China, the US, and PPP: a pretty poor parallel

Much is being made of China being about to pass the US as the world’s biggest economy — and of China’s fight to massage down the figures.

We hate to side with Chinese statisticians, but at the very least Beijing may well be right to play down the comparison in its local media.

Here are a couple of surprises which come out from using similar adjustments to the PPP calculations used to show China’s economy is bigger (using the IMF’s World Economic Outlook database)…

  • In 1980, Greece and Gabon (which was in default on its debt from 1999 to 2005, but has lots of oil) were ranked above the UK for PPP-adjusted GDP per person. Before adjustment they were about a third poorer.
  • East Timor, on the IMF’s 2014 estimates, is ranked as richer on PPP-adjusted GDP per capita than Poland, Estonia or Hungary – and is ranked only 1.4 per cent poorer per person than Portugal, its former colonial master. It has discovered oil, boosting GDP. But before the PPP adjustment, GDP per capita is put by the IMF this year at $4,669 vs $14,166 a head for Portugal.

There are plenty of problems with the US-China comparison, starting with the calculation of GDP in the first place (even Chinese Premier Li Keqiang has admitted that his country’s GDP number can’t be trusted).

But the broader problem comes with the calculation of purchasing power parity (PPP), which tries to adjust for differences in the cost of goods and services. If the GDP of country A is half that of country B, but the cost of living is also half as much, PPP-adjusted GDP would be equal. Simplifying (a lot), PPP aims to measure how much stuff people can buy, rather than just how much money they spent buying it.

It isn’t just that the Chinese spend a lot more on food than Americans (it makes up almost a third of the basket of goods and services used to calculate inflation, against 14 per cent in the US) and a lot less on housing (17 per cent against 37 per cent). It’s also the question of what is comparable. Angus Deaton and Alan Heston give the example of a Thai farmer who lives on rice and an Ethopian who lives on teff: there is no basis for comparison as rice is hard to find in Ethopia, and teff isn’t available in Thailand. Here’s what they say:

This is an extreme case, but many goods and services that are widely consumed in rich countries are not available at all in poor countries, or are only available at high-priced specialty [sic] stores in a few large cities. One general rule is that the comparisons become less reliable the further apart are the structures of GDP (or its components) of the countries being compared.

Those putting faith in the latest data should also remember this: China’s PPP-adjusted GDP was cut 40 per cent in the last round of revisions of the World Bank PPP methodology, in 2005. It’s now been revised up.

Who’s to say it won’t be revised back down again in 2015?

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