In order to better estimate the relative consumer purchasing power between nations, the International Monetary Foundation (IMF) revised its estimates of the comparative size of economies in the spring of 1993. Traditional benchmarks of GDP per capita convert each country's GDP into dollars using market exchange rates. The resulting figures indicate what the average resident in India or China can purchase compared to the typical inhabitant of the United States. This provided an international comparison of purchasing power but ignored differences in home markets regarding the cost of goods and market structure (the presence of barter and other nontraditional markets).
Comparing GDP per capita in dollars causes the real output of many developing countries to be underestimated, as markets are not as well defined as in developed countries. Furthermore, changes in exchange rates could help or hinder a country's GDP per capita. Countries with an appreciating currency were given a boost to GDP per capita, the opposite occurring for countries with deflating currencies. To help correct these distortions, the IMF now uses purchasing power parities (PPP). The PPP takes account of what money can buy in each country's home market, accounting for international differences in prices. It is especially useful in capturing differences in the prices of non-internationally traded goods such as housing, domestic transport, and energy, items that make up a large percentage of consumer expenditures.
In theory, if the prices of traded goods were equal everywhere, then wages in each country would depend on the productivity of its traded-goods industries. We would expect that countries with low productivity would have low wages, while countries that are abundant in capital and workforce skills would have greater productivity and higher wages. The same reasoning applies for producers of non-traded goods in high vs. low worker-productivity countries. Low productivity and low wages result in a minimal GDP per capita in comparison to the more productive countries. Yet for the majority of developing countries, the prices of many services, housing, energy, and other consumer goods will be cheaper in these developing countries, partially offsetting the wage disparity with developed economies.
Using the PPP instead of GDP as an international measure yields some eye-opening results. Overall, the share of world output consumed by the rich industrial countries drops from 73% to 54%. And given the generally higher economic growth rates of the less-developed countries (LDCs), it can be expected that by the end of this century industrial countries will account for less than half of global consumption.
Using the PPP rather than GDP per capita also leads to a revised list of the world's largest economies. With the PPP, China is the world's third largest economy in terms of overall consumption, due to a large population with increasing purchasing power (the ranking are U.S. 22.5%, Japan 7.6%, China 6%). Furthermore, using the PPP, countries with large populations and growing incomes, such as India, Brazil, and Mexico, have a much more important place in the global economy than by traditional measures.
As the PPP shows, there are alternatives to using GDP as a measure of international economic size and growth. The PPP shows what workers can actually afford in their own markets, giving a more accurate picture of domestic wealth. While used for international comparisons of consumption, the PPP is not used to compare production across national boundaries.
Copyright © 1999, Jay
Kaplan
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Last updated January, 1999