Starbucks Index: What it is, How it Works, Criticisms

What Is the Starbucks Index?

The 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.

The purpose of the Starbucks index 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.

How the Starbucks Index Works

The Starbucks index was first created in 2004 by The Economist, a global publication, which offers a printed issue every week and articles online.

The Starbucks index provides insight into what currency exchange rates should be based on the price of a tall latte. It does so by comparing the price in multiple 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.

In other words, the 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. According to the index, the Chinese renminbi would be considered overvalued compared to the U.S. dollar, while the Thai baht undervalued.

Purchasing Power Parity (PPP)

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, which occurs when the currencies are at par when a basket of goods is priced the same in both countries, taking the exchange rates between the two currencies into account.

Relative purchase power parity (RPPP) may be a more accurate metric. RPPP considers the difference between two countries' inflation rates—or the pace of rising prices—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.

Starbucks Index vs. Other Indexes

Indexes using other products, such as the Big Mac, and similar Starbucks indexes, using the price of a tall latte, have been created to measure the purchasing power between the U.S. and other countries.

The Wall Street Journal's Latte Index

The Wall Street Journal compared prices in U.S. dollars in more than a dozen major cities worldwide with its own latte index based on prices at Starbucks locations. According to its last publication in 2018, the WSJ found that a latte cost $3.45 in New York City, $4.24 in Singapore, and $5.76 in Zurich, Switzerland.

The Finder's Latte Index

Online publication Finder also has a Starbucks index, which calculates latte prices in U.S. dollars in 76 different countries. The most recent index was published in 2019. According to the findings, a Starbucks tall latte in New York City was the 16th most expensive.

Listed below are examples of the latte costs in U.S. dollars:

• Denmark: $6.05
• Singapore: $4.50
• The United States: $4.30
• United Kingdom: $3.58
• Canada: $3.15
• Brazil $2.43

The study adjusted for the cost of labor and taxes. Northern Europe and Asia were two of the most expensive regions.

The Big Mac Index

The Starbucks index is based on the Big Mac Index, which The Economist also started, described as "a lighthearted guide to whether currencies are at their 'correct' level."

The Big Mac Index—or Big Mac PPP—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 latte index, replacing the basket of goods with the Big Mac. Although the cost of a basket of goods will vary when comparing the U.S. versus another country, the Big Mac is usually the same price in each country.

For example, in June of 2021, The Economist reported that the Big Mac cost 3.49 British pounds in Britain, while in the United States, it cost $5.65, which implied an exchange rate of .62 (3.49/$5.65). In other words, the index indicated an exchange rate of .62 British pence for one U.S. dollar. However, the actual exchange rate was .73 British pence per dollar, and when taking the difference, it suggested the British pound was 15% undervalued versus the U.S. dollar.

Criticism of the Starbucks Index

Applying the comparison or product prices globally as a viable measure of purchasing power can be challenging. The indexes don't factor in several variables when comparing currencies, including differences in product quality, consumer attitudes, and economic conditions in each country.

Although the product inputs and the way they're manufactured and distributed is uniform across all countries, both the Starbucks and Big Mac indexes fail to consider 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 restaurant
• Raw material costs, including the costs to build the store and the various ingredients if sourced locally
• Costs to import and acquire any necessary input goods, such as machinery and equipment

These factors may sway the price of the Starbucks latte or Big Mac, throwing off the ratio relative to the cost of the U.S. version of the product.