Lol another chinese slave fighting for his master.Do you know how ppp calculated?
GDP, PPP (current international $) | Data | Table
The estimates of the real cost of living, known as purchasing power parity or PPPs, are recognised as the best way to compare the size of economies rather than using volatile exchange rates, which rarely reflect the true cost of goods and services.”
There is a lot of very interesting information in the World Bank study but this statement is largely incorrect, or at least exaggerates the way PPP is recognized. Adjusting GDP for differences in purchasing power makes a great deal of sense in certain cases, but the way it is done is so filled with problems that it is extremely difficult to find any economist who takes these measures very seriously.
The concept behind PPP is quite simple. You cannot always compare two countries in a meaningful way by comparing their GDPs at current exchange rates. Prices are different in different countries in ways that current exchange rates do not offset. This means that relative living standards are a function of more than just relative incomes.
This doesn’t mean that comparing the GDP of two countries directly at current exchange rates is useless. For example – and this is a fairly obvious mistake made in the FT article, and indeed in nearly every other article I have seen on the topic – if we are interested in the relative weight of two countries in geopolitical terms you would almost certainly want to compare their GDPs on the basis of current exchange rates. Exchange rates may be volatile, as this article notes, but a direct comparison, unadjusted for price differences, better measures the relative importance of each economy for its trade partners.
And contrary to what the article says later, the World Bank findings should not “intensify arguments about control over global international organisations such as the World Bank and IMF, which,” the article correctly notes, “ are increasingly out of line with the balance of global economic power”. While there is no question that countries like China, India and Brazil should see an increase in their representation among international bodies, it is not because the PPP measure tells us much about the relative weight of these countries.
Its usefulness lies elsewhere. The PPP adjustment attempts to measure the relative living standards between the two countries adjusting for the fact that prices are not equal at current exchange rates. A family earning $40,000 in one country, for example, will have the same nominal income but a better standard of living than a family earning $40,000 in another country if both families spend a significant portion of their income on nannies for their children, and if nannies are far cheaper in the first country than in the second.
This is really what the PPP adjustment tells us, but even here there are lots of obvious problems when we try to compare the two countries. One such problem is the assumption that both families have the same consumption baskets, which the PPP adjustment implicitly assumes. It is very unlikely that this is true for all sorts of reasons, not the least being that consumption itself is affected by relative prices. All of us are likely to adjust our consumption baskets in favor of those goods and services that are cheapest in relative terms.
In Beijing, for example, the cost of getting someone to clean your apartment is far, far lower than it is in New York. On the other hand New York has one of the most vibrant theater scenes in the world. No one would be surprised to hear, consequently, that someone currently living in Beijing is likely to have a cleaning lady come to his apartment far more often than he did when he lived in New York, and is less likely to go to the theater in Beijing than he did when he lived in New York. In that case comparing his standard of living in Beijing and New York, even assuming he had the same income in both places, can be pretty difficult.
But these are all obvious problems with the PPP measure, the kinds that are discussed in almost any undergraduate economics class. As long as we keep them in mind we can find the PPP measures to be quite useful in some circumstances, even if in our excitement over the kinds of news stories that generate headlines we interpret PPP to have geopolitical implications that are almost the opposite of reality.
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