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International comparison using PPP index

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If you are from a high-income country or city and have traveled elsewhere, you will likely notice, at least occasionally, that many goods, such as food, meals, entertainment, and healthcare, are significantly cheaper in lower-income countries. As a result, the purchasing power of $100 in the U.S. economy seems to be able to buy many more goods and services in many other places around the world.

The World Bank’s International Comparison Program tries to adjust prices around the world – that is, calculate how much it costs to buy the same “basket of goods” (as economists call it) in different countries. This adjustment results in the calculation of the difference between the “market exchange rate” and the “purchasing power parity or PPP exchange rate.” Market exchange rates tell you how much you receive in exchange for one currency for another. PPP exchange rates adjust for the goods and services that you can actually buy with that currency. Because making these “purchasing power parity” comparisons is a massive task, the ICP only updates the PPP figures every few years. 2021 Comparison Now Available.

When comparing the size of economies of countries or regions, a standard result is that high-income economies appear relatively smaller when measured on a PPP basis than when measured at market exchange rates because prices tend to be lower in low-income countries. For example, The third panel of this figure High-income countries account for 62% of world GDP when measured at market exchange rates, but 46% of world GDP when measured at purchasing power parity exchange rates (what it can buy).

If we compare the size of economies using PPP exchange rates, we find that China is already the largest economy in the world. ICP Report Note:

The world’s largest economy in 2021 was China, with a GDP of $28.8 trillion based on purchasing power parity, accounting for 18.9% of the world’s GDP. The United States came in second, with about $23.6 trillion, accounting for 15.5% of the world’s GDP. The Indian economy came in third with $11 trillion, accounting for 7.2%. Also in the group of top 10 economies were the Russian Federation ($5.7 trillion, 3.8%), Japan ($5.6 trillion, 3.7%), Germany ($5.2 trillion, 3.4%), Brazil ($3.7 trillion, 2.4%), France ($3.6 trillion, 2.4%), the United Kingdom ($3.5 trillion, 2.3%) and Indonesia ($3.5 trillion, 2.3%).

Here’s a snapshot of the global economy seen through a PPP lens: the vertical axis shows each country’s share of global population (so China and India are the largest), and the horizontal axis shows GDP per capita measured at PPP exchange rates. Go to linkClick on each bar to see which country it represents.

To capture the differences in price levels across countries, and therefore the magnitude of the adjustment due to purchasing power parity exchange rates, the ICP sets each country’s world price level average at 100. From this base, we can see that:

An index above 100 indicates rising prices relative to the global average, and the PLI [Price Level Index] A value below 100 indicates low prices. The most expensive economy in the world is Bermuda with a GDP PLI of 194, followed by the Cayman Islands, Switzerland, Israel, Iceland and Australia. The United States is ninth in the world with a GDP PLI of 158. High-income economies have a GDP PLI of 136 … Upper-middle-income economies have a GDP PLI of 81 … Lower-middle-income economies have an average GDP PLI of … Low-income economies had an average GDP PLI of 50 …

You might have thought that measuring price levels in a way that is comparable across all countries around the world, while adjusting for differences in the quality and availability of different goods and services, is a Herculean task. There is a reason why the estimated PPP exchange rates for 2021 will be published in 2024: putting all this together takes time. The report explains its methodology in detail, but there is room for skepticism. Indeed, In 2010, Angus Deaton dedicated his presidential address to the American Economic Association. (Available free online) here) merely details the “weak theoretical and empirical justification” for such measures. But if you’ve read this far, it should come as no surprise to you that imperfect economic statistics can still be useful when applied in context and with care.

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