality. It is simply a product of the difference in cost of living between the two countries. In fact this difference goes down the line in every aspect of the economy. Rent, utilities, public transport, food, even medicine. This difference in purchasing power or cost of living is typically captured by economists in purchasing power parity (or PPP in short).

However, trying to slap a single number across the board is woefully inaccurate. First because purchasing power will drastically differ depending on which goods and services are being compared. A locally produced commodity like bread is going to be a lot more isolated from the global economy, while a fully imported good like an iPhone or laptop is going to have a fixed cost across the world, especially considering how the supply of such goods are so limited and concentrated by a handful of producers (like TSMC) across the world.

All that said, it would still be better than nothing to at least, at the bare minimum, consider PPP when comparing standards of living. Canada's immigration ministry (IRCC or Immigration Refugee Citizenship Canada) for example will look at nominal earnings (i.e. the raw dollar value) of applicants when they want to assess whether or not on a balance of probabilities the quality of life living in Canada is higher than the applicant's home country to then evaluate whether the person might therefore overstay their visa. In practice, this can produce misleading conclusions because nominal salary figures alone often fail to capture differences in purchasing power and local cost structures. You have to consider the difference in purchasing power, there's no way around it.

So how does this work? What goods and services are more detached from the global economy and more localized, and which ones are more singular? Our bagel example here is in fact. This degree of independence (or dependence) can be measured and put on a spectrum.

On one hand we have completely global and therefore singular prices. Crude oil would be a perfect example of that, but so would be semiconductors where the number of suppliers are so few and the demand is so global, that location doesn't really matter beyond transportation costs. On the other hand we have something like labour which is almost completely localized. If you need to hire someone to clean your house, you can only hire locally, and since people need to live (shocker!) where they are, they need to earn in accordance to the cost of living.

Then we can fill in this spectrum from each side. Moving from the completely international side, we can get to commodities that are globally traded, but also have many suppliers therefore creating localized pressure. An example of this, again from our bagel example, would be wheat and most perishable goods and common food produce. Moving from the completely local side we have labour that can be outsourced to a limited extent. Think about work that can be done remotely. Most knowledge workers fall into this camp. Since you don't necessarily need people to be present at a site, but for coordination purposes you'd still want some amount of on-site presence or at least some time zone overlap.

As a recent example, Warhammer 40K Space Marine 2 owes a lot of its financial success to being able to leverage wage arbitrage in lower cost of living countries.

And as such, this is why cheaper cost-of-living hubs currently are winning in the global games industry right now. Arguing that a Chinese engineer or designer in Shenzhen or Shanghai working on a new game is somehow less competent or productive than their counterpart in Los Angeles merely because they earn a fraction of the latter is factually wrong. Wage differences are often mistaken for differences in capability, even when the underlying work quality is comparable. This same pattern of thinking is then applied to newcomers and immigrants moving from less "developed" countries with lower GDPs. Something something Canadian Work Experience where I live. When in reality there is no less value in the skills of the labour coming in; all there is, is a superficially (arguably political in nature) imposed difference in cost of living that results in some countries having industries and people who then have lower revenues and social capital to become well known. It's not a lack of knowledge, or skills, or creativity. It's just circumstances that make things look different on paper.

To round this up: be more aware of purchasing power parity and cost of living differences, and their consequent effects. If you see someone from a geographic background that diverges wildly from the one you're making evaluations in, try to compare equivalents rather than absolutes. And ultimately just be kinder to newcomers and immigrants.

Have a Beautiful Day!