Sunday, 31 August 2014

World growth

I always thought that China was in place to overtake the west with recent growth patterns, however the world bank says the experts have been getting carried away with bogus data using PPP [Purchasing Power Parity] rather than on actual exchange rates.

PPP based measures of GDP [Gross Domestic Product] (per capita) might make sense if we want to measure how much an average citizen can buy for given an average income, however, it does not make sense when we want to measure the size of the economy. There we have to use measures based on actual exchange rates and if we do that then it turns out that the Chinese economy is still significantly smaller than the UK or US economy.

My argument is that it makes no sense to use nominal exchange rates to compare the size of economies. Perhaps it makes sense if you want to look at the impact on global trade [China exports far more than the UK or US], but surely not if comparing domestic production. Take the US as an example, I recall the Euro being about 85 cents around 2002, then by 2008 it peaked around $1.60, and yet the US and Euro zone had roughly similar NGDP [Nominal Gross Domestic Product] growth rates over this 6 year period. Does anyone believe that comparing non-PPP adjusted GDPs would have given a meaningful comparison of the relative size of these two economies? Did the Euro zone suddenly go from having an economy much smaller than the US to one far larger, in six years? Maybe.

Now consider the effect of tax regimes. Suppose you adopt a VAT that provides revenue equal to 20% of GDP. Your nominal GDP at market exchange rates will suddenly jump by 20%, even though nothing has happened to the real size of your economy. Indeed the European VATs are one factor that explains why Europe often looks better against the US if you don’t adjust for PPP.

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