Will China become largest economy? …playing with and understanding PPP

There was recent news on how China will takeover US as the largest economy in 2014. Well this will be in PPP terms.

Kaushik Basu, World Bank’s chief econ has this interesting piece on the issue.

A fascinating feature of purchasing power parity (PPP) is more people hold an opinion on it than know what it means. This was in ample display last week, when the Global Office of the International Comparison Program (ICP), hosted by the World Bank, announced the latest PPP data for the world, pertaining to 2011. 

Putting aside complexities, PPPs may be viewed as an estimate what one US dollar can buy in different countries. In case a dollar in Ghana can buy three times what it can buy in the United States, then a person who earns 1,000 dollars each month in Ghana is said to earn 3,000 in terms of ‘PPP-adjusted dollars’. The calculation of PPPs is a massive exercise, involving the collection of detailed price statistics from around the world, followed by complex computations to work out the relativities.  Not surprisingly, the release of this data was widely anticipated and gave rise to newspaper headlines and front page stories around the world.

PPPs come laced with fun facts. It was discovered that compared to the last time PPPs were computed, in 2005, the economic geography of the world has changed considerably. The US is still the largest economy in the world but China is pretty much on its heels. In 2005, India was the fifth largest economy in the world, behind US, China, Japan and Germany. By 2011, it was the third largest having crossed Japan and Germany. Indonesia, which was a little over one third the size of Italy in 2005 PPP terms, was completely on par with it by 2011. 

In his typical humor, he predicts (with caution) the exact date when China will takeover US:

But what grabbed the headlines last week were estimates based on back-of-the-envelope calculations that extrapolated from the 2011 data, something popular news outlets were quick to do. Thus The Economist, the Financial Times and many others announced how this year the Chinese economy is expected to surpass the United States’ economy, in terms of PPP-adjusted GDP. Fun with PPPs can be taken a step further by asking when exactly this will happen. According to the World Bank’s most recent published forecasts, US and China will grow in 2014 by, respectively, 2.8% and 7.7%. Using these to compute the daily growth rates and adjusting the GDPs with the recent PPP numbers, it can be shown that China’s economy will overtake the American economy on November 2nd this year. I have not yet been able to determine the time of day. And for those with an interest in astrological diversions, I may point out that November 2nd happens to be the birthday of the Chinese emperor Huizong (1082) and the 11th US President, James Knox Polk (1795).

While the above calculation is done carefully and is mathematically valid, it is important to understand that computing PPPs entails several assumptions and so we need to exercise utmost care in interpreting the numbers and the forecasts. 

lol 🙂

He then gets into the limitations of these calculations and why being largest does not mean you are the richest/poverty-free etc..

Nice stuff..

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