Purchasing Power Parity (PPP) is an important economic concept, requiring significant efforts to arrive at an authentic value. World Bank carries out an extensive exercise, called International Comparison Program (ICP), to get a fair value and understand where different economies are placed. As per the latest World Bank statistics, global GDP (PPP) stood at $164.1 trillion in 2022, 1.6 times the exchange rate-based GDP of $101 trillion. Here is a brief analysis of the report and issues surrounding PPP.
The concept of PPP originates from the fact that purchasing power of a dollar is different across different economies as price of a product or service is different across economies. This does not get captured in GDP converted from local currency to dollar based on market exchange rate. For instance, a doctor’s fees in India could be say, Rs 1,000 which would translate to about $12 on exchange rate basis. However, the fees in US or other developed economies would be much higher than that. This necessitates a measure which could capture the ‘value’ each dollar provides. ICP attempts to do the same by eliminating the impact of price differential. Apart from measuring relative size of the economy, this also helps in measuring the level of well-being of population.
To capture this, world bank started a project called ICP (International Comparison Program) under which, it collects prices of as many as 17 expenditure items across about 200 countries. This is, then, standardized to one scale to arrive at the purchasing power parity of each currency. The last exercise was carried out it 2017, six years after the earlier one in 2011. As per the report, among all the expenditure items, health and education showed maximum contrast being cheapest at 26% and 38% the global average price in South Asia against 176% and 261% in North America.
As per the statistics for 2022, extrapolated from 2017 detailed report, China had the highest GDP at $30.3 tr, higher than USA at $25.5 tr. Exchange rate based (termed nominal in this article) GDP for China stood at $18 tr implying that price of a product or service in China, on an average, is only about 60% of that calculated by exchange rate (18/30.3). In other words, price of a one-dollar product would be 60 cents in China. (This is only on aggregate basis. Prices of individual product would vary). For USA, nominal GDP is same as PPP as the dollar serves as the benchmark. India stands as third largest economy with GDP PPP of $11.9 tr. Against this, nominal GDP for India in 2022 is estimated at $3.4 tr, implying a one-dollar product (or service) would cost only 29 cents in India. That is essentially the reason why India is an attractive destination for variety of services. India is followed by Japan, Germany and Russia in PPP ranking.
But why does the price level differ so significantly. A reason is that developing and under developed economies have lower level of salaries & wages. This gets built into the prices of services such as medical, education, even real estate and so on. As economy grows and income level increases, cost of services also increase, leading to overall increase in price level. As a result, variation between PPP and exchange rate-based GDP diminishes. This is corroborated by the fact that aggregate prices are 30% of nominal price in case of low and low-middle income countries which increases to 51% for upper-middle income countries and further to 82% for high-income countries. In terms of individual countries, UK has its GDP PPP closest to nominal GDP with prices being 85% of nominal price. Surprisingly, price level in sub-Sahara Africa region is higher than low/low-middle income group at 38%. A possible reason could be that region spends higher share of its income on food items where price differential is low.
The report also delves into income and expenditure on per capita basis across different regions. Despite higher purchasing power of domestic currencies, the difference in per capita income between developed, developing and under-developed remains significantly high. Per capita income for upper-middle, lower-middle and low-income countries stands at 33%, 13.5% and 3.5% of high-income countries respectively. In comparison, the ratio is 20%, 5% and 1.7% on exchange rate basis. (These figures are for 2017). In terms of individual countries, Luxembourg had the highest GDP PPP per capita at over $112,700, 6.8 times the world average whereas Burundi had the lowest at $784, 0.05 times the world average.
With regard to consumption, under-developed countries have to spend most of its income on basic needs such as food and are left with very little surplus to spend on social or physical investment. For instance, Sub-Saharan Africa, having 45 countries, accounted for 3.1% of global GDP but their share in global expenditure on food & non-alcoholic beverages was as high as 8% whereas the share in capital formation was only 1.9%. The region could spend only 15% of its GDP on capital formation against global average of 24%. Even though Gini Coefficient, the measure of inequality, has come down marginally as per the report, 74% of world population lives in countries where per capita consumption expenditure is less than the global average.