The world is poorer than we thought

In: Uncategorized

19 Nov 2007

Today’s Fund Strategy includes a comment by me on the revision of statistics on the size of Chinese and Indian economies.

Last week’s biggest economic news got hardly any attention. Both China and India are about 40% smaller than they were. Also global economic growth was half a percentage point less than previous assumed. Never mind the Bank of England possibly reducing interest rates by a little bit at some point in the future. This was shocking.

Of course, the Chinese and Indian economies have not literally shrunk. What has happened is that more accurate statistics are becoming available which give a better idea of the size of their economies.

Nowadays growth statistics are often quoted on a purchasing power parity (PPP) basis. This means that the figures are adjusted to take into account different price levels in different countries. So a dollar in America can buy a lot less than its equivalent in China.

The truth is that until now the PPP statistics have largely been based on guesswork. So it turns out that the size of the Chinese and Indian economies has been substantially over-estimated. And since these are large components of global growth it means the world GDP figures are exaggerated too.

Such statistical revisions do not change reality but they do make some comparisons starker. For example, they show that both China and India are considerably poorer than previously assumed. Not only is the average income level lower but the number of people below the standard $1 a day threshold is much higher.

It is a sobering thought that, according to the new data, China’s average GDP per head is only 10% of the American level. China may be growing rapidly but its living standards remain well below America’s.

Another lesson from this revision is that it is generally better to compare the relative sizes of economies by using GDP at market exchange rates rather than PPP. This may seem a small technical detail but it can make a huge difference to the numbers.

Since countries trade and invest with each other at market rates, these provide the most meaningful comparisons of the relative weights of national economies. Judging on a market exchange rate basis the Chinese economy is still only fourth largest in the world rather than second.

PPP statistics have their uses. But they are more appropriate for comparing living standards between different countries than comparing their relative economic weights in the world.

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