What’s
the biggest economy on earth?
When the Group of 20 met in Hangzhou for an economic
summit last weekend, the United States media was fastidious about putting China
in its proper place. The Washington Post daily
repeated, as relentlessly as a drumbeat, that China was “the second largest
economy.” According to The New York Times,
the People’s Republic “is determined to show the world that it is an equal
partner in one of the most exclusive clubs of wealthy nations….Not for the
first time, officials want to demonstrate to people at home and abroad that
China, the world’s second-largest economy after the United States, deserves a
bigger role in global governance.”
There is only one problem with these bromides. China
is the largest economy and has been
since 2014. No wonder the Chinese forgot to provide a gangway for the
presidential entourage to clamber down from Air Force One.
The error occurs because the press ranks economies in
a way that economists rejected decades ago. That is to adjust the value of a
nation’s annual production (gross domestic product) by using the current
exchange rate. Suppose that GDP in Kazakhstan is 10 trillion tenge and that the
exchange rate is 200 tenge per US dollar. Then the dollar value of GDP is 1
trillion tenge divided by 200 tenge per dollar, or $50 billion.
The flaw in this method is that the exchange rate may
vary for reasons that have little to do with the nation’s ability to produce. For
example, in August 2015 the central bank of Kazakhstan decided to let the
market determine the exchange rate of tenge per dollar; up to that point, the
National Bank had held the exchange rate within a corridor. Overnight, the
dollar value of the tenge plunged by more than a fourth. But Kazakhstan’s
productive capacity certainly didn’t fall by this much.
Numlock
Rather than use the current exchange rate, economists
recommend an approach that mirrors productive capacity more closely. This is a
metric that has the same value, in terms of output, in any country. For
example, suppose that we are measuring national production in terms of
newspapers. Also suppose that a newspaper costs $1 in the US and 100 tenge in
Kazakhstan. Then our metric for comparing American and Kazakhstani production
is 100 tenge per dollar, regardless of the actual exchange rate of the moment (340
tenge per dollar, as we speak). To calculate the dollar value of Kazakhstan’s
economy, we will divide its tenge GDP by 100. For obvious reasons, the idea behind
this metric is called purchasing power
parity.
Here’s a simple example. Suppose that Rich Country has
a GDP of $1,000; and Poor Country has a GDP of $100 at the current exchange
rate. Also suppose that a newspaper costs $1 in Rich Country and $.50 in Poor
Country. Then, adjusted for purchasing power parity, GDP is equivalent to 1,000
newspapers in Rich Country and 200 newspapers in Poor Country.
In reality, economists base PPP on a bundle of typical
products -- not on just one good like a newspaper. But you get the idea.
The World Bank provides measures of parity for nations,
online for free. Table 1 shows the lineup for 2015. Adjusted with PPP, gross
domestic product in international dollars is higher for China than for the
United States. (The international dollar is the price, in local currency, of a
bundle of goods that would cost $1 in the US.) China’s GDP is 19.5 trillion
international dollars; that of the US, 17.9 trillion.
Rank
|
Nation
|
ID
|
1
|
China
|
19.5
|
2
|
United
States
|
17.9
|
3
|
India
|
8
|
4
|
Japan
|
4.7
|
5
|
Germany
|
3.8
|
6
|
Russia
|
3.6
|
7
|
Brazil
|
3.2
|
8
|
Indonesia
|
2.8
|
9
|
United
Kingdom
|
2.7
|
10
|
France
|
2.65
|
Table 1: The 10
biggest economies in 2015, measured in trillions of international dollars of
GDP.
Data
source: World Bank, World Bank Indicators.
Well, surprises galore. Of the G7 nations, which
journalists call the “rich man’s club,” only 5 are among the 10 biggest
economies (the US, Japan, Germany, the United Kingdom and France). This is
largely because the biggest economies are often big because of population
rather than individual affluence. Moreover, of the 10 largest economies, 4 are
in Asia (or 5, depending on whether you classify the Russian Federation as in
Europe, Asia or Hades). There’s your pivot. Finally, 4 are among what used to be called "developing
countries." So much for the American Century.
Why do journalists still refer to the US as the
biggest economy? Because of the occupational hazard of journalism –
intellectual inertia. Why bother to check the facts when you have the mantra
down pat, especially when all the other journalists are chanting it, too?
There may be a murkier reason. The White House surely
knows of parity, and the puzzle is why it doesn’t correct reporters who still
refer to China as second banana. Hmm…I seem to remember that this is an
election year. China became the largest economy on President Barack Obama’s
watch, although he didn’t have much to do with it. Pointing out the event might
give the Republican Party candidate, Donald J. Trump, a card to play against
the Democratic Party candidate, Hillary Clinton. God knows he’s holding a weak hand. –Leon Taylor, tayloralmaty@gmail.com
Notes
Technically, the theory of purchasing power parity
holds that changes in the exchange rate will ensure that a given bundle of
goods will eventually have the same price in any country in a given
currency. Suppose, for example, that the
bundle costs $1 in the United States and 100 tenge in Kazakhstan. Then the
exchange rate will go to 100 tenge per dollar. At that rate, the bundle will
sell for $1 in either country – or, if you prefer, for 100 tenge in either
country.
This proposition is logical. Suppose, for example,
that the current exchange rate is 200 tenge per dollar. Then the bundle’s price
is $1 in the US but $.50 in Kazakhstan. Since the bundle is cheaper in
Kazakhstan, people will demand tenge (and sell dollars) in order to buy it
here. The tenge will gain value in terms of dollars until the exchange rate
becomes 100 tenge per dollar. The bundle will now sell for $1 (or 100 tenge) in
either the US or in Kazakhstan. That’s parity.
In the real world, the theory of purchasing power
parity rarely holds, especially in the short run; for a good discussion, see the textbook by Kaufman,
Obstfeld and Melitz. But because parity is logical, it provides a useful way to
compare the output value of two countries.
For its GDP estimates, the World Bank calculates exchange rates as if
parity held.
References
Paul Krugman, Maurice Obstfeld, and Marc Melitz. International economics: Theory and policy. Ninth
edition. Addison-Wesley. 2012.
Jane Perlez and Yufan Huang. China, eager to host
elite club, primps for G-20 meeting. New York Times. August 30, 2016.
World Bank. World Development Indicators.
worldbank.org
No comments:
Post a Comment