What Will We Know And When Will We Know It?

By Simon Johnson

One of the most basic questions in economics is: Which countries are rich and which are relatively poor?  Or, if you prefer a highly relevant question for today’s global situation, who recovers faster and sustains higher growth?

The simplest answer, of course, would be just to compare incomes – i.e., which country’s residents earn the most money, on average, at a point in time and how does that change over time? 

But prices differ dramatically across countries, so $1,000 in the United States will generally buy fewer goods and services than would the same $1,000 in Guinea-Bissau (although this immediately raises issues regarding consumer’s preferences, the availability of goods, and the quality of goods in very different places.)

The standard approach developed by economists and statisticians, working with great care and attention to detail on a project over the past 40 years known as the “Penn World Tables”, is to calculate a set of “international prices” for goods – and then to use these to calculate measures of output and income in “purchasing power parity terms.”  For countries with lower market prices for goods and services, this will increase their measured income relative to countries with higher market prices (with Gross Domestic Product, GDP, per capita being the standard precise definition, but components and variations are also calculated along the way).

Some of the limitations inherent in the Penn Tables are well known.  But it turns out there are other, quite serious issues, that should have a big effect on how we handle these data – and how doubtful we are when anyone claims that a particular country has grown fast or slow relative to other countries.

The Penn Tables are based on collecting detailed price information – what it actually costs to buy all kinds of things in different places.  But the basic problem is that the people running the Tables do not have access to such data for all years and all countries – so they have to make a number of moderately heroic assumptions.

In “Is Newer Better?”, we show that a particular technical issue – the extrapolation of estimated price levels backwards and forwards in time – has a big impact on estimated GDP.  This in turn changes, dramatically in some cases, the calculated growth rates for particular countries; and these changes can be huge for smaller countries with less good data, particularly when the year in question is quite far from the moment when prices were actually “benchmarked” though direct observation.

Just to illustrate our point, in Table 1 we show that the ranking of growth rates – e.g., top 10 and worst 10 countries, in terms of growth performance – within Africa, from 1975 to 1999, is completely different if you use Penn World Tables version 6.1 or if you use version 6.2.  Just speaking for ourselves, we were quite shocked by these differences – and consequently spent a long time digging through the details (see the appendices of the paper for much more than you wanted to know about how this kind of sausage is made).  We’ve also tried to figure out exactly how much these issues matter both for how people have studied growth in the past (to do this, we replicated and checked the robustness of 13 influential and indicative papers), and for how to think about (and measure) economic success and failure moving forward.

Our bottom line is: while the Penn Tables are reasonably reliable for comparing changes in income level over long periods of time (e.g., 30-40 years), they are much less appealing – and results based on them will generally not be robust – as a source for annual data.  You should regard claims based on such annual data with a great deal of skepticism.

We also suggest there is a different and – for some purposes – better way to use the information in the Tables (see Section 6 of our paper).  In essence, we suggest combining estimated GDP levels directly from the Tables, rather than using the standard (and problematic) extrapolation method.

Looking at annual growth rates from national statistics is fine – or at least raises different issues – for thinking about short-term growth dynamics (i.e., who is in crisis, who is recovering, who may be overheating).  But for considering longer-run comparisons, say over 5-10 years or longer, you unfortunately cannot avoid worrying about comparable prices and some sort of purchasing power adjustment.

Whether or not you like our specific proposal, the main takeaway point is the same: do not rely on just one growth series.  Check that your claims (or anyone else’s) hold across different versions of the Penn World Tables, and – if you are focused on annual growth rates – look also at estimates from the World Bank’s World Development Indicators.

If you are interested in these issues more broadly, see the papers presented at the “Measuring and Analyzing Economic Development” conference at the University of Chicago today.

23 thoughts on “What Will We Know And When Will We Know It?”

  2. Of course, for political economists the question of how a country is actually doing is dwarfed by how people in that country THINK it is doing.

  4. This is a tremendously difficult equation to figure, and full of flaws. For example, with all the problems the US has, in general most public tap water is extemely drinkable and cheap, we’re fairly safe from crime and violence, we have access to libraries, public schools and the like, we have fairly dependable electric systems. Contrast that to Eqypt where my Father is currently living. He is extremely rich in relative terms compared to how he would be in the US, because food, clothing, taxis and other services are so inexpensive. He has cleaning people and an arab “friend” who also serves as a driver, bodyguard and tour guide whenever he goes siteseeing or to the areas outside Cairo he doesn’t know very well, he could never afford a guy like that in the U.S. on his earnings. However, he can’t drink the tap water without getting sick, he has to leave Cairo at least once a week or he starts to have breathing problems, his internet service is down for at least a few hours everyday, and they have electric blackouts for a few hours at least once or twice a week.

    By that standard, you could earn very little and still buy things that a much higher salaried person in the US could buy – but all those other things contribute to standard of living. Even the richest man in the neighborhood may find his house has no power for a day out of the blue, or a sudden political action has effectively shut down the city for a couple days – and no amount of income can get him from his house to the market during that time period. There is something to be said for the base starting point we have in the Western world vis-a-vis the “emerging” world. It’s a difficult comparison to make.

  5. Mr. Johnson wrote:

    “One of the most basic questions in economics is: Which countries are rich and which are relatively poor? Or, if you prefer a highly relevant question for today’s global situation, who recovers faster and sustains higher growth?”

    Mr. Socrates wrote:

    “If a man is proud of his wealth, he should not be praised until it is known how he employs it.”

    (469 BC – 399 BC)

  6. Unemployment Extension Fails in Senate

    WASHINGTON, Feb 26, 2010 – excerpts

    (AP) “The Senate failed late Thursday to extend programs for laid-off workers, jeopardizing unemployment benefits scheduled to expire over the weekend.

    The benefits are part of a larger package of government programs, from highway funding to loans for small businesses, set to expire Sunday because senators couldn’t agree on how to pay for an extension.

    The House passed a bill Thursday extending the programs for a month while lawmakers consider how to address the issues long-term. Senate Democrats repeatedly tried to follow suit Thursday night but they couldn’t overcome the objections of a single lawmaker, Republican Sen. Jim Bunning of Kentucky, that the $10 billion bill would add to the budget deficit.

    The bill would extend unemployment payments to laid-off workers and provide them with subsidies to help pay health premiums through the COBRA program. It would extend funding for highway projects and spare doctors from a 21 percent cut in Medicare payments. It would extend a small business loan program, the National Flood Insurance Program and the copyright license used by satellite television providers.

    The Senate adjourned just before midnight with no further votes scheduled until Tuesday. To avoid an interruption in benefits, senators would have to act quickly when they return, a task made difficult by Senate rules that let a single senator slow the process. Bunning vowed to fight the extensions as long as they add to the deficit, though he acknowledged they will probably eventually pass.

    The dispute leaves the programs in limbo as the Senate struggles to overcome partisan bickering over a budget deficit projected to hit a record $1.56 trillion this year. Democrats are eager to address unemployment, with the jobless rate just under 10 percent and congressional elections looming in November. Some Republicans, however, are not eager to accommodate.

    About 1.1 million people will lose unemployment benefits in March if the payments are not extended, according to an estimate from the National Employment Law Project, a group that advocates on behalf of low-wage workers.

    Bunning said his only objection to the bill is its impact on the deficit. He proposed paying for the extensions with unspent money from the massive economic recovery package enacted a year ago, but Democrats objected. ”

    http://tinyurl.com/y922qx5

  9. When Cassandra speaks

    Friday, Feb. 26, 2010 5:36PM EST – Globe & Mail

    “I don’t know what’s going on in the market right now, because it makes no sense to me.”

    The last time Whitney sounded so gloomy might have been in her Citigroup report in October, 2007, and that had an immediate impact. Citigroup shares skidded from about $42 to $33 within days, and CEO Chuck Prince resigned. The share price kept sliding—to below $10 a share in late 2008, where it remains.

    Meredith Whitney (a.k.a. Wall Street’s Cassandra).

    http://tinyurl.com/yhgjq3r

  10. The idea that countries are rich or poor is perhaps interesting; that elites are sabotaging our social contract and papering over the results with fraudulent statistics is important. Why not leave Africa to the Africans and pay closer attention to what is happening here at home?

  11. To answer the former question: could we see ourselves whining and dining on “two all beef patties, special sauce, lettuce, cheese, pickles, onions on a sesame seed bun…” A lacto-vegetarian is willing to consume nominal amounts of meat and dairy but do not go as far as vegans (politically or socially).

    To answer the latter question: “13 Banks” available on March 30th (looking forward to your usual astute and prescient analysis, owning the podium as they say, Simon – our dollars and sense best reflects a boring bank.

  12. Not to get too excited about State unemployment benefits but there is also a little known program in the unemployment brochure that is mailed out after filing for an unemployment claim; the program is entitled (Your state) Training Benefits Program; availability, conditions, and qualifications vary by state and by the person filing, but worth looking into nonetheless….

  13. I implore Mr. Johnson to discuss externalities with us novices. From what I understand about GDP it is no longer a reasonable measure of “rich”. GDP enables continuance of the mindset from which we struggling to recover. The water and air issues are great examples. How can we measure success by growth when growth uses resources at 5 times our only resource can regenerate itself? Or worse, growth dependent on exhausting resources.

    Seems obvious that rich will eventually be determined by who can live within their means (natural capital). Why is it still considered radical to suggest taxing consumption or carbon and eliminating taxes on labor? What am I missing?

    Lastly, let’s stop referring to humans as consumers. Let’s use citizens. American Oxford, Consumption: 1. Using up of a resource. 2. a wasting disease esp. pulmonary tuberculosis (credit to Gil Friend).

  14. Leaving “Africa to the Africans” is a fine-sounding idea. The only problem is that we (Western businesses, primarily) relinquished that choice years ago. African nations are in the calamitous state they’re in largely as a consequence of the plundering of their resources by Western interests. And along with the theft of oil and minerals, etc., has come the crushing ruin of a number of cultures on that continent. This is hardly news; and to suggest that now we can walk away from it because the plundering has extended to our home territory is immoral.

  15. This is a never ending issue with a thousand of facets.

    If we include what the people from Honduras and El Salvador have been earning abroad in the national income of Honduras and El Salvador then we could conclude that Honduras and El Salvador have been growing faster than China. And why should we not? Is not a nation something more important than a piece of geography?

    Also should we just be adding? Should we not deduct the costs? What is the cost of all that time wasted attending uncalled for marketing calls in the US? Should it not be deducted? And the time wasted in car queues?

  17. Who exactly is “we” and do you really believe anything “we” are doing is helpful? This bogus altruism provides the idea excuse for perpetual blunder and plunder. No doubt commiting financial suicide and destroying what is left of our freedom has its masochistic appeal, but for now I’ll just say no thanks.

  19. Big Mac does not work with me: I do not eat hamburgers. Big Mac is a consumption index invented by the consumption obsessed greedy ones at “The Economist”. Schools, hospitals, day care, health care, hospices cannot be eaten.

    PPP is, I reckon, the abbreviation for Pathetic Plutocratic Ploy.
    PA

  20. There is, of course, a much deeper problem with GDP as an index of “richness” or “poorness.” It measures the wrong things (as well as measureing what it does measure badly). GDP cares not for how widedspread literacy is, whether significant portions of the population are living in unsanitary conditions, whether there is good nutrition, whether the population has good health care, etc. That is, it fails to give us any measures that shed light on whether the quality of life for the population of a country is high or low. While at the extremes, GDP can be a crude way to measure “propserity” or “poverty” (Haiti has very low per capita GDP compared to the US, and has miserable quality fo life for most of the population, earthquake or no), it does not in any way tell us how that per capita GDP is distributed, and whether it has any relation to delivering the things that make for decent living are being bought. A country with extreme inequality with a tiny super-rich minority and an immiserated majority (think some petro states) will score quite high on per capita GDP, but having an economy that delivers gold-plated Rolls Royces to a minuscule minority while leaving a majority in squalor does not qualify as a prosperous country.

    Amartya Sen has done terrific work trying to change how we think about and measure development. He used the State of Kerala in southern India as an example of a place in which the quality of life is quite high for the population as a whole, notwithstanding that convernional measures fo development would class it as “poor.”

  23. Mr. Johnson wrote:

    “What Will We Know And When Will We Know It?”

    Unemployment Benefits: One Month Extension of Final Date

    CalculatedRisk wrote on 3/03/2010 08:06:00 PM:

    “I wonder how many people have exhausted all of their unemployment benefits?”

    http://www.calculatedriskblog.com/

Comments are closed.