Purchasing power gains give a new outlook on world

The UAE has become an economy worth more than $500bn - larger than Belgium.

New calculations of purchasing power have put China on course to overtake the United States as the world’s biggest economy this year.

The International Comparison Programme (hosted at the World Bank) last week released its new estimates of Purchasing Power Parity (PPP), which is used to compare GDP across countries. These estimates are released about every five years and they serve as the basis for the PPP-adjusted statistics used by most international organisations or statistical sources.

These estimates get updated on an annual basis using inflation rates but it is the five year survey that produces the complete data that allows us to compare purchasing power across countries.

The release emphasised the fact that China looks bigger than we thought before and it is likely to become the number one economy by the end of this year.

The news on China makes for great headlines but the reality is that many countries saw significant changes in their PPP estimates. While China’s PPP jumped 21 per cent, there are 65 countries whose size increased at an even faster rate and about 30 countries where the increase was larger than 50 per cent.

The UAE doubled its size and now becomes an economy worth more than $500bn (larger than Belgium). Indonesia increased by 85 per cent to pass $2 trillion and becomes the 10th largest economy in the world (larger than Italy and very close to the United Kingdom). All these are very large changes that clearly show that the most recent PPPs have introduced a completely different lens to compare price levels and living standards across countries.

PPP estimates are done for a particular year (2011 in this case). The PPP-adjusted figures take the same GDP data that we were already using for that year and they publish a new set of PPP estimates that allow for a conversion of GDP to a purchasing-power basis just for that year (2011).

Soon most databases will start using those PPP estimates (from 2011) to extrapolate and calculate more recent annual GDPs (2013). This calculation will be done by adjusting 2011 PPP estimates with domestic inflation rates. To understand what has really changed with these new estimates and avoid the possible distortions that using inflation rates could cause, let me do a simpler calculation. Let’s stick to 2011 GDP and ask the following question: how different is the size of economies as calculated using 2011 PPP, compared to what we thought before these estimates were released?

Before the estimates were released, we were using PPP estimates calculated in 2005 and updated using domestic inflation rates.

The pattern is that emerging markets tend to look a lot cheaper than we had thought earlier and therefore their GDP measured in purchasing power parity looks much larger.

This has not always been the case. The previous release of PPP estimates (2005) caused a lot of controversy because it reduced the size of the Chinese economy by about 15 per cent.

One can argue that changes in the PPP-adjusted size of countries have very little practical impact, and that GDP has not really changed.

It does have an impact on those who care about size and rankings of countries and think that PPP-adjusted series are better at capturing size (which is probably not correct). But it also has a large impact for those who care about comparisons of living standards (for which PPP correction is a must). These large movements in PPP estimates completely change our reading of living standards for many countries.

Antonio Fatas is a professor of economics at Insead Business School

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Published: May 10, 2014 04:00 AM


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