International Price Comparisons-- Purchasing Power Parities vs. Exchange Rates

2. Purpose or goal of this presentation Provide an understanding of what is a Purchasing Power Parity How they are estimated and their statistical and economic properties Provide an overview of the International Comparison Program Present uses of PPPs

3. The Problem�Comparing economic measures across countries Country Level Statistics are in National Currencies. Comparisons across countries require converting data into a common currency i.e. Gross Domestic Product Inter country comparisons of Agricultural output

4. How convert national data into a common currency? Exchange rates or Purchasing Power Parities

5. Statistical basis of PPPs

6. Why not use exchange rates (X-rates)? X-rates will convert the GDPs to a common currency X-rates are easily understood being determined by the demand for & the supply of currencies X-rates are easily observed, cover all countries, readily available

7. Exchange rates differ from PPPs

8. What is a Purchasing Power Parity (PPP)? Form of Exchange Rate Based on comparison of prices between countries International Price Index Compares prices at a point in time across space vs. CPI comparing prices across time (Big Mac Example)

9. The Economist has popularized its international price comparisons based on the Big Mac The Big Mac Index works because the Big Mac is a highly standardized product, available in many countries world wide. It is a composite of several inputs: bread, beef, lettuce, and the labor needed to assemble it. However, it falls far short of representing the full mix of goods produced by an economy.The Big Mac Index works because the Big Mac is a highly standardized product, available in many countries world wide. It is a composite of several inputs: bread, beef, lettuce, and the labor needed to assemble it. However, it falls far short of representing the full mix of goods produced by an economy.

10. Calculating the Big Mac Index

11. Limitations of the Big Mac Index It is based on only one product, and is not representative of the output of the full economy For example, Big Macs are sold mostly in urban areas and leave out traditional food such as rice

12. Overview of the International Comparison Program

14. Historical Global ICP Participation

15. Basic Data Required to compute PPPs for GDP --Expenditures

16. The steps Start with GDP and Main aggregates Individual Consumption by Households Individual Consumption by NPISH Individual Consumption by Government Collective Consumption by Government Capital Formation Change in Inventories Trade Balance

17. Individual Consumption by Households�Categories Food & non-Alcoholic Beverages-29 Alcohol and Tobacco Clothing & Footwear Housing, water, electricity Health Education Transport--etc

18. Food Basic Headings Rice Other Cereals Pasta Beef and Veal Fish & Seafood Fresh Milk Fresh Fruit - - - Sugar

19. Purchasing Power Parities - The Steps

20. The Structured Product Definition

21. Data Collection Utilize CPI framework if possible supplemented to obtain national coverage Product coverage Annual estimates National Annual Averages vs time to time change

22. Number of items priced by region Need to add column for the Eurostat/OECDNeed to add column for the Eurostat/OECD

23. Purchasing Power Parities - The Steps

24. Calculation of PPPs First step-compute BH PPPs Then combine / average Basic Heading PPPs to aggregates such as food, clothing, and on the consumption and the GDP ICP Handbook, www.worldbank.org/data/ICP

26. PPPs for Basic Headings Two approaches EKS method OECD-Eurostat countries and the CIS Region CPD method Used in all other Regions PPPs for Basic Headings PPPs are calculated for Basic Headings. Two approaches are used: OECD-Eurostat countries and the CIS Region use an EKS method All other regions use a CPD method EKS gets its name from the two Hungarian and one Polish statisticians who are its originators � �ltet�, K�ves and Szulc. CPD stands for Country Product Dummy and is a method developed by Robert Summers of the United States for the first round of ICP. PPPs for Basic Headings PPPs are calculated for Basic Headings. Two approaches are used: OECD-Eurostat countries and the CIS Region use an EKS method All other regions use a CPD method EKS gets its name from the two Hungarian and one Polish statisticians who are its originators � �ltet�, K�ves and Szulc. CPD stands for Country Product Dummy and is a method developed by Robert Summers of the United States for the first round of ICP.

27. Bilateral PPPs are calculated for each pair of countries in the region. They are the geometric averages of the price ratios of the individual products included in each Basic Heading. If not all the products were priced by all the countries: Bilateral PPPs obtained in this way will not be transitive. If they are not transitive, then for the three countries A,B and C. Elteto-Koves-Sulc (EKS) Method In the EKS approach, bilateral PPPs are calculated for each pair of countries in the region. They are obtained as the geometric averages of the price ratios of the individual products included in each Basic Heading. If, as is usually the case, not all the products were priced by all the countries, bilateral PPPs obtained in this way will not be transitive. If they are not transitive, then for the three countries A,B and C. Elteto-Koves-Sulc (EKS) Method In the EKS approach, bilateral PPPs are calculated for each pair of countries in the region. They are obtained as the geometric averages of the price ratios of the individual products included in each Basic Heading. If, as is usually the case, not all the products were priced by all the countries, bilateral PPPs obtained in this way will not be transitive. If they are not transitive, then for the three countries A,B and C.

28. Bilateral PPP made transitive by: Taking the geometric average of the PPP calculated directly between A and B. And all the PPPs for A and B that can be calculated indirectly. With 3 countries we have: Each bilateral PPP can be made transitive by taking the geometric average of the PPP calculated directly between, say, A and B and all the PPPs for A and B that can be calculated indirectly. With 3 countries we have: ------------------------------------------------------------------------------------------------------------------------------------------------------- This procedure generates the �best� estimate of transitive PPPs in the sense that it minimises the differences between the original (non-transitive) and the transformed (transitive) PPPs. Each bilateral PPP can be made transitive by taking the geometric average of the PPP calculated directly between, say, A and B and all the PPPs for A and B that can be calculated indirectly. With 3 countries we have: ------------------------------------------------------------------------------------------------------------------------------------------------------- This procedure generates the �best� estimate of transitive PPPs in the sense that it minimises the differences between the original (non-transitive) and the transformed (transitive) PPPs.

29. The CPD is a regression model which assumes: - Individual product PPPs within a Basic Heading are constant between any given pair of countries - Each country has overall price level that determines the absolute prices of products in the Basic Heading for that country CDP Method The CPD is a regression model which assumes that: - PPPs for individual products within a Basic Heading are all constant between any given pair of countries. - Each country has its own overall price level for the Basic Heading which determines the level of absolute prices of the products in the Basic Heading for that country.CDP Method The CPD is a regression model which assumes that: - PPPs for individual products within a Basic Heading are all constant between any given pair of countries. - Each country has its own overall price level for the Basic Heading which determines the level of absolute prices of the products in the Basic Heading for that country.

30. When there are c countries and n products, the model can be written (in logarithmic terms) as: is the price in country i of product j, ai is the country parameter, bj is the product parameter, and uij is the residual term. Results are transitive Product 1 in country 1 is taken as the reference product, all prices being measured relative to its price. Country 1 therefore becomes the reference country. The country and product parameters are multiplied by dummy variables (not shown in the equation above) which take the value of 1 if a product is priced by a country or 0 if not. (Hence the D in CPD). The anti-log of the country parameter is the estimated Basic Heading PPP for country i with country 1 as reference country. PPPs estimated using CPD are transitive because they are obtained multilaterally (taking all countries simultaneously into consideration) rather than bilaterally (considering only pairs of countries successively). Product 1 in country 1 is taken as the reference product, all prices being measured relative to its price. Country 1 therefore becomes the reference country. The country and product parameters are multiplied by dummy variables (not shown in the equation above) which take the value of 1 if a product is priced by a country or 0 if not. (Hence the D in CPD). The anti-log of the country parameter is the estimated Basic Heading PPP for country i with country 1 as reference country. PPPs estimated using CPD are transitive because they are obtained multilaterally (taking all countries simultaneously into consideration) rather than bilaterally (considering only pairs of countries successively).

31. The cheese PPP is then averaged with other food PPPs to obtain an overall �food PPP� using expenditure weights. The food PPP is averaged in turn with the PPPs for other things that households buy to obtain a PPP for �total household consumption expenditure�. Expenditures used to compute weight average. The process is continued up to the level of total GDP. IMPORTANT POINT No weights were used to get the �cheese PPP�, but for aggregation after the Basic Heading level expenditure weights are available and the PPPs for �food�, �household consumption expenditure�, etc are weighted averages. But whose weights? The weights for countries A and B are both equally valid, so we calculate two weighted averages � one using A�s weights and another using B�s weights and the final PPP for � say �food� � is the geometric average of these two weighted averages.The cheese PPP is then averaged with other food PPPs to obtain an overall �food PPP� using expenditure weights. The food PPP is averaged in turn with the PPPs for other things that households buy to obtain a PPP for �total household consumption expenditure�. Expenditures used to compute weight average. The process is continued up to the level of total GDP. IMPORTANT POINT No weights were used to get the �cheese PPP�, but for aggregation after the Basic Heading level expenditure weights are available and the PPPs for �food�, �household consumption expenditure�, etc are weighted averages. But whose weights? The weights for countries A and B are both equally valid, so we calculate two weighted averages � one using A�s weights and another using B�s weights and the final PPP for � say �food� � is the geometric average of these two weighted averages.

32. Aggregation�Different methods available EKS�per example. Weights based on relative shares, thus countries treated equally regardless of economic size. Components not additive to total G-K�Geary-Khamis. Uses quantity weights. Results are additive, however, can overstate real expenditures in poor countries. (Gershenkron effect)

33. Geary-Kharmis (GK) Method Based on the simple idea of estimating a unique set of international prices and these, like constant prices in a time series, are then used to revalue expenditures in each country. GK is based on the simple idea of estimating a unique set of international prices and these, like constant prices in a time series, are then used to revalue expenditures in each country. There are i to n products and j to C countries; G refers to the group of countries. The group (international) price of each product is a quantity-weighted average of the prices in the C countries with these prices converted to a common currency by the PPP. GK is based on the simple idea of estimating a unique set of international prices and these, like constant prices in a time series, are then used to revalue expenditures in each country. There are i to n products and j to C countries; G refers to the group of countries. The group (international) price of each product is a quantity-weighted average of the prices in the C countries with these prices converted to a common currency by the PPP.

34. Geary-Kharmis (GK) Method There are i to n products and j to C countries; G refers to the group of countries. The group (international) price is a quantity-weighted average of the prices in the C countries with these prices converted to a common currency. The PPP is defined as: There are i to n products and j to C countries; G refers to the group of countries. The group (international) price of each product is a quantity-weighted average of the prices in the C countries with these prices converted to a common currency by the PPP. There are i to n products and j to C countries; G refers to the group of countries. The group (international) price of each product is a quantity-weighted average of the prices in the C countries with these prices converted to a common currency by the PPP.

35. Geary-Kharmis (GK) Method - Problem Gerschenkron effect Tends to overstate the volumes of countries whose relative prices are very different from the uniform set of prices. Tends to resemble the price structure of the larger and richer countries in the group. Volume measures obtained for poor countries appear artificially large. A problem with GK is that because it uses a uniform set of prices to value quantities in each country, it is affected by the Gerschenkron effect. (Alexander Gerschenkron was a Russian-born economist who worked at Harvard University in the United States. He identified what became known as the Gerschenkron effect in a 1947 article.) The Gerschenkron effect is the tendency for GK PPPs to overstate the volumes of countries whose relative prices are very different from the uniform set of prices. The uniform set of prices used for GK is a quantity weighted average of all countries� prices and so it tends to resemble the price structure of the larger and richer countries in the group. As price structures are generally quite different in poor countries, the volume measures obtained for poor countries using GK PPPs appear artificially large. A problem with GK is that because it uses a uniform set of prices to value quantities in each country, it is affected by the Gerschenkron effect. (Alexander Gerschenkron was a Russian-born economist who worked at Harvard University in the United States. He identified what became known as the Gerschenkron effect in a 1947 article.) The Gerschenkron effect is the tendency for GK PPPs to overstate the volumes of countries whose relative prices are very different from the uniform set of prices. The uniform set of prices used for GK is a quantity weighted average of all countries� prices and so it tends to resemble the price structure of the larger and richer countries in the group. As price structures are generally quite different in poor countries, the volume measures obtained for poor countries using GK PPPs appear artificially large.

36. Purchasing Power Parities - The Steps

37. Linking regions for Global Comparison The previous steps done independently by each of 6 regions

38. Ring to link regions Combine regional lists to create new set of global specifications Updated regional SPDs to global set Supporting software Develop linking methodology�see ICP Handbook www.worldbank.org/data/icp

39. Number of items priced by region Need to add column for the Eurostat/OECDNeed to add column for the Eurostat/OECD

40. Results Published by Three Regions LAC�Full GDP�10 countries Asia�Full GDP�23 countries Africa�Consumption�48 countries Remaining to follow Oct/Nov. for regional data. Global results--December

41. Examples how PPPs are used

42. Examples how PPPs are used

43. Other Applications of PPPs

44. Sustainability�www.worldbank.org/data/ICP ICP Handbook and Operational Manuals Software and supporting documentation Numerous research papers Newsletter

45. Thank you Questions????????????????/

46. Fundamental Principles of the ICP Comparability of results between countries Common understanding of data sharing and confidentiality No other international statistical program requires as much cooperation between international, regional and countries

47. The ICP: New Benchmark Estimates Includes over 100 countries plus adding in 40+ Eurostat/OECD � 1000+ items priced New methods of data collection and estimation will improve quality New PPPs will allow recalibration of estimates of poverty and sizes of economies

48. Table 3. CO� emissions per unit of GDP(tons per Dollar of GDP) Because GDP(PPP) measures volumes, it is used in comparing key ratios between countries where the numerator or denominator is also expressed in volume terms: CO� emission per unit of GDP; Energy consumption per unit of GDP; GDP per employee; GDP per hour of work�. Quite different � and misleading � results are obtained if GDP (exchange rates) is used. The table above is from Key World Energy Statistics 2006 (International Energy Agency, Paris 2007). It refers to CO� emissions from energy use. This is a commonly used environmental indicator showing how much pollution is generated per unit of output. Using the correct measure based on PPPs gives a quite different picture from the incorrect measure based on exchange rates: For example, exchange rates show India�s GDP as three times more �polluting� than that of the United States. Using the (correct) PPP measure shows that its CO� emissions are only about two-thirds of the US level per unit of GDP. Because GDP(PPP) measures volumes, it is used in comparing key ratios between countries where the numerator or denominator is also expressed in volume terms: CO� emission per unit of GDP; Energy consumption per unit of GDP; GDP per employee; GDP per hour of work�. Quite different � and misleading � results are obtained if GDP (exchange rates) is used. The table above is from Key World Energy Statistics 2006 (International Energy Agency, Paris 2007). It refers to CO� emissions from energy use. This is a commonly used environmental indicator showing how much pollution is generated per unit of output. Using the correct measure based on PPPs gives a quite different picture from the incorrect measure based on exchange rates: For example, exchange rates show India�s GDP as three times more �polluting� than that of the United States. Using the (correct) PPP measure shows that its CO� emissions are only about two-thirds of the US level per unit of GDP.

50. Number of products to price in each Basic Heading Depends on homogeniety of products with the Basic Heading Fish and sea food vs. Milk and eggs Time and cost also factors Need 5 minimum up to 20+

51. Why We Need New Estimates of PPPs Existing PPPs are based on price surveys carried out during the 1993-96 period and updated by comparing domestic price levels They include estimates for countries that did not participate. For example, China, India, and many African countries were not included in the previous surveys Size and structure of economies have changed

52. Multilateral Comparison

54. The cheese PPP is then averaged with other food PPPs to obtain an overall �food PPP� using expenditure weights. The food PPP is averaged in turn with the PPPs for other things that households buy to obtain a PPP for �total household consumption expenditure�. Expenditures used to compute weight average. The process is continued up to the level of total GDP. IMPORTANT POINT No weights were used to get the �cheese PPP�, but for aggregation after the Basic Heading level expenditure weights are available and the PPPs for �food�, �household consumption expenditure�, etc are weighted averages. But whose weights? The weights for countries A and B are both equally valid, so we calculate two weighted averages � one using A�s weights and another using B�s weights and the final PPP for � say �food� � is the geometric average of these two weighted averages.The cheese PPP is then averaged with other food PPPs to obtain an overall �food PPP� using expenditure weights. The food PPP is averaged in turn with the PPPs for other things that households buy to obtain a PPP for �total household consumption expenditure�. Expenditures used to compute weight average. The process is continued up to the level of total GDP. IMPORTANT POINT No weights were used to get the �cheese PPP�, but for aggregation after the Basic Heading level expenditure weights are available and the PPPs for �food�, �household consumption expenditure�, etc are weighted averages. But whose weights? The weights for countries A and B are both equally valid, so we calculate two weighted averages � one using A�s weights and another using B�s weights and the final PPP for � say �food� � is the geometric average of these two weighted averages.

55. Different methods can be used EKS�Elteto, Koves, and Szulc Provides results that are base country invarient and transitive CPD�Country Product Dummy Regression method-results are invarient and transitive Provides measures of variability Used for this round Both provide same results if there are no missing prices

57. Statistical basis of the ICP

58. Statistical basis of the ICP

59. What are PPPs? Purchasing Power Parities based on relative price levels between countries A method to convert national GDPs to a common currency for comparison purposes using national prices instead of exchange rates

60. Statistical basis of the ICP

68. Statistical basis of PPPs

69. The Steps

72. Gaps - not all types of rice are sold in all countries A/B rice PPP may be based on a different set of rice products from the A/C and B/C rice PPPs Set of PPPs will not be consistent with each other. They are not �transitive.� PPPA/B ? PPPA/C * PPPC/B Comparison between any two countries should not depend upon choice of base country A Complication A complication: In the example, all three countries supplied prices for all three types of cheese. In practice there are usually gaps because not all types of cheese are sold in all countries. As a result, the A/B cheese PPP may be based on a different set of cheeses from that used to get the A/C and B/C cheese PPPs. When this happens, the set of cheese PPPs will not be consistent with each other. We say they are not �transitive� � meaning that the A/B PPP is not equal to the product of the A/C and C/B PPPs. There are two ways to make the PPPs transitive � the EKS and CPD methods. These are explained later. A complication: In the example, all three countries supplied prices for all three types of cheese. In practice there are usually gaps because not all types of cheese are sold in all countries. As a result, the A/B cheese PPP may be based on a different set of cheeses from that used to get the A/C and B/C cheese PPPs. When this happens, the set of cheese PPPs will not be consistent with each other. We say they are not �transitive� � meaning that the A/B PPP is not equal to the product of the A/C and C/B PPPs. There are two ways to make the PPPs transitive � the EKS and CPD methods. These are explained later.

73. Calculate Basic Heading Parities Parities are calculated from average prices in national currency for products in each of 155 basic headings of the GDP

75. Moving from Bilateral to Multilateral The parity between A and B can be made transitive by using the indirect comparisons between other countries:

76. Gross Domestic Product Represents size of a country�s economy and structure Per capita measures provide evaluation of economic well-being Compare sizes and components such as investments, between countries to evaluate growth and development Compare income--$1/per day for poverty comparisons.

77. Inter country comparisons of Agricultural measures Total value of production Per capita TVP / GDP comparisons across countries.