Any global mobility professional will agree that one of the most crucial steps in the preparation of a home-based salary package for a long-term international assignment is the protection of the employee’s home spending power while they are in post. It ensures that employees are no worse off (nor better off) while in a host location than they would be if they had remained at home. The difference in spending power between countries is measured with cost of living indices.
What is a cost of living index?
A cost of living index is a comparison of living costs between the assignee’s home location and the one of assignment. For example, an index of 130 means that the host location is 30% more expensive than the home location, whereas an index of 80 means that the host location is 20% less expensive. An index of 100 indicates cost of living parity.
Calculating ECA’s cost of living indices
In order to calculate cost of living indices, prices are collected for a basket of over 160 key everyday goods and services across more than 480 locations globally. ECA takes a multi-source approach to collecting these prices which enables us to cross-reference for consistency and check for bias, while also ensuring greater statistical reliability.
Average prices in the home location are compared to prices of the same items in the host location, via a common currency, which allows us to calculate an index for each item: host price ÷ home price x 100.
Each item is then given a weight that reflects its relative importance in the home consumption pattern. For example, food items are given a higher weighting than leisure items, because generally households spend a larger proportion of their income on the former.
Weighted averages of item indices are produced based on home country or international average consumption patterns. This then allows us to calculate an overall index.
The impact of weights
The weights are derived using data from household expenditure surveys published by national government statistical bodies. This enables us to reflect geographic variations in consumption patterns, which are significant. For example, spending on rice makes up a higher proportion of expenditure for a household in Thailand than for a household in Belgium. Meanwhile, spending on meals out makes up a significantly larger portion of expenditure for a household in Hong Kong relative to a household in Germany.
ECA offers a choice of three index types. The Standard home-based index type and the Cost-effective home-based index type both reflect the consumption pattern of the assignee’s home country, the assumption being that the assignee will continue their home spending pattern while on assignment. The Cost-effective international index type, however, is based on international average consumption patterns, and may be appropriate for an assignee who does not have strong ties to the home location.
Exchange rates
ECA quotes the exchange rate used to compare home and host prices with every index, and some companies like to use these rates in their calculations. Others favour applying their own exchange rates, and these can be easily applied to ECA’s cost of living indices. Regardless of preference, what is important to remember is that, when running a salary calculation, the exchange rate used should be the same as that used for the cost of living index.
How are cost of living indices used?
A cost of living index is applied to a portion of the assignee’s home salary, usually their home spendable – that is, the portion of the assignee’s net salary spent on day-to-day goods and services (as opposed to housing or savings commitments).
For example, an index of 130 means that the home spendable should be multiplied by 130/100. In other words, the home spendable needs to be topped up by 30% in order to protect the assignee’s home spending power while on assignment. After the home spendable has been adjusted for cost of living it is referred to as the host spendable.
The difference between the home spendable and the host spendable is typically known as the COLA, i.e. the cost of living adjustment.
FIND OUT MORE
ECA’s Cost of Living Survey measures the cost of a wide range of goods and services used by expatriates in 489 locations around the world. Find out more about how ECA's cost of living data can help you, or take a look at our full range of services.
ECA’s Consultancy team can assist in benchmarking, critiquing and writing policies, so that companies can ensure they are both competitive with market practice and aligned to business objectives.
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