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.