Global Purchasing Power Parities and Real Expenditures - Afristat

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Introductionpurchasing power of the U.S. dollar and the euro, a Big Maccosts 79 percent more in France than in the United States.Travelers exchanging their dollars to euros would noticethis immediately.PPPs between any pair of countries change slowly,whereas market exchange rates can change quickly. Suddenchanges in PLIs result mainly from changes in marketexchange rates. When market exchange rates change rapidly,a PLI for a country could change too in a short time, indicatingthat a country that was relatively cheap has now becomerelatively expensive compared with the base country.The Use of PPPs and Market ExchangeRates for International ComparisonsPPPs are the preferred means of converting the value ofthe GDP and its components to a common currency. Theyenable cross-country comparisons of the sizes of economies,average consumption levels, poverty rates, productivity,and the use of resources. However, PPPs should not beused for all international comparisons; for example, marketexchange rates should be used to measure internationaltrade, capital flows, or the values of foreign debt.PPPs adjust for differences in price levels betweeneconomies, which may not be reflected in market exchangerates, at least in the short run. Market exchange rates arethe prices at which currencies trade in international markets.Because developing economies tend to have relativelylower wages leading to lower prices for nontraded goodsand services, a unit of local currency has greater purchasingpower within a developing economy than it does inthe global market. Consequently, the GDP of a developingeconomy and the consumption of its residents willtypically be underestimated if market exchange rates areused to compare their value with those of high-incomeeconomies. Although differences in price levels are generallyless pronounced among economies at similar levels ofdevelopment, large and rapid movements of exchange ratescan alter the apparent size of economies or the perceivedwelfare of their residents. For example, the Euro exchangerate has changed from US$ 0.853 in October 2000 to US$1.562 in March 2008, but that does not mean that the welfareof Euro area countries has changed accordingly in relationto the United States in that time.There is no need to convert from national currencies toa common currency (whether by market exchange rates orPPPs) when calculating growth rates for a single economy.However, in computing regional (or world) growth rates, thesizes of the economies matter: national GDPs and aggregatesare first converted to a common currency and then summedto regional (or world) totals, from which growth rates arecomputed. The appropriate conversion factor is providedby PPPs. Developing economies have often had (at leastin the past decade) higher rates of economic growth thandeveloped economies. As a result, the global growth ratescomputed with PPP-based activity levels tend to be higherthan those computed using market exchange rates. The reasonis that the developing economies have a higher weightin the PPP-based regional totals (both levels and growthrates) than those based on market exchange rates.The initial rounds of the ICP in the 1970s focusedmainly on what are referred to as “volumes” or “real expenditures”of GDP, its major components, and their per capitaestimates. PPPs were seen mainly as providing a steppingstonefrom national accounts expressed in national currenciesto volumes expressed in a common currency. In recenttimes, economic analysts have shown increasing interest inPPPs in their own right as a measure of relative price levelsbetween economies.A major use of the PPP results is the estimation of thewidely used “dollar-a-day” international poverty threshold.PPP results also enter the estimation of the United NationsHuman Development Index and Gender EmpowermentMeasure, allow the World Health Organization to use healthexpenditures per capita to assess health inequality acrosseconomies, and provide the basis for international organizationsto design effective aid programs. The EuropeanCommission relies on PPP-based indicators to allocate theStructural and Cohesion Funds across member economies.Purchasing power measures are also useful for policymakers at the national level. For example, with the internationallycomparable data, policy makers can draw on theexperience of other economies by comparing the data forthe components of the GDP and their relationship to economicgrowth. Similar analyses can inform policy makersof their economy’s comparative advantage by examiningwhich goods or services are relatively cheap or expensivecompared with those of other economies.Purchasing power parities allow comparisons betweeneconomies of expenditure shares or price levels for componentssuch as food, health care, and investments. Forexample, capital goods tend to be relatively more expensive
Global Purchasing Power Parities and Real Expendituresthan consumer goods in developing economies, while servicestend to be cheaper. Comparisons between economiesat this level provide another view of what is contributing todifferences in growth rates between economies.The PPP-based measures of the GDP are needed tocompare volume measures with other economic variables.Examples include the following:m Carbon emissions per unit of GDPm Energy use per unit of GDPm GDP per employeem GDP per hour workedThe first two are useful for environmental comparisons,while the latter two provide important comparisons ofproductivity.Reliability of PPPs and GDPVolume MeasuresPurchasing power parities are statistical estimates. Like allstatistics, they are point estimates that fall within somemargin of error of the unknown, true values. The errormargins surrounding the PPPs depend on the reliability ofthe expenditure weights and the price data and how wellthe goods and services that were priced represent the consumptionpattern and price levels of each participatingeconomy. As with national accounts data generally, it is notpossible to calculate precise error margins for PPPs or thereal expenditure data derived from them.The 2005 ICP included economies ranging from citystatesto large and diverse countries such as China, India,and Indonesia, which collectively account for more than40 percent of the world’s population and include manypeople living in remote, rural locations. These and similareconomies had to produce national average prices forgoods and services that were comparable with those ofother economies in their region. The accuracy of the PPPsfor these economies depends upon the extent to which theselected goods and services were representative of theirentire economy and on their ability to provide nationallyrepresentative average prices. The need to measure pricesfor internationally comparable goods and services meansthat they are more likely to reflect consumption patterns ofurban areas. It is also true that many household goods andservices are available only in towns, so the urban and ruralprices become the same. If the urban-to-rural price differentialsare similar across economies, any bias will tend tocancel out in the estimation of PPPs; if not, results for someeconomies may be biased, up or down, depending on theextent of over- or underrepresentation of urban and ruralareas. Additional detail about estimating PPPs for largeeconomies follows in box 1.To minimize this potential bias, each ICP region preparedits own list of goods and services to be priced so thatthey would better reflect the characteristics of the economiesin its region. The need to deal with the wide diversityof sizes, urbanization, and performance of economiesin each region was considered at every step leading to theestimation of PPPs.Therefore, caution should be used when comparingeconomies by the size of their GDP or in per capita expenditures.Mindful that there may be errors in the calculationof GDP and population sizes, as well as in the estimationof PPPs, small differences should not be considered significant.It is generally accepted that differences in GDP ofless than 5 percent lie within the margin of error of thePPP estimation. Rather than ranking economies, it is preferableto group economies by broad size categories. Cautionshould also be exercised about making comparisonsof price levels or per capita expenditures at low levels ofaggregation, where small errors may lead to large discrepancies.Some areas such as housing and health are moredifficult to measure, and services in general are more difficultto price than are goods; therefore, comparisons of thesecomponents have wider measures of error than those forfood products.PPPs should not be used as indicators of the under- orovervaluation of currencies, nor should they be interpretedas equilibrium exchange rates. The PPPs cover all of GDPvalued at purchaser’s prices, which include both traded andnontraded goods. Exchange rates, unlike PPPs, reflect thedemand for currencies as a medium of exchange, speculativeinvestments, or official reserves. Exchange rates shouldbe used to price international transactions and to makecomparisons between economies of international debt, theflow of international capital, and the export and import ofgoods and services.The PPPs in this report are not comparable with previousPPPs published by the World Bank in the World DevelopmentIndicators (WDI) or other publications.
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Page 5 and 6: © 2008 by the International Bank f
Page 7 and 8: viContentsPart II: Technical Notes
Page 10 and 11: Acronyms and AbbreviationsADBAfDBBO
Page 12 and 13: PrefaceThis publication presents th
Page 14 and 15: AcknowledgmentsThe ICP shares a com
Page 16: Part IPurchasing Power Paritiesand
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Page 24 and 25: 2005 ICP:Results and Major Findings
Page 26 and 27: 2005 ICP: Results and Major Finding
Page 36: Tables of Results21
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Part IITechnical Notes of the 2005
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Comparison-Resistant AreasSome comp
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Comparison-Resistant Areas 149mmmHo
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Data ValidationData validation was
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Data Validation 153determines the l
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Appendix AHistory of The ICPEconomi
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Appendix A 169which selected econom
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GlossaryActual individual consumpti
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Glossary 203tice, general administr
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Glossary 205in nonmarket production
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Glossary 207Multilateral comparison
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Glossary 209able as a result of the
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