One big implication of lower prices is that converting a poor country’s GDP into dollars at market exchange rates will significantly understate the true size of its economy and its living standards. If China’s GDP is converted into dollars using the Big Mac PPP, it is almost two-and-a-half-times bigger than if converted at the market exchange rate. Meatier and more sophisticated estimates of PPP, such as those used by the IMF, suggest that the required adjustment is even bigger.
The global economic picture thus looks hugely different when examined through a PPP lens. Take the pace of global growth. Anyone wanting to calculate this needs to bundle together countries’ growth rates, with each one weighted according to its share of world GDP. Using weights based on market exchange rates, the world has grown by an annual average of only 1.9% over the past three years. Using PPP, as the IMF does, global growth jumps to a far more robust 3.1% a year.
The main reason for this difference is that using PPP conversion factors almost doubles the weight of the emerging economies, which have been growing much faster. Measured at market exchange rates, emerging economies account for less than a quarter of global output. But measured using PPP they account for almost half.
Small wonder, then, that global economic rankings are dramatically transformed when they are done on a PPP basis rather than market exchange rates. America remains number one, but China leaps from seventh place to second, accounting for 13% of world output. India jumps into fourth place ahead of Germany, and both Brazil and Russia are bigger than Canada. Similarly, market exchange rates also exaggerate inequality. Using market rates, the average American is 33 times richer than the average Chinese; on a PPP basis, he is “only” seven times richer.
The way in which economies are measured also has a huge impact on which country has contributed most to global growth in recent years. Using GDP converted at market rates China has accounted for only 7% of the total increase in the dollar value of global GDP over the past three years, compared with America’s 25%. But on PPP figures, China has accounted for almost one-third of global real GDP growth and America only 13%.
This helps to explain why commodity prices in general and oil prices in particular have been surging, even though growth has been relatively subdued in the rich world since 2000. Emerging economies are not only growing much faster than rich economies and are more intensive in their use of raw materials and energy, but they also account for a bigger chunk of global output if measured correctly. As Charles Dumas, an economist at Lombard Street Research, neatly puts it, even if a Chinese loaf is a quarter of the cost of a loaf in America, it uses the same amount of flour.
All measures of PPP are admittedly imperfect. But most economists agree that they give a more accurate measure of the relative size of economies than market exchange rates—and a better understanding of some of the dramatic movements in world markets. The humble burger should be part of every economist’s diet.