1350.0 - Australian Economic Indicators, 1992  
ARCHIVED ISSUE Released at 11:30 AM (CANBERRA TIME) 20/04/1992   
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1992 Feature Article - International Comparisons of Gross Domestic Product as Purchasing Power Parity
This article was published in Australian Economic Indicators April 1992 issue on 1 April 1992.


Introduction

In order to compare output or expenditure data for different countries it is necessary to convert values expressed in different currency units into a common unit of currency. A method often used is to convert data for different currencies into a common currency (usually US dollars), using market exchange rates as the currency convertor. However, the uniform application of the exchange rate to all goods and services produced and sold within the economy can result in quite misleading comparisons between countries. Exchange rates are influenced by a variety of financial, political, economic and institutional factors which are unrelated, or not closely related, to factors determining national price levels. They do not convey meaningful information about relative price levels within an individual country, and are therefore inappropriate for deriving comparisons of measures of output between countries. In order to obtain valid international comparisons of GDP, and GDP per head, a measure of relative prices between countries is required. Purchasing power parities (PPPs) provide such a measure.

The Organisation for Economic Co-operation and Development (OECD) co-ordinates a project which has produced PPPs for member countries for a number of years with the most recent being 1990. Summary results were published in the 1991 edition of its National Accounts: Volume One, released early in 1992. More detailed results are expected to be published in a supplement to the publication later in 1992. The ABS recently published estimates of PPPs and of gross domestic product and its components adjusted for PPPs in Gross Domestic Product at Purchasing Power Parity in OECD Countries, 1990 (cat. no. 5226.0).

The meaning of Purchasing Power Parities

PPPs are essentially indexes of relative national price levels. In the same way that a consumer price index and other price indexes reflect changes in prices of a defined basket of goods and services within a given country over time, PPPs present a picture of how the level of prices in one country compares with that in another country at a given time. Similarly, where conventional price indexes are used to deflate current price values to derive changes in ‘real’ values within a country over time, so PPPs can be used to adjust current price values to obtain ‘real’ value comparisons between countries at a point in time. In this respect PPPs are particularly useful for comparing GDP per head, regarded by many international organisations as a key indicator of living standards and progress in economic development.

Calculation of PPPs

In its simplest form, a PPP is the ratio of the prices of the same commodity between two countries. For example,

Australia
United States
Price in $A
Price in $US
Commodity A
0.75
0.50
Commodity B
1.00
1.10

The Australian PPP for commodity A relative to its price in the United States is

0.75 / 0.50 = 1.5

The Australian PPP for commodity B relative to its price in the United States is

1.00 / 1.10 = 0.91

The PPP for commodity A shows that $A1.50 is needed to buy in Australia the quantity of commodity A which can be bought for $US1.00 in the USA. Similarly, it would require $A0.91 to buy, in Australia, the quantity of commodity B which can be bought for $US1.00 in the USA.

PPPs for individual commodities can be aggregated, using weights derived from national expenditure data, to calculate an overall PPP for each country. The current price, or ‘nominal’, value of GDP for each country can then be deflated by its PPP to obtain an estimate of GDP which can be compared across countries. The OECD has calculated PPPs for individual member countries relative to average prices across the OECD to derive the real expenditure values contained in the ABS and OECD publications.

Comparative price level indexes

Comparative price level indexes are derived by dividing the PPPs for each country by the corresponding average OECD PPPs and then by the exchange rate (per $US). Thus, they are standardised PPPs expressed in terms of a single currency - the $US. Like PPPs, they permit comparisons of the relative prices of goods and services within a country but unlike PPPs, they also permit comparisons of prices between countries. Thus, given the expenditure patterns and exchange rates prevailing during 1990, one can compare the prices of goods and services in Australia with those in other OECD countries.

Estimates for years prior to 1990

For the latest issue of cat. no. 5226.0, estimates of gross domestic product at purchasing power parity for years prior to 1990 have been derived by dividing current price estimates of gross domestic product by estimates of PPPs for earlier years. The latter have been derived by extrapolating retrogressively the 1990 PPPs using each country’s annual rate of inflation relative to that of the United States. The measure of inflation used for each country is the implicit price deflator of gross domestic product.

Background to the OECD PPP project

The OECD first became involved in the study of PPPs in the early 1950s. In the 1960s and 1970s the main focus of this work shifted to the Statistical Offices of the United Nations and the European Community. In 1982 the OECD resumed work on PPPs, resulting in calculations of some member country PPPs and real gross domestic product and its components for 1980. Australia first became involved with the PPP project in the 1985 round. The ABS provided detailed expenditure and commodity price data for both the 1985 and 1990 projects. Most of the data contained in the latest issue of 5226.0 relate to 1990.

Analysis of results

The following comments refer to estimates of gross domestic product (GDP) at average OECD prices using purchasing power parities - referred to hereafter as adjusted GDP.

In 1990, Australia’s adjusted GDP per head continued to fall below the OECD average. As indicated in Table 1, Australia’s adjusted GDP per head in 1985 was 2 per cent below the OECD average. In 1990 it had fallen to 6 per cent below the OECD average. As a consequence, Australia’s ranking dropped from joint 10th of the 24 OECD member countries in 1985 to joint 13th in 1990. The USA continued its lead over all other OECD members with a GDP per head in 1990 of $US21,449 (34.5 per cent higher than Australia’s $US15,951). Since 1985, Australia’s average annual growth rate of adjusted GDP per head (4.9 per cent) has lagged behind those of the USA (5.3 per cent) and the OECD average (5.9 per cent).


TABLE 1. RANKING OF OECD COUNTRIES' GDP PER HEAD AT AVERAGE OECD PRICES, USING PURCHASING POWER PARITIES, 1985 AND 1990
Ranking
% variation from OECD Average
Country
1985
1990
1985
1990
USA
1
1
30
26
Switzerland
2
2
27
24
Luxembourg
5
3
8
14
Canada
3
4
16
12
Germany
4
5
9
8
Japan
13
6
-4
4
France
8
7
3
3
Denmark
6
8
4
-1
Sweden
6
8
4
-1
Austria
12
10
-3
-2
Belgium
15
11
-6
-3
Finland
15
11
-6
-3
AUSTRALIA
10
13
-2
-6
Italy
17
13
-7
-6
Norway
9
13
0
-6
Iceland
10
16
-2
-7
Netherlands
14
16
-5
-7
United Kingdom
18
18
-9
-8
New Zealand
19
19
-13
-22
Spain
20
20
-36
-31
Ireland
21
21
-43
-37
Portugal
23
22
-55
-51
Greece
22
23
-54
-57
Turkey
24
24
-81
-80


Compared with the average OECD expenditure distribution in relation to adjusted GDP per head in 1990, Australia spent relatively little on private consumption (6 per cent less) and capital expenditure on equipment (9 per cent less), but relatively more on government consumption (11 per cent more) and capital expenditure on construction (29 per cent more).

These deviations from the OECD average expenditure distribution mirror, to some extent, the deviations in Australia’s price structure from the OECD average. Australian prices were relatively higher for private consumption (4 per cent higher) and equipment (5 per cent higher) and relatively lower for government consumption (2 per cent lower) and construction (14 per cent lower). Thus, at this broad level of expenditure, Australia spent proportionally more on the goods and services that were relatively cheap - government consumption and construction - and proportionally less on the goods and services which were relatively expensive - private consumption and equipment.

According to 1990 PPP estimates, 1.39 Australian dollars were equivalent to one US dollar. This compares with the prevailing exchange rate of $A1.28 to $US1.00 in 1990. In this sense the Australian dollar was ‘overvalued’ with respect to the American dollar by about 9 per cent. With respect to the OECD as a whole, however, the Australian dollar was ‘undervalued’ by about 5 per cent.

Table 2 contains price level indexes for broad categories of goods and services for Australia, the ‘Group of Seven’ major industrial economies and New Zealand for 1990. Similar comparisons at a more detailed level in 5226.0 show that Australians paid less for food, communications and housing than consumers in any of the ‘Group of Seven’ countries but paid more for personal transport equipment.


TABLE 2. COMPARATIVE PRICE LEVEL INDEXES(a) FOR SELECTED COUNTRIES, 1990 (OECD = 100)
Australia
Japan
USA
Canada
Germany
France
UK
Italy
NZ
PRIVATE FINAL CONSUMPTION EXPENDITURE
99
126
88
101
112
108
95
101
86
Food, beverage and tobacco
84
148
80
105
101
102
96
99
85
Clothing and footwear
100
110
75
101
134
153
94
139
88
Gross rent, fuel and power
109
143
100
105
122
95
85
68
86
Household equipment and operation
98
114
87
100
105
112
94
113
90
Medical and health care
94
68
123
95
109
80
71
86
74
Transport and communication
106
112
84
105
113
113
119
109
85
Education, recreation and culture
105
107
89
100
111
123
86
131
94
Miscellaneous goods and services
107
156
78
98
109
122
107
116
89
GOVERNMENT FINAL CONSUMPTION EXPENDITURE
93
103
105
109
120
104
78
107
74
GROSS FIXED CAPITAL EXPENDITURE
89
117
76
85
120
108
117
114
88
Construction
82
130
79
77
118
94
117
100
82
Machinery and equipment
100
104
74
97
126
131
119
137
97
INCREASE IN STOCKS
75
93
61
78
88
91
80
91
71
BALANCE OF EXPORTS AND IMPORTS
100
100
100
100
100
100
100
100
100
GROSS DOMESTIC PRODUCT
95
119
88
99
114
107
96
104
84
(a) Derived from average exchange rates for 1990 and the corresponding purchasing power parities for each item.


Conclusion

Purchasing power parities provide a measure of relative prices between countries and therefore enable meaningful comparisons of measures of expenditure and GDP. Australia’s ranking against other OECD countries using such measures is made possible by ABS participation in the OECD PPP project. The latest results of this project have recently been published in 'Gross Domestic Product at Purchasing Power Parity in OECD Countries', 1990 (cat. no. 5226.0). This article has provided an explanation of the methodology used and some of the results.

More details are available from the publication mentioned above.

This feature article was contributed by Charles Aspden and Alan Tryde, ABS.


ATTACHMENT

Aggregation methods

In 1988 and again in 1989, EUROSTAT (the Statistical Office of the European Community) and the OECD, together with the United Nations Statistical Office, convened a group of experts to discuss aggregation methods. The experts recognised that comparisons of price and volume aggregates are used for many different purposes and that there is no one method of aggregation which can be considered satisfactory for all these purposes.

The Geary-Khamis (GK) method uses a weighted arithmetic mean of prices, and was used to produce the estimates published in the 1985 issue of 5226.0. It is known to be affected by the Gerschenkron effect - i.e. a country whose price structure differs from the average price structure used as weights in the aggregation process will have relatively higher volume levels than it would have had if weights more characteristic of its price structure had been used. On the other hand, the GK method provides results which are additive: a requirement not met by aggregation methods free of the Gerschenkron effect.

The experts recommended the calculation and dissemination of two sets of results: one set to be aggregated using the EItelo-Koves-Szulc (EKS) method which uses a weighted geometric mean of prices, the other to be aggregated using the GK method. However, only results derived using the EKS method are available for 1990 at present.

Estimates obtained by the EKS method are not additive, but there is no Gerschenkron effect and they are better suited for comparisons of the prices and volumes of an individual aggregate between countries, for example comparisons between countries of expenditure on or prices of a particular commodity. Those obtained by the GK method are affected by the Gerschenkron effect, but they are additive and better suited to the analysis of price and volume structures across countries, for example comparisons of the relative prices of commodities within one country with the relative prices within another country. Details of the two methods are available on request.

An outcome of the change in methodology is that the estimates presented in the 1985 issue of 5226.0 are not comparable with the estimates presented in the latest issue. To enable comparisons to be made in the latest issue, estimates have been recalculated for years prior to 1990 as described in the article above.