# Does the exchange rate between 2 currencies NOT account for the cost of living (COL) in their respective countries? [closed]

Alice and Bob both live in a country that has a very low cost of living (like India). They are entry-level software engineers straight out of college. Alice works remotely for a US company that pays, say 75k\$ per year (average figure). After converting to her local currency, the monthly salary comes out to be ~ 57 lakhs rupees per year. Bob works for a local company in his country and his earning is 6 lakhs per year (again, average). So my questions are:

1. Why isn't the dollar-rupee exchange rate such that Alice makes about the same as Bob does? After all, they have an equal skill level and contribute equally.

(IMO Alice has an unfair advantage just because she works for a US company. 57 lakhs would be an impossible salary for a fresher in India straight out of college, yet Alice gets it. For her, she enjoys a low cost of living while having a high conversion rate of the rupee from the US dollar.)

1. If Alice's employer were to make some kind of adjustment in her salary to account for the lower COL such that after converting to rupee, Alice makes the same as Bob (6 LPA), isn't the employer getting away by actually having a lot of savings? If her employer were to hire Charlie, a US citizen instead of Alice, they would have to pay him way more than Alice. The question here is why isn't the exchange rate such that Alice's employer pays what they would to a US citizen (75k) and at the same time Alice gets about the same as Bob?
2. This is more like asking the converse question: if Bob wants to avail a remote service from the US (say tutoring), isn't it too expensive for him, since he is earning according to the COL in India? Why isn't the exchange rate such that the tutoring fees are affordable to Bob and at the same time Bob's tutor gets what they would if they were to tutor a US citizen.

I have very little knowledge of economics and I ask this question more like an outsider. From this outsider POV, it seems the exchange rates should automatically fix this, but in reality, they don't. Something doesn't add up. I am not talking about unfairness in particular, but I would expect that equal work and skill would pay almost equally. The difference between 57 and 6 is really huge. So, does the exchange rate not account for the cost of living?

• There's an advantage for sure. The exchange rates won't make this even out. If I earn 75k USD and live in the US, I pay for the cost of living in the US. If I earn 75k USD and live in India, I pay the cost of living in India. The currency I'm paid in and exchanging it is irrelevant (except for minor exchange rate fees). Aug 2, 2021 at 22:08
• If the work and skills are really the same between the two, the situation you describe doesn't really arise, if both Alice and Bob work in countries, remotely or not, in countries with similar costs of living (and average wages). For example if an US expat in India earns that much more, it's because they are NOT doing the same work and have not the same skill. Otherwise, the US company would be happy to pay lower wages.
– BrsG
Aug 3, 2021 at 11:34

does the exchange rate not account for the cost of living?

Yes it does, but only indirectly and among other superseding factors that reflect better the particularities of each economy. Forcing the COL to be an artificially greater driving factor in determining an exchange rate would cause severe distortions and inefficiencies to the markets.

Why isn't the dollar-rupee exchange rate such that Alice makes about the same as Bob does?

Because Alice and Bob are not the only workers in these two economies, nor does their labor comprise the bulk of trading going on in a domestic economy, let alone in international markets. There are millions of additional economic agents worldwide whose decisions in the aggregate determine the exchange rates between any two currencies.

it seems the exchange rates should automatically fix this, but in reality, they don't.

Exchange rates are not supposed to force uniformity in the purchase power parity of agents from one same location. It would be unrealistic to expect or intend that exchange rates lead to that outcome.

Bob's lower purchase power should prompt him to withdraw from the Indian labor market and switch to one he believes would be more profitable. Whether or not his bargaining power accomplishes his purpose is a different story, but his permanence in the Indian labor market suggests he is not much interested in a change. Although exchange rates and COL might prompt an economic agent to rethink his preferences and choices, exchange rates are not for "curing" an agent's indifference.

Currency exchange rates are based on exactly one thing*: how much someone wants to pay for the money.

If lots of people in India want dollars but not many people in the USA want rupees, then dollars are worth more than rupees. That's just how it is. This can be changed if people from the USA buy more stuff from India, for example through tourism or remote work. Then, they will buy more rupees so they can spend them in India.

It seems that people want dollars a lot more than they want rupees. Essentially, if someone has rupees and wants dollars, the person with the dollars is like "I don't want your rupees, but if you give me a whole bunch, I guess I'll take them. Maybe I can use them for something." And if someone has dollars and wants rupees, the person with the rupees is like "Yes, please, give me your dollars, I need dollars!"

Why this is, exactly, I can't tell you. There are probably many different reasons and nobody knows for sure.

* Sometimes governments try to keep them fixed, but the way they do that is by buying and selling opposite to how other people are buying and selling. The fixed rate still has to be based on the amount that people want to have the currency, or else the government runs out of things to sell, or buys way too much stuff it can't use and other people don't get that stuff.

Why isn't the dollar-rupee exchange rate such that Alice makes about the same as Bob does? After all, they have an equal skill level and contribute equally.

(IMO Alice has an unfair advantage just because she works for a US company. 57 lakhs would be an impossible salary for a fresher in India straight out of college, yet Alice gets it. For her, she enjoys a low cost of living while having a high conversion rate of the rupee from the US dollar.)

It just isn't. There is no reason it should be. This is a sad truth about the economy - a lot of luck is involved. If it makes you feel any better, when people in India work remotely for American companies, it makes dollars worth less and rupees worth more, so everyone benefits a little bit.

If Alice's employer were to make some kind of adjustment in her salary to account for the lower COL such that after converting to rupee, Alice makes the same as Bob (6 LPA), isn't the employer getting away by actually having a lot of savings?

Yes. I'm not sure why the employer hasn't done this. Perhaps it's because if they did, they'd be underpaying Alice quite a lot compared to their American employees! Which is legal, but makes them look like assholes, but companies look like assholes to save money all the time so that shouldn't be a problem for them.

If her employer were to hire Charlie, a US citizen instead of Alice, they would have to pay him way more than Alice. The question here is why isn't the exchange rate such that Alice's employer pays what they would to a US citizen (75k) and at the same time Alice gets about the same as Bob?

See the first section.

This is more like asking the converse question: if Bob wants to avail a remote service from the US (say tutoring), isn't it too expensive for him, since he is earning according to the COL in India?

Yes. If it makes you feel any better, when Bob buys tutoring service from America, it makes the problem worse (because he wants more dollars and less rupees). When Bob doesn't buy tutoring service from America and buys it from India instead, he does not make the problem worse.

Why isn't the exchange rate such that the tutoring fees are affordable to Bob and at the same time Bob's tutor gets what they would if they were to tutor a US citizen.

See the first section.