Differences in the cost of living around the world are an eternal issue for International HR, whether it be when sourcing assignees from developing countries, relocating headquarters within a region or expanding into emerging markets. Anna Michielsen takes a closer look.
There was a time when Australia was an appealing destination to live and work not just for its renowned good weather and outdoor lifestyle but also as an affordable option for people from many other countries. While Australians baulked at the cost of a meal or coffee in international cities such as London, many visitors were able to enjoy these things relatively cheaply in Australia. Together with significant tax concessions available for living away from home, it is not surprising that Australian employers found it relatively easy to attract overseas talent.
Today, Sydney is the 16th* most expensive city in our global ranking of cost of living for international assignees: more expensive than New York, London or Hong Kong. While just three years ago, no Australian city featured in the top 60, now all cities surveyed rank in the world's top 30 most expensive locations. Sydney is followed by Canberra (18th), Adelaide (21st), Melbourne (24th), Perth (25th), Darwin (27th) and Brisbane (28th).
Furthermore, the ending of Living Away from Home (LAHFA) concessions in 2012 has meant prospective employees from overseas need to be much more aware of Australia’s cost of living relative to what they have been used to. While Australia has relatively high gross salaries on an international comparison basis, relatively high tax rates and cost of living erode the purchasing power of these salaries.
International assignments and cost of living
In an environment of intense competition for suitably skilled staff, companies must be able to offer a remuneration package that is competitive when recruiting from an increasingly global talent pool. Whether international mobility is required by a company or seen as desirable by the employee, a concern can be the differing levels in living costs between the country the employee is in (the home country) and the one to which they are potentially relocating (the host country). There are many different ways in which an expatriate salary package can be calculated. However, the ‘build-up’ (or balance-sheet approach) is the most common. It involves a series of adjustments - of which cost of living is one - to the home salary that would be paid to the assignee if they were doing the job at home.
A cost of living index enables the adjustment to be made. It provides a comparison of living costs between the expatriate's home or base location and the location of assignment, based on a basket of goods and services of comparable quality. Being able to make comparisons is necessary so that the company can understand the potential mark-up, or down, against salaries in the home country. At the same time, this can enable the employee to see that the standard of living they have in the home country would at least be maintained whilst on assignment.
Cost of living indices are usually applied to a defined proportion of the home net salary, often the proportion deemed ‘spendable’ – i.e. the amount usually spent on day-to-day living as opposed to housing, savings or pensions. Different types of index may be used by companies to reflect different shopping habits and expenditure patterns. This gives the company flexibility with regards to the cost of the assignment as well as enabling them to better reflect the assignee’s lifestyle and ability to shop cost effectively, or not, in a new location.
What influences cost of living for international assignees?
Inflation and exchange rates are the primary economic factors affecting foreign assignees’ purchasing power. The stronger the home currency, the more it buys overseas. If the home currency begins to weaken against the host currency, it will buy less overseas. If, over a period of time, the home currency continues to fall in value against the host currency, the purchasing power deteriorates, making the host location more and more expensive. The varying fortunes of currencies remain in the news, driven by whether the currency is seen as a safe haven, the country is an oil producer or commodity rich, or the strengthening of the currency needs to be restrained to protect exports.
Like currency values, prices change over time as a result of short and long-term impacts. Think of a cyclone’s short-term impact on banana prices in one country or region or the longer-term decreases in the prices of electronic goods with technological innovation and mass production.
What happens at home still matters
A common issue international HR have to deal with is assignees asking why their cost of living allowance has not gone up or has even gone down, despite the fact that inflation in the country of assignment is high. There are several reasons why this might be. Often when on assignment, people fail to take into account the inflation back in their home location and therefore expect the index to be affected simply by the level of inflation they’re witnessing on a day to day basis in the host. This is not the case, as cost of living indices reflect the differential in prices between home and host and therefore are affected by the changes in both.
The other major factor people fail to take into account is the way exchange rates have moved between reviews. Even if home inflation is low and host inflation is high, if the host currency has depreciated in value then the index is not going to increase by as much as the assignee is expecting. This is because they essentially have more host currency per unit of home currency so they do not need as much of an uplift.
Monitoring cost of living movements
The often volatile movements of both inflation and exchange rates can upset even the most thorough planning by international HR managers trying to safeguard assignees from excessive changes in cost of living. Unfortunately, volatility has become almost the norm in recent times and IHR have to keep a close eye on movements to ensure the purchasing power of their assignees is maintained successfully. Findings from ECA’s Expatriate Salary Management Survey shows that 44% of companies that monitor exchange rates between annual reviews make an adjustment if the rate has changed by more than 10% since the previous update. Just over a third cited a 5% change as the trigger. In terms of inflation, an unscheduled pay review is likely to be made if the current annual rate exceeds 10% to 25%. As always, adherence to policy and procedures as well as clarity of communication is vital.
*All rankings taken from ECA International’s Cost of Living Survey September 2012
Points to note
Before you expatriate an employee to Australia be sure to understand the relative cost of living between Australia and their home country. Make sure the employee has an understanding too – the last thing you want is for the employee to arrive and say ‘I never would have moved here if I knew how expensive everything was”. The same applies when expatriating an employee out of Australia.
Available talent, company culture and the business reasons for the assignment all have a role in determining how cost of living differences will be addressed in a salary package.
Companies who regularly move people around the world have expatriate policies which define how cost of living differences are addressed - if you are responsible for managing international assignments know your company’s policy. If your company is new to international assignments consider the issues up front.
Ensure your company’s policy addresses changes in cost of living differentials over time including exchange rate movements.
Free, downloadable document looking at the issues regarding cost of living for expatriates available here
About the author
Anna Michielsen is General Manager for Australia, New Zealand and the Pacific at ECA International, Sydney (www.eca-international.com). ECA specialises in providing data, expertise and solutions for the management of international assignments. The company works with clients from around the globe including major corporations and small and medium size enterprises as well as government entities.