Penn Effect - The International Development Implications

The International Development Implications

The PPP-deviation allows rural Indians to survive on an income below the absolute subsistence level in the rich world. If the money income levels are taken as given, then ceteris paribus, the Penn effect is a very good thing. If it did not apply, millions of the world's poorest people would find that their income was below the survival threshold. However, the effect implies that the money income level disparity as measured by international exchange rates is an illusion, because these exchange rates only apply to traded goods, a small proportion of consumption.

If the genuine income differential (taking local prices into account) is exaggerated by the RER, so the real difference in the standard of living between rich and poor countries is less than GDP per capita figures would suggest. To make a more significant comparison, economists divide a country's average income by its consumer price index.