The Absence from Public Discourse of Evaluations of GDP based on Purchasing Power



Walter Stanners         Home       Date: 13th June 2003


ABSTRACT.     Politicians, journalists - commentators on economic matters generally - evolve a sort of quasi-stable rhetoric. They select two or three foreign countries with which they like to compare their own, either as models to be followed, or traps to be avoided. Other countries are rarely or never mentioned. They repeat over and over again mantras such as "we are the fourth largest economy in the world" in the UK, or variants of "the dot.com revolution" or "the new paradigm" in the USA. In arguments in the UK over the replacement of sterling by the Euro, it is almost a daily occurrence to hear growth in the UK contrasted with recession in Eurozone Germany. It appears likely that these stories emerge in part from appraisals of GDP expressed for the purpose of cross-country comparison in a currency unit (the Euro or dollar, say) calculated at the ruling rate of exchange. This calculation can be done instantly. It is "news". The more recent method of using purchasing power is much more complex and its results are published late. They are not "news", and do not affect the established rhetoric. Nevertheless, they are the truth, or as near to that as economic data can be, and often quite strikingly at variance with the current story.
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Introduction

Is the UK the fourth largest economy in the world as both government and opposition politicians of that country are fond of saying, the former as a boast, the latter as a preamble to complaining about the state of the hospitals, railways, etc? Is the USA motoring ahead, widening the gap with the rest of the world? Is Italy lingering behind the leading EU nations? Would it be a grave mistake, as UK newspapers and politicians are stating at present, for the UK to adopt the Euro currency when the UK is at present growing while the Eurozone is stagnating? At any given time, the world view is being shaped by a sort of chorus, in which vague but persistent and near-universal positions are, not argued or demonstrated, but merely propagated by the endless repetition of and re-echoing of standard phrases. Presumably these phrases originated in forgotten sources of factual data, but only “facts” which fit the required rhetoric are preserved, repeated and amplified. They are usually not retailed as the central story, but as received background, to be worked in as throwaway phrases.

The origin of these notions cannot be certain, but it seems from their nature that those relating to economics rely heavily on GDP statistics obtained from tables which present cross-country data in units of a standard currency, say the US dollar or the Euro, the conversions being done at ruling currency exchange rates. Such statistics inevitably reflect the volatility of the currency market, so much so that it is rather odd that official bodies continue to publish such numbers. On this basis the fourth largest economy of the world could easily become the sixth largest almost overnight, while nothing changes that any citizen of that country would notice.

The attraction of GDP expressed in a standard currency, presumably, is that the underlying calculation is “transparent”. The calculation of GDP for each country is in itself highly un-transparent, but the hugely expensive procedures needed can be afforded only by the state, so there is not much room for argument. Merely to tabulate more or less unquestioned national GDP data, converted into a foreign currency using the uncontroversial, published, and immediately available, market exchange rate is an easy, cheap, quick, and trouble-free option.

The use of Purchasing Power Standards (PPS), i.e., the use of a unit related to purchasing power rather than to supply and demand in the currency markets, has achieved prominence only relatively recently. To an outsider, the immense difficulties can only be imagined. First, the data involved are available only within the statistical offices of each country, and second, it is by no means clear what “basket” of goods should figure in the cross-country conversion matrix - it might even be argued that a different basket is needed depending on what use is to be made of the result which emerges. The complexities also mean that the results come late (see footnote), a fact which may also imply that it is the quick results which fashion the public myths. The truth rarely catches up.

Be all that as it may, Keynes’ observation applies. It is better to be approximately right than to be precisely wrong, and it is abundantly clear that cross-country comparisons using precise market currency conversion rates are too volatile ever to be right.




The evidence

In what follows, the data published by the European Commission for GDP and GDP per head, in Euros and in PPS (Purchasing Power Standard) are used. It should be noted that even within the Eurozone of 12 countries, the purchasing power of the currency used, the Euro, varies quite markedly from country to country. The European Commission data include of course the 3 EU countries which are not in the Eurozone (the UK, Sweden and Denmark), and also, for comparison, data for the USA and Japan. To what extent US and Japanese officials are in agreement with the Commission’s PPS data is unknown to the author.



A glance at figure 1 illustrates many of the points mentioned above.


Figure 1. GDP per head in Euro (full line) and PPS (dotted line). US-blue. Japan-brown. Italy-red. For both Euro and PPS, EU=100



Even from a simple common-sense view, the three relatively stable dotted lines (PPS) are more plausible than the much more volatile full lines (Euros).

The EU (meaning the 15 countries which now make up the EU) did indeed close the living-standards gap with the US from 1960 to 1980, but at nothing like the rate shown using currency conversion rates. Since 1980, virtually nothing has happened to this gap (according to this PPS data), contrary to the universal cacophony of comment on the new paradigm of US growth (dot-com, high-tech, etc.) from 1995 to 2000 (now more muted of course).

Japan is shown not to have been so poor, and never to have become so rich, as was thought. It has never come near to US levels. On the other hand, the downturn (remembering always that this is measured relative to the EU) from 1996 onwards is shown to be real.

Italy, which in the public discussion of economic progress is for some obscure reason virtually never mentioned in any capacity whatever, is shown to have marched steadily upwards during this 40-year period, is now above the EU average in GDP per head in PPS terms, and is apparently about level with Japan.



What about the other three large EU countries, Germany, the UK, and France? The data are shown in figure 2.


Figure 2. GDP per head in Euro (full line) and PPS (dotted line). France-blue. UK-brown, Germany-red. For both Euro and PPS, EU=100



Again, it is seen that that the curves for GDP per head in Euros, while not so volatile as the US and Japanese ones, are much more so than those based on PPS.

For a not-too-young UK reader, the most noticeable feature of the UK's PPS-based curve, is that nothing much happened, relative to EU levels, between 1974 and 2002, in spite of the enormous hoop-la associated with “the winter of discontent” and the “Thatcher miracle”. The UK just more or less kept up with the rest of the EU throughout. If there was a notable turning point in British economic progress, it would appear to be, not in 1979, when Mrs. Thatcher became Prime Minister, but in 1974, the beginning of the ill-starred Wilson/Callaghan government, when the decline of the UK relative to the EU apparently halted. In recent years, presumably it is the very rapid nominal rise of the UK’s GDP which has given rise to the myth of the world’s 4th economic power, the nominal rise being due to the strong pound (or the weak Euro). The UK’s real relative living standards have if anything tended to fall somewhat. There is no evidence in this graph that the UK is in real terms doing noticeably better or worse, in recent years, than the Eurozone.

Germany in PPS terms has followed a path of gradual decline, relative to the EU average, over the 40-year period. France too follows a fairly smooth path, in this case one of rise and then fall. At no time in this period has France surpassed Germany in living standards, not even in and after 1991 when the (then West) German level was reduced by amalgamation with the DDR. After 1968, the French level remained very significantly above the UK level until recent years when it fell very near the EU average, where Britain had been, more or less, since 1974.



Showing all the data of figures 1 and 2 on one graph would result in an incomprehensible tangle of lines. In figure 3, the data for GDP per head, in units of PPS only, are amalgamated for all six countries.


Figure 3. GDP per head in PPS. France-green. UK-pink. Germany-red. US-light green. Japan-brown. Italy-blue. EU=100.



It is striking that apart from the US, the five others have in 40 years converged from quite a wide spread, to living standards which are, within 5 percentage points, more or less identical. The US seemed for about 15 of these years to be taking part in this process of convergence, and then stopped - that is, its real growth rate in living standards recovered to about the same as that of the European Union, and has remained so for the last 25 years. Of course, this observation regarding the convergence of the four others depends on the marked slowing of growth rate in Japan in the last 5 or 6 years, and on the sudden fall in the German figures in 1991 due to re-unification.

To eyes used to years of British or Anglo-Saxon commentary, the position regarding Italy is quite remarkable. The usual Anglo-Saxon story is that while serious figures like Macmillan, Willy Brandt, and Greenspan wrestle with varying degrees of success with our economies, Italian leaders come and go with such dizzying speed that they have no time to get to grips with anything. So it is odd to notice that this country, which like re-unified Germany has great regional disparities, has steadily drawn level with the UK around 1980, and with France around 1995, and is by this measure now among the leaders. This being so, the position in the world league table, of “economies” other than the US, depends almost entirely on population, with Japan clearly ranking second, and Germany third.



In figure 4, the data for GDP per head, in units of Euros at current rates of exchange, are amalgamated for all six countries.


Figure 4. GDP per head in Euros. France-green. UK-pink. Germany-red. US-light green. Japan-brown. Italy-blue. EU=100.



No detailed commentary will be given. The greater volatility is evident. The comparative trajectories of the US versus Japan, and Italy versus the UK, are radically different from the relation conveyed by the “real” data in figure 3.



The following tables 1-3 give data for the year 2002, for the 6 “largest economies of the world”, the USA, Japan, Germany, the UK, France and Italy. The three tables all contain exactly the same data, but are ranked according to the value of three different parameters, the GDP in Euro, the GDP in PPS, and the GDP per head in PPS.

Tables 1, 2, 3. Main parameters for 6 leading countries. EU=100 for all parameters.



The populations of the US, Japan and Germany place them by any measure as the three largest economies of the world (Tables 1 and 2).

Table 1 shows that GDP, evaluated at current exchange rates, ranks the UK quite distinctly in 4th place. France, and Italy, trailing behind by very clear margins, 9 and 24 percentage points respectively. Presumably it is these figures which have launched "the fourth largest economy of the world" into the standard rhetoric of British comment.

Table 2 gives a totally different and truer impression, based on rankings using GDP in PPS units. Now France is nominally the “4th largest economy in the world” (one wonders, are French politicians aware of this?). Italy is still 6th. But the margins involved are quite insignificant, given that the placing of a number on GDP is in any case an inexact science. If the UK is re-based to UK=100, France is placed at 100.5, Italy at 99.6. In effect, none of these three countries can claim on a realistic basis to be the “4th largest economy in the world”. They are all 4th equal (are Italian politicians aware of this?).

Table 3 ranks the countries by PPS per head, or standard of living. The USA, of course, heads the list again. The spread among the five trailing countries is not great - less than 5 percentage points from top to bottom. Italy does, however, lead those five, along with Germany and Japan. To the author of this note, it speaks volumes about the objectivity and scientific basis of general comment on economic matters, that over the last several decades, there has been endless analysis of the lessons to the world of the Japanese and German economies (as well as that of the US), and the odd mention of the UK and France, but total silence on Italy.



In order to give a fuller picture, including the smaller countries of the European Union, from Spain downwards, a further three figures are given, all in terms of GDP per head in terms of PPS (EU=100).

The first, figure 5, represents six of the richer countries of the EU, apart from the “big four” already presented.


Figure 5. GDP per head in PPS. Denmark-green. Holland-pink. Belgium-red. Austria-light green. Sweden-brown. Luxembourg-blue. EU=100.

The tiny state of Luxembourg (less than half a million people) can be ignored, since totally untypical regions of this size could be found within almost any country of the EU. The remainder show convergence, Denmark and Sweden losing ground relatively, Austria gaining ground to catch up. It is not suggested, of course, that convergence has to do with the EU - Denmark joined in1973, Austria and Sweden in 1995.





Figure 6 shows six “poorer” countries, this term being stretched to include Finland, which was not much poorer than Austria in 1960, and Japan, which began relatively poor in the period covered.


Figure 6. GDP per head in PPS. Spain-green. Portugal-pink. Greece-red. Finland-light green. Japan-brown. Ireland-blue. EU=100.



Ireland is highly anomalous for reasons which are not clear to the author. Although a number of glib explanations are current for its phenomenal growth since 1986, it is by no means clear why they do not apply to other countries or regions. One way in which it shows anomaly is that of all the countries covered, it has by far the largest share of GDP “exported” (net) as the earnings of foreigners. This factor means that although GDP per head in PPS in 2002 is near 120 (EU=100), the standard of living of inhabitants is more like 105. According to these figures, the progress of Ireland and Japan during those 40 years has been similar, although by very, very different trajectories. It can be seen that, leaving Ireland and Japan aside, the other countries have by less spectacular routes gained from 20 to 30 percentage points relative to the EU average in the period covered, with, in the case of Spain Portugal and Greece, as much again still to go.



Figure 7 shows all the data for the 17 countries, limited to GDP per head in PPS, in an attempt to show something like the whole picture.


Figure 7. GDP per head in PPS. 17 countries, US to Luxembourg. EU=100.



It is seen that if we exclude Luxembourg on grounds of its smallness, and the US on grounds of its god-given size, geographical, agricultural and mineral resources, and historical luck, 12 other countries have converged from a spread of 40 or more percentage points to one of half that. The remaining three countries, Spain, Portugal and Greece, have closed the gap between themselves and the richer countries very considerably. Even the US has lost about 20 percentage points of its initial advantage, but has maintained that new relative position for the last 3 decades



Conclusions

Politicians, journalists - commentators on economic matters generally - evolve a sort of quasi-stable rhetoric. They select two or three foreign countries with which they like to compare their own, either as models to be followed, or traps to be avoided. Other countries are rarely or never mentioned. They repeat over and over again mantras such as "we are the fourth largest economy in the world" in the UK, or variants of "the dot.com revolution" or "the new paradigm" in the USA. In arguments in the UK over the replacement of sterling by the Euro, it is almost a daily occurrence to hear growth in the UK contrasted with recession in Eurozone Germany. It appears likely that these stories emerge in part from appraisals of GDP expressed for the purpose of cross-country comparison in a currency unit (the Euro or dollar, say) calculated at the ruling rate of exchange. This can be done instantly. It is "news".

The more recent method of using purchasing power is much more complex and its results are published late (see footnote). They are not "news", and do not affect the established rhetoric. Nevertheless, they are the truth, or as near to that as economic data can be, and often quite strikingly at variance with the current story.

Thus, since 1974, the US has not increased, but simply maintained the gap in living standards between itself and the EU. In the last four years, it has if anything lost ground, but, expressed in neutral terms, it is too early to say that this is a trend. Similarly, the UK, also since 1975, has merely kept pace with the EU average. Germany, like the UK, has declined over the years to around the EU average, but by a different route, and helped on its way very much by the re-unification of 1991. As to current talk of German or Eurozone "recession" (supported, it must be said, by the native German rhetoricians), or, by contrast, talk of UK growth, there is simply no convincing evidence. Gordon Brown gets a very good press for rhetoric, but the figures show no evidence of his presence.

Italy, almost unobserved by the commentators, has shown almost uninterrupted progress. Contrary to British claims, or rather re-iterated and unargued statements, about being "the fourth largest economy in the world", Italy now shares with France and Britain the rank of 4th equal in terms of living standards multiplied by population. Japan, on the other hand, does conform to the general story of its relative decline. It reached a peak of prosperity in 1993, maintained this, relative to the EU, until 1997, but since then has declined (relatively) to a level similar to that of Italy and Germany, around 4 percentage points above the EU average.

A striking feature of the data, when seen as a whole as in figure 7, is that, if the tiny state of Luxembourg is excluded, there is no country which is exempted from the tendency towards convergence, poor countries tending to grow faster than the rich ones.

Footnote (added 9th June 2004):

I quote from the Eurostat Statistics in Focus, KS-NJ-04-027-EN-N, May 2004, "GDP per capita in Purchasing Power Standards for EU Candidate Countries and EFTA":

“A frequent user complaint was that the PPP results came too late for their purposes and that there were no early estimates available. Until 2003, preliminary PPP results for the reference year T were only available 12 months, and final results 24 months, after the end of the reference year.”



Bibliography

European Economy No 6/2002, The European Commission.




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