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A joint initiative of Ludwig-Maximilians University’s Center for Economic Studies and the Ifo Institute for Economic Research
Area Conference on
Global Economy
19 - 20 February 2010 CESifo Conference Centre, Munich
Measuring China’s Economy:
The Proper Use of PPP Methods
George J. Gilboy and Ninghua Zhong
CESifo GmbH
Poschingerstr. 5
81679 Munich
Germany
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Measuring China's Economy:
The Proper Use of PPP Methods
George J. Gilboy
Center for International Studies, Massachusetts Institute of Technology
&
Ninghua ZHONG
Department of Finance, Hong Kong University of Science and Technology
February 8, 2010
Abstract:
This article uses Purchasing Power Parities (PPP) price data from the World Bank 2005
International Comparison Program to compare China with other major countries in terms of
real economic size, economic structure, as well as development level. The article presents the
proper usage of PPP prices and Market Exchange Rates, and points out several common
misuses of PPPs in measuring and comparing China‟s relative international wealth and power.
Using the PPP data, the article examines differences in real aggregate productivity, living
standards, investment expenditures, and price level of major countries in the world.
Furthermore, we have constructed a variable, the Relative Manufactured Goods Price, to
characterize the industrialization level of one country. Employing sector-level PPP data, the
article compares the total expenditure within various sectors by China and India in 2005,
offering insights on both the utility and the limits of PPP analysis in comparing relative
development level and comparative advantage in the two economies.
Key Words:
Purchasing Power Parities (PPP), International Comparison Program, China‟s economy
1
1. PPPs of ICP 2005
1.1 ICP 2005
In February 2008, the World Bank International Comparison Program (ICP)
released new data which were estimates of Purchasing Power Parities (PPPs) in the
year of 2005. PPPs are based on inter-country comparisons of the national annual
average prices for a representative selection of goods and services. They convert
nominal values in terms of the local currency to „real‟ values in terms of a common
currency1 . More specifically, a PPP is defined as the number of currency units
required to purchase the amount of goods and services equivalent to what can be
bought with one unit of the currency of the base country2.
Figure 1 lists three most important PPP data concerning China‟s economy. In
2005, one needs 3.45 RMB to purchase the same quantity of standard GDP goods and
services in China as what can be bought by 1 USD in the US. On the major
composition of GDP, the basket of standard consumption (capital) goods that 3.46
(3.7) RMB would buy in China is equivalent to what 1 USD would buy in the US.
This article discusses the proper use of PPPs, using the ICP data to compare
China with other major countries. All of the data used in this article, if without special
notes, come from the website of ICP (http://www.worldbank.org/data/icp/).
1
Global Purchasing Power Parities and Real Expenditures: 2005 International Comparison Program, (Washington,
D.C.: World Bank, 2008), available at: http://siteresources.worldbank.org/ICPINT/Resources/icp-final.pdf. The
data was first published as: 2005 International Comparison Program: Preliminary Results, (Washington, D.C.:
World Bank, December 2007).
2
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 1, “Introduction to the International
Comparison Program”, page 2, available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
K:60002244~piPK:62002388~theSitePK:270065,00.html.
2
New PPPs against Previous PPPs
Considerable differences exist between the GDPs measured by the old PPPs and
by the new estimates, especially for China and India. Notice that ICP2005 is the first
time China participated in the International Comparison Program. The previous PPPs
for China were based on a bilateral comparison of the US and China in 1986, which
was based on very limited data3. In comparison, China‟s PPPs by ICP 2005 are based
on comprehensive surveys in 11 cities4, using more than 1,000 closely specified goods
and service.
Figure 2 lists the GDPs of China and India measured by exchange rate, previous
GDP, and new PPPs. The new estimates revise up considerably China‟s price level,
relative to other countries, and thus revise down the size of China‟s economy in PPP
terms. These new estimates show the Chinese economy to be about 40 percent smaller
in PPP terms than previously thought5. Similarly, the estimated GDP of India also
drops by about 40 percent.
By the revised PPP, the share of China and India in the world‟s total output
decreases greatly compared to that by previous PPPs6. Figure 4 presents the share of
3
2005 ICP Regional Summary, East Asia and Pacific, (Washington, D.C.: World Bank, December 2007).
The 11 cities include: Beijing, Shanghai, Ningbo, Qingdao, Guangzhou, Xiamen, Dalian, Harbin, Wuhan,
Chongqing, and Xi‟an. There may be some “urban bias”, or overrepresentation of products commonly consumed
in urban centers. Some articles regard this upward bias in the prices as one reason for underestimation of China‟s
GDP by ICP2005. For example, “Shrinking giant?”, Business China, 18 Feb 2008, published by The Economist
Intelligence Unit limited.
5
China Quarterly Update (Beijing: World Bank, February 2008), available at:
http://siteresources.worldbank.org/INTCHINA/Resources/318862-1121421293578/cqu_jan_08_en.pdf.
6
Relative sizes of the economies is especially important in computing regional (global) growth, as pointed by the
following words: “Morgan Stanley predicts global growth of 2.4% for this year, down from 4.8% in 2000. J.P.
Morgan, on the other hand, is gloomier, with growth forecast at just 1.6%. However, closer inspection reveals that
the difference between the two forecasts is due largely to different methods used to add together individual
countries' growth rates. Morgan Stanley, like the IMF, uses weights based on countries' GDP measured at PPP... J.P.
Morgan uses weights based on GDP at market exchange rates. The PPP method gives far more weight to emerging
economies, especially to China, and since these economies are growing faster than rich ones, the PPP-based figure
4
3
China and India by new PPPs. In 2005, China accounts for slightly less than 10
percent of world GDP, ranking the second; India accounts for about 4 percent, ranking
the fifth7.
Many early research use previous PPPs, which overestimate the volume of
output and rank of China and India. For example, Figure 3 presents an example in a
report by Morgan Stanley. Note that by previous PPPs, China and India account for
15.4% and 5.9% of world total output in 2005, with combined share of about 21%.
In a recent article on Foreign Policy8, Robert Fogel estimates that, by 2040,
China's share of global GDP would reach 40 percent. Studying the article which is the
evidential basis for the statements 9 , however, one can find that he uses old
PPP-adjusted China‟s GDP in 2000 as the start point. By that PPP, China‟s share of
GDP in 2000 is about 11.12%10, in contrast, by ICP2005, China‟s share of GDP in
2000 is about 7.02%11. So the use of the old PPPs-adjusted China‟s 2000 GDP inflates
"start" point by about 58%, which casts doubt on his 2040 predication.
Figure 4 also presents both nations‟ shares by market exchange rate (MER). Not
surprisingly, the ranks of both China and India decrease, with China ranking fifth and
for global growth comes out higher. ...” From Datuk R. Chander, “The International Comparison Program and the
System of National Accounts,” (Washington, D.C.: World Bank 2002), page 2, available at:
http://siteresources.worldbank.org/ICPINT/Resources/Chander.doc
7
Although both nations have a very large economy, they are also burdened by a more than 1 billion population
each. Consequently, China‟s GDP per capita is less than one half of the world average level, while India‟s GDP per
capita is less than one-fourth of the world average.
8
Robert W. Fogel, “$123,000,000,000,000”, Foreign Policy, January/February 2010. Available at:
http://www.foreignpolicy.com/articles/2010/01/04/123000000000000
9
Robert W. Fogel, 2009, “The Impact of the Asian Miracle on the Theory of Economic Growth”, NBER Working
Papers 14967. Available at: http://ideas.repec.org/p/nbr/nberwo/14967.html
10
See Table 7, which is on page 59 of “The Impact of the Asian Miracle on the Theory of Economic Growth”.
11
By ICP2005, China‟s GNI (PPP) in 2000 is about 2,940 billion USD, the world total GNI in 2000 is about
41,852 billion USD. Data from “World Development Indicator”, available at:
http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers&userid=1&queryId=135
4
India ranking twelfth12.
1.2 Twelve Largest Economies by New PPP
Twelve economies in the world account for two-thirds of world output (or
expenditures) and nearly 60% of world population. Seven of them are high-income
economies (the United States, Japan, Germany, the United Kingdom, France, Italy,
and Spain). Five are developing or transitional economies (China, India, Russia,
Brazil, and Mexico). In this report, we pick these twelve economies when doing
international comparisons. Figure 5 presents the share of each country‟s GDP in the
world total GDP (2005, in PPP terms). The United States is the largest economy,
accounting for about 22.5% of world total output.
Economic Growth Rate
As the economic development of these twelve nations largely determine the
world‟s economic growth, whether these economies enjoyed rapid growth is of utmost
interest. Yet,
“The revised PPP estimates do not change our understanding of real growth. As
the best estimate of growth rates, for all countries, comes from the country‟s own
constant-price GDP data. So, the new data do not mean that China was growing more
slowly than we thought, only that, in PPP terms, it started from a lower base in 1978
than the previous estimates suggested”.13
Using the GDP data provided by “World Development Indicator”14, which is
12
The major reason for the decrease is that, when translated through official exchange rates, the prices of many
non-traded services are much lower than when translated by PPPs.
13
China Quarterly Update (Beijing: World Bank, February 2008), page 1, available at:
http://siteresources.worldbank.org/INTCHINA/Resources/318862-1121421293578/cqu_jan_08_en.pdf.
14
Data are available at:
5
new-PPP adjusted, Figure 6 presents the growth rate of these nations‟ GNI. The figure
at the top depicts the GNI growth of five developing nations during the period of
1997-2006. The average annual GNI growth rate of this group during this period is
7.73%. Among them, China grew fastest and steadily. India also enjoyed a high rate of
economic growth. The figure at the bottom shows economic growth of the seven
developed countries. The annual average growth rate of this group is 4.64%.
Compared to the group of developed nations, the growth pattern of these nations are
more similar to each other in this ten-year period, which indicates that they are more
strongly inter-connected and more deeply involved in the global economy.
2. Usage of Exchange Rate and PPP
2.1 Market Exchange Rate (MER)
The GDP of developing countries will typically be underestimated if MER are
used to compare their values with those of high-income economies, for two major
reasons:

The prices of important (non-traded) basic goods and services, for example,
food and health service, are usually relatively lower in developing countries, because
they are determined domestically or locally.

Currencies in most developing countries are usually “weak”, since in general,
investors tend to view the assets of developing countries as riskier than the equivalent
assets in more developed countries. All else being equal, these currencies thus tend to
http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers&userid=1&queryId=135.
6
be less attractive than more established currencies such as US dollar.15
MER should be used to measure international trade, capital flows, or the values
of foreign debt16. Figure 7 provides one example using MER. It shows that, in 2005,
China‟s current account ran a large surplus, while India was the only developing
country that ran a deficit.
What is noteworthy is that MER are determined by the demand for and supply of
currencies used in international transactions. They are, hence, based on short-term
factors and are subject to substantial distortions from speculative movements as well
as government interventions. Therefore, comparisons based on exchange rates yield
unreliable and misleading results. It is also widely acknowledged that MER neither
measure relative price levels nor move with domestic prices over time17.
2.2 PPPs
PPPs aim to reflect differences in price levels, which is not fully reflected in
MERs, as the prices of many goods and services within economies are determined in
partial or complete isolation from the rest of the world. By taking account of price
differences between countries, PPP conversion rates allow for comparisons of real
levels of output or income between countries. PPPs are also used in multiple academic
papers dealing with international aspects of pricing, growth or structural
15
Keith Crane, Roger Cliff, Evan S. Medeiros, James C. Mulvenon, William H. Overholt, “Modernizing China‟s
Military: Opportunities and Constraints”, 2005, page 10. Available at:
http://www.rand.org/pubs/monographs/2005/RAND_MG260-1.pdf
16
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007), page 10.
17
Datuk R. Chander, “The International Comparison Program aAnd the System of National Accounts”, By Datuk
R. Chander.(Washington, D.C.: World Bank 2002), page 3, available at:
http://siteresources.worldbank.org/ICPINT/Resources/Chander.doc
7
convergence.18 But PPPs should not be used for all international comparisons. In
particular, PPP do not reflect the demand for currencies as a medium of exchange,
speculative investment, or official reserves19.
PPPs usually change slowly. However, in the long run, PPPs for developing
countries will depreciate, this is mainly because:

As incomes and wages rise, relative prices of basic goods and services rise

Being wealthier, people tend to shift consumption towards durable and other
tradable goods and services.20
Therefore, PPPs need to be carefully updated year by year. When using PPP for
forecasting, a projection of the likely changes of PPPs is required21. This is especially
important for rapidly growing nations such as China and India22.
2.3 PPPs at Sub-sector Level:
The 2005 round of the ICP program also provides PPPs at lower levels of
disaggregation of expenditure components, or PPPs for sub-sectors. These PPPs can
be used to compare the value of output and productivity of the sub-sectors23.
18
Note that these aspects are not affected by transitory movements of MER.
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007), page 11.
20
Keith Crane, Roger Cliff, Evan S. Medeiros, James C. Mulvenon, William H. Overholt, “Modernizing China‟s
Military: Opportunities and Constraints”, 2005, page xviii. Available at:
http://www.rand.org/pubs/monographs/2005/RAND_MG260-1.pdf.
21
In the Rand‟s report, they project the possible change of China‟s PPPs‟ real effective depreciation. Keith Crane,
Roger Cliff, Evan S. Medeiros, James C. Mulvenon, William H. Overholt, “Modernizing China‟s Military:
Opportunities and Constraints”, 2005. Available at:
http://www.rand.org/pubs/monographs/2005/RAND_MG260-1.pdf
22
Based on the "World Development Indicators", we estimate the PPPs that the World Bank uses for China‟s GDP
in recent years to be: 3.45 for the year 2005, 3.41 for 2006，and 3.35 for 2007.
23
The ICP final report warns that PPPs are based on the final price of gross output and not the price of
value-added of the sector, which would be of greater relevance in measuring relative sector productivity.
19
8
Figure 8 presents PPPs for China‟s various sectors, showing the degree to which
the price in a sector is determined domestically. While prices of China‟s non-traded
goods and services, such as health and construction, are very low, PPP of traded goods
are relative high, such as “Clothing and footwear” at 6.86. Notice that PPP for
“Machinery and Equipment”, 8.79, is higher than the 2005 average MER, 8.17.
3. The Inappropriate Uses of PPP:
3.1 The incorrect rule of thumb:
Some studies first convert China‟s GDP into US dollar by MER, and then
multiply it by 2.4. For example:
“The appropriate measure… is the purchasing power parity (PPP) measure
which for Chinese GDP is estimated to be two and a half times larger than that based
on the exchange rate measure.”
24
As shown in Figure 9, from March 2005 to July 2008, China‟s MER appreciated
by about 18%. If one wants to use the “rule of thumb” approach, he should adjust the
multiplier correspondingly. For example, with MER appreciating from 8.27 to 6.80,
the multiplier should decrease from 2.38 to 1.9725. Actually,
“PPPs are used instead of exchange rates to convert national economic
24
Ernest.H.Preeg, “India and China: An Advanced Technology Race and How the United States Should Respond”,
Mar 2008, pp150. Some scholars and government officials believe the proper way to compare China‟s relative
international wealth and power – not just its relative living standards – is to use PPP adjusted figures. See for
example, Ian Castles, “Measuring China‟s Size and Power,” East Asia Forum, 10 May 2009, available at:
http://www.eastasiaforum.org/2009/05/10/measuring-chinas-size-and-power-correctly/. Others have used
PPP-adjusted figures to estimate China‟s share of global high technology products trade and R&D. See “China will
become world‟s second highest investor in R&D by end of 2006, finds OECD,” announcement of OECD Science,
Technology and Industry Outlook 2006, (Paris: OECD 2006), available at:
http://www.oecd.org/document/26/0,2340,en_2649_201185_37770522_1_1_1_1,00.html.
25
Note that here we suppose the PPP didn‟t change. However, as China grows at an annual rate of about 10%,
PPPs are very likely to drop at a relatively high speed.
9
measures such as GDP into a common currency.”26
This means that we should use PPP to convert the GDP volume into dollars
directly, avoiding the use of MERs as well as the multiplier.
3.2 Use PPP for GDP to convert sector output into dollars:
Example 1. Manufacturing sector:
“In China, one only needs about 3.4 yuan to buy what would be a dollar‟s worth
of goods on the U.S. market... about 2.38 times the nominal exchange rate. Applying
the PPP factor of 2.38, China‟s $1.124 trillion worth of manufacturing output (in
2006) would be worth $2.717 trillion on the U.S. market -- slightly higher than
America‟s $2.7 trillion manufacturing output.”27
As shown in Figure 8, the PPPs for traded goods are very close to MERs. Since
most of China‟s manufactured goods are tradable goods, using the average MER of
2006, or 7.77, is more proper in this case. By this rate, China‟s 2.68 trillion RMB
manufacturing output in 2006 worth $1.124 trillion.
Example 2. Defense sector (1):
“Chinese manpower and procurement costs are far less than those of the United
States, so China, as the clichéwould hold, gets more bang for the renminbi28”
“This figure reflects the reality that a billion dollars can buy a lot of more „bang‟
in China than in the United States”
29
.
26
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007), page 9.
27
John Tkacik, “A Chinese Military Superpower”, March 8, 2007, available at:
http://www.heritage.org/Research/AsiaandthePacific/wm1389.cfm.
28
See Council on Foreign Relations, “Does China Pose a Military Threat?” Council on Foreign Relations Online
Debate,” March 26, 2007, accessed at: http://www.cfr.org/publication/12901/does_
china_pose_a_military_threat.html.
29
John Tkacik, “A Chinese Military Superpower”, March 8, 2007. Available at: www. heritage.org. In addition to
the basic calculation error made by Tkacik and others, two other types of error are common when PPPs are used to
10
As shown in Figure 4, the PPPs for different sub-sectors have very large
variations. China‟s PPP for “Clothing and footwear” is 6.86, which is very close to the
MER, and the PPP for “Machinery and Equipment” is even higher than the MER.
This suggests that China pays almost the world price for uniform and equipment.
Since uniform and equipment accounts for a larger portion in military expense than in
total GDP, if one uses the PPP for China‟s GDP to convert China‟s military
expenditure, he tends to overestimate China‟s military power.
Note that similar mistakes also appear in studies on other developing countries,
in particular, those on estimating the real size of India‟s manufacture and military
expenditure. Moreover, since the gap between the PPP and MER for India is even
larger (refer to Figure 4), improper use of PPP will result in larger over-estimation.
Example 3. Defense sector (2):
“The PPP factor gives a more accurate picture of China‟s defense spending in
U.S. dollar terms. The methodology is as follows: Convert China‟s announced 2006
GDP into U.S. dollars; multiply by the PPP ratio of 3.94 to get about $10.5 trillion
for China‟s GDP; and calculate 4.3 percent of GDP to get about $452 billion for
measure and compare defense spending. Some sources apply a general PPP-at-GDP prices adjustment to an entire
defense budget, which improperly inflates prices for traded or manufactured goods, including military equipment.
Some make comparisons of PPP-adjusted defense budgets for one country to the defense budgets of other
countries which have not been adjusted for PPP. See for example,
http://www.sipri.org/contents/milap/milex/mex_major_spenders.pdf (from Stålenheim, P., Perdomo, C. and
Sköns, E., 'Military expenditure', SIPRI Yearbook 2008 (Oxford University Press: Oxford, 2008), pp. 175-206;
http://www.iiss.org/whats-new/iiss-in-the-press/press-coverage-2006/may-2006/chinas-increasing-defense-spendin
g/;
http://www.iiss.org/whats-new/iiss-in-the-press/press-coverage-2006/may-2006/chinas-increasing-defense-spendin
g/. See also C. Fred Bergsten, Charles Freeman, Nicholas R. Lardy, and Derek J. Mitchell China's Rise: Challenges
and Opportunities, (Washington, D.C.: Peterson Institute, 2008), pp 200. Bergsten et al correctly note that PPP
adjustments are appropriate for measuring relative living standards and consumption; pp.192, box 9.1. However,
like others, this source re-prints Chinese defense budget estimates from the IISS and SIPRI which use a general
PPP at GDP price series to adjust the total Chinese defense budget, and also conflate the effects of adding off
budget items with the effects of PPP adjustments to currency.
11
China‟s military spending30”
The percentage of a sector in GDP would change if we move from nominal terms
to PPP terms. As calculated in Figure 10, with the conversion rate changed from MER
to PPP, the pie of China‟s GDP in USD increases, while the share of the “Machinery
and equipment” pie decreases. This indicates that the above method is incorrect.
3.3 Regarding PPPs as equilibrium MER
“There are many reasons that PPPs and exchange rates may diverge. Exchange
rates are determined by the international demand for currencies… PPPs reflect the
relative prices of goods and services in the economy, including those not traded on
international markets.”
“…Another common fallacy (See Figure 11) is that PPPs are calculated because
they provide estimates of underlying equilibrium exchange rates.”31
Some research regards PPPs as equilibrium MERs. For example, Figure 11 is
quoted from a report by MSCI32. Notice that, the first line of the table uses the old
PPPs. As that data seriously undervalues China‟s price level, its gap with MER is as
high as 75%. In the ICP2003-3006 Handbook, it is stated that:
“There are no assumptions whatsoever about exchange rates, or their
determination, underlying the ICP other than that, in general, exchange rates are
different from PPPs.”33
30
John Tkacik: “Questioning the CIA‟s Claim of a Drop in China‟s Military Spending”, Aug 31, 2007. Available
at: http://www.heritage.org/research/asiaandthepacific/wm1597.cfm
31
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 1, “Introduction to the International
Comparison Program”, page 5; available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
K:60002244~piPK:62002388~theSitePK:270065,00.html
32
It is titled "China‟s Currency is Undervalued: Second Report from the Fair Currency Alliance", available at:
http://www.ssci.org/news/archives/details.aspx?ArticleID=43
33
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 1, “Introduction to the International
Comparison Program”, Page 5, available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
12
Basically agreeing with this statement, we want to point out that, with China
more deeply integrated with the world economy, the gap between its PPP and MER
should be smaller (please also see discussions in section 4.4 about PLI).
4. Application of PPPs in International Comparisons:
4.1 Aggregate Productivity
“Aggregate productivity levels may be compared by comparing per capita
volumes for GDP as a whole.”34
Figure 12 presents the GDP per capita of the twelve nations. China‟s GDP per
capita in 2005 is $4091. That is less than one-tenth that of the United States, and
about twice the GDP per capita of India in the year 2005. Although China has the
world‟s second largest economy with 10% of the world‟s total output, it is also
burdened with 21% of the world population. This explains why its GDP per capita is
less than half of the world average level.
It is commonly accepted in the academic field that PPP based GDP per capita is
the best indicator of a nation‟s productivity. From Figure 12, we can see that China, as
well as India, lag behind high-income developed countries by a substantial margin.
GNI per capita Growth, PPP
Figure 13 presents the growth rates of the 12 nations in GNI per capita in the
K:60002244~piPK:62002388~theSitePK:270065,00.html
34
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 1, “Introduction to the International
Comparison Program”, page 6; available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
K:60002244~piPK:62002388~theSitePK:270065,00.html
13
period of 1997-2006, using the data of “World Development Indicator”35. These two
figures are very similar to Figure 6 which shows the growth rate of GNI. Yet, since
each nation has a different population growth rate, there are differences in the two sets
of figures. Due to China‟s lower population growth rate, it exceeds India by a larger
margin in the per capita measure.
The average growth rate of the five developing nations is 6.78%, and of the
seven developed nations 4.09%. Note that almost all of these economies grew at a
high rate since the year 2003, as commented by Chairman Ben S. Bernanke: “over the
past several years [before 2008], the world economy has expanded at its fastest pace
in decades.”36
4.2 Living Standards
“Living standards in different countries may be compared by comparing per
capita volumes of household consumption, or components of household consumption.
Comparisons of poverty may be made using selected consumption data.”37
Figure 14 presents data on individual consumption per capita of the twelve
nations. The consumption expenditure of an average Chinese in 2005 is about $1,752.
The world average level is $6,095, about 3.5 time of that of China. An average
Indian‟s comsumption is $1,455, which is about one-fourth of the world average level.
While China‟s GDP per capita is about twice that of India, China‟s consumption
35
Data are available at:
http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers&userid=1&queryId=135
36
Testimony before the Senate Banking Committee, 15 July, 2008. Available at:
http://www.federalreserve.gov/newsevents/testimony/bernanke20080715a.htm
37
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 1, page 6; available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
K:60002244~piPK:62002388~theSitePK:270065,00.html.
14
per capita is higher than India‟s by merely 20%. For the world as a whole, on average,
individual consumption comprises 69% of GDP38. In contrast, China‟s consumption
only comprises 42.8% of its total GDP. Low consumption is widely regarded as the
fundamental weakness of the economy39.
What does 1,000 dollar mean?
“The size of the economy is the key determinant of one nation‟s ability to expend
resources on its military…China has an economy large enough to sustain a
substantial level of military expenditures in comparison with most countries in the
world, excluding the United States.”
40
What does 1,000 dollar mean? As indicated by Figure 15, it has a different
connotation for different countries. For China and India, 1,000 dollar accounts for
about 2/3 of one person‟s total annual consumption expenditure. In contrast, the same
1,000 dollar is only 1/32 of individual consumption in the U.S.
It is evident that the marginal utility carried by this same amount of money
differs dramatically across nations. For the Chinese and Indian people, it means a
majority of their basic consumptions -- rice, food and clothing. For high-income
nations, “the last 1,000 dollars” probably means some luxury goods, with much
smaller utility than necessity good. Therefore, although RAND‟s report is right in the
sense that a large economy has more resources available to devote to military
38
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007).
39
For example, Chetan Ahya, et al, India and China: New Tigers of Asia, Part II, (Mumbai: Morgan Stanley, June
2006), available at: http://ibef.org/download/indiaandchina.pdf.
40
Keith Crane, Roger Cliff, Evan S. Medeiros, James C. Mulvenon, William H. Overholt, “Modernizing China‟s
Military: Opportunities and Constraints”, 2005, page 10. Available at:
http://www.rand.org/pubs/monographs/2005/RAND_MG260-1.pdf
15
spending, to extract the same amount of money on military sector, the governments of
China and India would face much greater pressure than their counterparts in
high-income nations.
4.3 Investment Expenditure:
“PPP based Gross Capital Formation measures countries‟ investment
expenditure, which are mostly comprised of purchases of equipment and construction
services.41”
Figure 16 presents the real investment expenditure of the 12 nations. Although
China only accounts for 10% of the world‟s total GDP, it accounts for 18% of the
world‟s real total investment expenditure in 2005, closely following the U.S. All of
the other eleven nations, including India, have similar shares in world‟s total GDP and
world‟s total investment.
Choice between Consumption and Investment
Figure 17 further compares the five developing nations with respect to their
levels of consumption and investment per capita. Measured by the GDP per capita,
Russia is the wealthiest nation, with about 130% of the world average GDP per capita.
China and India rank the last two, with their GDP per capita of 45% and 23% the
world average level respectively.
In terms of consumption per capita, China and India also lag far behind the other
three nations. Their average consumption is about 30% of the world average level.
41
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007), page 17.
16
Mexico lays most emphasize on consumption. Its relative consumption level is much
higher than its relative GDP level.
China has pursued a manufacturing-led growth strategy42. Despite its relative
low level in GDP per capita, which is about 43% of the world average level, its
investment per capita reaches more than 80% of the world average level. Compared
with China, India has a more balanced economy, as indicated by the similar levels of
its GDP, consumption and investment.
4.4 Price level indices (PLI):
“PLI is the ratio of an economy‟s PPP to its exchange rate with another economy.
The PLI indicates the relative price of GDP (or its components) in a country. It
corresponds to traveler‟s experience of making purchases after converting their
currency at market exchange rate. PLIs are generally low in poorest countries43”.
Figure 18 shows the PLI over one hundred nations. This ratio tends to be low for
developing countries, where prices of non-traded goods are low. It rises towards 1 as
per capita income increases. Notice that the ratio by old PPPs for China was far below
the regression line, whereas the revised data put China right around the regression
line44.
Figure 19 presents the PLI of the five developing nations in terms of GDP,
consumption and investment. We can see that compared to their PLI for total GDP, the
42
More specifically, China has pursued the typical East Asian model of recycling export revenue into fixed
investment.
43
2005 International Comparison Program: Preliminary Results, (Washington, D.C.: World Bank, December
2007), page 17.
44
China Quarterly Update (Beijing: World Bank, February 2008), available at:
http://siteresources.worldbank.org/INTCHINA/Resources/318862-1121421293578/cqu_jan_08_en.pdf.
17
PLIs for consumption are relatively lower in India, Russia and Mexico. In contrast,
China and Brazil have relatively low PLI for investment.
4.5 PPP for “Machinery and equipment”:
The sector of “Machinery and equipment” consists mostly of traded goods. As a
result, the PPP for this sector has two features:

They are very close to the exchange rate45. Figure 20 shows the scatter of 132
nations‟ exchange rates and PPPs for “Manufacture and equipment”. The scatter lies
very close to the 45 degree line, implying that these two variables are almost the same.
The correlation between the two sets of data is as high as 0.992.

They vary the least at different levels of GDP per capita. In Figure 21, we
collect 136 nations‟ PLI for “Machinery and equipment” and their GDP per capita in
log terms. Although the Log (GDP) goes from 2.58 (or $383) to 4.85 (or $70014),
most of the PLIs for “Machinery and equipment” range within a small area range
from 65 to 135.
One implication of these characteristics is that using the PPP for total GDP to
convert the manufacturing output can be a serious mistake, especially for developing
countries. Instead, using the MERs can provide a much better approximate estimation
of the real volume. Figure 22 presents share of each country‟s expenditure on
“Machinery and equipment” in the world‟s total in 2005. China‟s expenditure ranks
45
ICP 2003-2006 Handbook, (Washington, D.C.: World Bank, 2007), Chapter 9 (Annex), “Use of Exchange Rates
as Approximate PPPs for „Machinery and Eequipment‟ ”, available at:
http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,contentMDK:20126612~pageP
K:60002244~piPK:62002388~theSitePK:270065,00.html
18
for the third, while India ranks the sixth.
4.6 Level of Industrialization
We construct an indicator “Relative Manufacture Goods Price” to indicate the
level of industrialization of a nation. It is the ratio of PPP for “Machinery and
equipment” to PPP for “Individual consumption”. This indicator tells us how many
standardized consumption goods and services a nation needs to give up in order to
obtain one standardized manufactured good.
One important feature of wealthy, industrialized nations is that they have ample
capital goods. As the total volume of capital increase, marginal productivity of capital
goods decreases, consequently, its price measured in consumption goes down. So we
expect capital goods to be relatively cheaper in developed nations. In contrast, in
developing countries, capital goods are relatively scarce. Hence, their marginal
productivity and price are higher.
Figure 23 presents the value of this indicator for the 12 nations. While for all the
7 developed nations, it is below 1.3, it is much larger for the 5 developing nations.
China gets 2.54 on this term. It means, to produce one standardized manufactured
good, China needs to give up about twice the standardized consumption goods and
services that Italy needs to give up. India gets 2.71 on this term, indicating lower
industrialization level.
To show that the relationship between “Relative manufacture goods price” and
“GDP per capita” can be generally applied, we put these two indicators in one figure.
19
Figure 24 contains data of 131 countries46. The negative relationship is evident. The
correlation between these two sets of data is -0.74.
This general negative relationship has a direct implication on estimating the
military power of less industrialized nations. Because these countries own low total
capital stock, the value of one additional “gun” equals to much more “rice” than in
developed nations. That means, in order to get the same quantity of military
equipment, their governments have to sacrifice more social welfare than in developed
nations. The poorer a nation, the tougher is the choice between manufactured goods
and consumption.
5. China and India: Application of PPPs for sub-sectors
5.1 Comparison of Sector Production Share by PPP
In Figure 25, we compare China and India‟s production across various sectors,
using sector level PPPs provided by ICP2005. The left side of the figure shows both
countries‟ shares in the world total output.
China‟s GDP accounts for about 10% of the world total GDP in 2005. We can see
in that year, the share of China‟s Construction, Collective government expenditure,
Education and Communication sector all exceed 10%, share of Health sector
expenditure is roughly 10% of the world total output. In contrast, China‟s expenditure
on Transport, Alcoholic beverage, Restaurant and hotels sector are lower than 5% of
the world total output. It highlights one feature of China‟s economy, which is driven
46
In ICP report, some countries have a “NA” in the term PPP for “Manufacture and equipments”.
20
by investment and government expenditure. India has a GDP accounting for about 4%
of the world total GDP. We can see from Figure 25 that its expenditure on Food,
Education and Health sector far exceeds 4% of the world total output. Compared with
China, India‟s economy is driven by consumption to a larger extent.
On the right side of the frame, we compare the two countries‟ share of output in
world total output in each sector. It calculates the ratio of share of China to that of
India. We rank all sectors by this ratio, from high to low. From this perspective, the
features of China‟s economy and India‟s economy are more evident. China spends
relatively more on Construction and Government expenditure, while India spends
relatively more on Food and clothing.
5.2 Comparison of Expenditure per capita by PPP
We have also compared China and India in terms of per capita expenditure on
each sector. In absolute value, China‟s per capita expenditure is larger than India‟s on
all items except Food, Clothing and Transport. China‟s GDP per capita is about 45%
of the world average level, and India‟s GDP per capita is about 23%. Similar with
Figure 25, we find that on sectors such as Construction, Government expenditure, and
Education, China‟s per capita expenditure level is much higher than 45%, while on
sectors such as Food, Education, and Health, India‟s per capita expenditure is much
higher than 23%.
We calculate the ratio of China‟s expenditure per capita to India‟s corresponding
21
value. The rank of the ratio is exactly the same as the previous one. So it also
highlights features of the two economy and the different challenges they face47.
5.3 Comparison of Price Level Index
Figure 26 compares China and India in terms of sector prices. The PLI for
China‟s total GDP is 52.2 (World=100, refer to part 4.4 about PLI), and 41.2 for India.
We can see that in China, Manufacture and equipment, Clothing and footwear,
and Alcoholic beverage is relatively more expensive, while Health and Education is
relatively cheaper. India shows a similar pattern, except that its food price is relatively
cheaper. The similarity is because PLI of one sector is mainly determined by the
degree that it involves in international trade.
To show in a clearer way the relative price of the same sector in the two
countries, we calculate the ratio of China‟s PLI to India‟s. We also rank the sectors by
this ratio. A lower value on this ratio indicates lower relative price of China. From the
Figure 26, we can see that China enjoys lower price in Government expenditure,
Communication, Alcoholic beverage, Transportation, Recreation and culture. For
these sectors, the ratio is smaller or close to 1.
47
According to India and China: New Tigers of Asia, Part II, China needs to slow its investment and export drive
in favor of consumption, while India requires an aggressive investment and export thrust while cooling
consumption. Chetan Ahya, et al, India and China: New Tigers of Asia, Part II, (Mumbai: Morgan Stanley, June
2006), available at: http://ibef.org/download/indiaandchina.pdf.
22
Notice that, the analysis above cannot be directly linked to the comparative
advantages in international trade. Because a low sector PPP is fairly likely to be the
result of a lack of involvement into international trade, which actually reflects the low
competitiveness of the sector. Therefore, when applying PPP in discussions on world
trade, one needs to carefully separate different cases.
6. Conclusion:
This paper introduces and applies the data on Purchasing Power Parities (PPPs)
provided by the World Bank 2005 International Comparison Program. The paper
discusses the different usages of PPPs and MERs. PPPs enable cross country
comparison of the sizes of economies, average consumption levels, poverty rates,
productivity, and the use of resources, while MERs should be used to measure
international trade, capital flows, or the values of foreign debt.
We point out some inappropriate uses of PPP on studies on China, which appear
also in studies on other countries. Some studies use the PPP for China‟s GDP to
convert sector expenditure, overestimating the relative size of China‟s manufacture
sector, relative military power as well as R&D input. Such mistakes are widely seen
in discussions concerning China‟s international relationship, leading to biased
estimations on China‟s international influence. Moreover, due to different
23
determinants, there are no strong relationship between PPPs and equilibrium MERs.
We use the ICP2005 data to compare China and India with other major countries
in terms of real economic size, economic structure, as well as development level.
Furthermore, we have constructed a variable, the Relative Manufactured Goods Price,
to characterize the industrialization level of one country. In many aspects, both China
and India remains a poor country. Both China and India have a relatively low per
capita GDP and individual consumption, and both are at a low level of
industrialization. Finally, using the sector level PPPs data, the article compares the
total expenditure of various sectors in 2005 by China and India. By the comparisons,
we show the features of the two economies, offering insights on both the utility and
the limits of PPP analysis in comparing relative development level and comparative
advantage in the two economies.
24
References:
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December 2007).
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u_jan_08_en.pdf
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tml.
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Overholt, “Modernizing China‟s Military: Opportunities and Constraints”, 2005, page
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Ian Castles, “Measuring China‟s Size and Power,” East Asia Forum, 10 May 2009,
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tentMDK:20126612~pagePK:60002244~piPK:62002388~theSitePK:270065,00.html
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26
Figure 1
Figure 4
PPPs of China
Share of China and India by New PPPs and
GDP
3.45
Exchange Rate
PPPs of China
Actual
Gross fixed
individual
capital
consumption formation
3.46
3.7
Source: 2005 ICP Final Results
Figure 2
GDP of China and India by different measures
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 3
Figure 5
Share of China and India by Old PPPs
The World’s Twelve Largest Economies
Source: 2005 ICP Final Results
Source: “India and China: New Tigers of Asia, Part II”, by Morgan
Stanley
27
Figure 6
Figure 8
Economic Growth Rate, PPPs
PPP for Sub-section of China
Source: 2005 ICP Final Results
Figure 9
Change of RMB Market Exchange Rate
Source: World Development Indicators, World Bank
Figure 7
International Comparison of Net Export (MER)
Source: 2005 ICP Final Results
28
Figure 10
Figure 13
Compare China’s GDP in nominal terms and
GNI per capita Growth Rate
in PPP terms
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 11
Estimates of Undervaluation
Source: “China‟s Currency is Undervalued: Second Report from the Fair Currency Alliance”, June 28, 2004
From http://www.ssci.org/news/archives/details.aspx?ArticleID=43
29
Figure 12
Figure 16
GDP per capita, PPP
International Comparison on Investment
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 14
Figure 17
International Comparision of Consumption
Investment Expenditure of Five Developing
per Capita
Nations
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 15
Figure 18
What does 1,000 dollars mean?
The Relationship between relative prices and
stage of development
Source: 2005 ICP Final Results
Source: China Quarterly Update, February 2008, by World
Bank.
30
Figure 19
Figure 22
Price Level Index of Five Developing Nations
Sector of “Machinery and equipment”
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 20
Relationship between PPP for “Machinery
Figure 23
and equipment” and MER
Relative Manufactured Goods Price
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
Figure 21
Figure 24
PLI for “Machinery and Equipment”
Relationship between Relative Manufactured
Goods Price and GDP per capita
Source: 2005 ICP Final Results
Source: 2005 ICP Final Results
31
Figure 25
Sector Production Share by PPP, China and India
Source: 2005 ICP Final Results
Figure 26
Price Level Index, China and India
Source: 2005 ICP Final Results
32