Why is a Big Mac in Brazil so expensive?

RIO DE JANEIRO, Brazil – Seven years ago, a Big Mac in Brazil cost less than $1.50. Try buying McDonald’s signature burger here today, and you need the equivalent of a $5 bill.

To figure out why, look no further than the Brazilian real’s worrisome surge against the dollar. The investment bank Goldman Sachs last year ranked it among the world’s “most overvalued” currencies, and it has kept rising since — gaining nearly thirty percent in 18 months. At the same time, the real has steadily climbed in the Economist magazine’s yearly inventory of world currency prices known, seriously, as the Big Mac Index.

Because the burger takes similar effort and materials to produce anywhere, the Index helps illustrate how far a given country’s currency has strayed from its fair value. In Brazil, Big Mac prices rose from $1.48 in 2003 to $4.91 this year.

(U.S. Big Macs cost $3.73 on average in 2010).

But pinpointing the reasons behind the change — and whether it signals strength or weakness in Brazil’s economy — is more difficult. Analysts say some relatively straightforward financial factors are at work, but there’s a chance that a complex disease, oil deposits and a certain kind of curse are part of the story, too.

On the bright side, Brazil’s currency is getting more expensive because it’s in high demand. Foreign investors need to swap their cash for Brazilian reals before doing business here and they’re scrambling to do so.

Tony Volpon, an economist and Latin America specialist at Nomura Securities in New York, said investors like Brazil because its markets are open and the potential returns are high. Brazil’s central bank has set the country’s benchmark interest rate at around 10 percent. Compare that to rates hovering below one percent for U.S. Treasury bills, and Brazil’s charms become easy to see.

Brazil has the World Cup to host in 2014, the Olympics two years later, and it recently discovered one of the planet’s largest remaining reserves of off-shore oil. There’s a lot to build and plenty of places to invest.

In a bid to slow the flood of foreign cash, the government has placed taxes on some inflows. But it hasn’t worked. “They try to tax one thing but they don’t tax another,” Volpon said. “At the end of the day the money ends up coming in anyway.”

That flow of money – along with Brazil’s heavy exportation of commodities like iron ore, soybeans and oil – has led some observers to conclude Brazil has come down with an economic malady called “Dutch Disease.”

The term was coined in the 1970s to describe the paradoxical way a North Sea oil boom had decimated the Dutch economy. In theory, the disease works like this: The discovery of oil draws a surge of foreign money into a country’s economy, both to buy the oil and invest in the oil industry. All this demand for the country’s currency drives up the exchange rate. This in turn means anything the country manufactures and tries to sell abroad – let’s say a pair of shoes for example – is suddenly less competitive.

There’s more to it, but the theory’s bottom line is that a bonanza for a commodity like oil can shrink a country’s manufacturing sector. Economists say this can hurt a country’s prospects for long-term growth – and not just because oil someday runs out.

“Investments, capital and labor will be pulled to the oil sector, which is very narrow and regionalized,” said Philip Hiroshi Ueno, a Brazilian economist at Friedrich Schiller University in Germany.

“To operate an oil platform, I don’t know how many people you need, but it’s much less than a factory,” he said. “So you create a dualism in the economy between the haves and the have-nots. You are an oil guy or you are on the outside.”

Brazil’s biggest oil fields haven’t started producing in earnest, but a surge of foreign money is coming into the country already, not only chasing oil, but other commodities and investments too. Although Brazil’s vast internal market for manufactured goods is likely to cushion the blow, Ueno’s research suggests his country has caught its own version of Dutch Disease.

“I would say we’re in the early stages,” he said.

Signs may already be evident in some of Brazil’s manufacturing sectors. Take, for example, shoes. Annual exports dropped by almost 50 percent between 2005 and 2010, according to Brazilian Association of Shoe Manufacturers, known as Abicalçados.

It remains to be seen what if any further effect the looming oil boom will have. Brazil’s economy is the 8th-largest in the world – ahead of Canada, India and Russia – and industry only accounts for about a quarter of its GDP.

But oil affects more than just the economy. In her 1997 book “The Paradox of Plenty,” Terry Karl argues that a sudden in-rush of oil money often corrupts a government as easily as it drags down an economy.

“Led by governments that seemed incapable of sound economic management or planning, most of the oil-producing nations found their economic performance and their oil and debt dependence worse than in the pre-bonaza years,” she wrote.

Other economists have called such petro-state woes “the resource curse” and some say there’s evidence it’s taking hold in Brazil.

A pair of researchers at the London School of Economics published a study spanning three decades and 5,000 Brazilian municipalities, concluding that, in towns already receiving oil windfalls, much of the money goes missing. Municipal employees end up with bigger houses but other residents don’t seem to. Also, the researchers said, oil significantly increased the chances the mayor or other officials would be accused of corruption, charged with embezzlement or arrested by Federal Police.

“All of these things seem to go up if your municipality gets a lot of oil,” said Guy Michaels, one of the authors. “If Brazil isn’t more careful, then a lot of money, at least a lot of the money that goes to the local level, might get lost along the way.”