World Bank

The World Bank shook up a lot of people this week with its declaration that by a new accounting, China’s GDP will top America’s this year.  But the meaning and significance of that accounting remain at best elusive.   Last year, the World Bank reported that using prevailing exchange rates, China’s GDP in 2012 was barely half that of America ($8.2 trillion versus $16.2 trillion).  The new report   draws on a statistical adjustment called “purchasing power parity” or PPP, often used to compare GDP in two or more countries when exchange rates fluctuate widely.  In analytic shorthand, PPP calculates GDP by looking at what it costs households in one country to feed, house, educate and otherwise take care of itself – including the costs of doing business and maintaining government –compared to households in another country.

            Setting aside the fact that U.S.-China exchange rates have been pretty stable, here’s how PPP works.  You start with a basket of personal and business goods and services in each country, taking account of habits, tastes and preferences.  So, the Chinese basket will be different from its American counterpart because, for example, Americans eat potatoes and subscribe to premium cable stations while Chinese eat rice and go to outdoor cinemas.  Since a serving of potatoes in America costs more than a serving of rice in China, China’s GDP is adjusted (upward) to take that into account.  These comparisons also require adjustments for quality.  Americans pay much more for health care and housing than Chinese – but the quality and quantity per-household of these services and goods as Americans consume them is much higher and larger than Chinese enjoy.  So, World Bank statisticians have to not only observe prices and levels of consumption, but also come up with adjustment factors for differences in quality for each country.  The truth is, nobody knows how to do that for countless goods and services, including the Bank’s PPP experts. 
 
            The United States is the baseline for PPP calculations.  So if China’s basket of goods and services takes half as much income to buy there as the American basket does in the United States, after accounting for quality differences, China’s GDP is adjusted up by that increment.  I should also mention that PPP analysis can produce a range of results based not only on all of the adjustments, but also on which of four distinct and accepted ways of calculating PPP the analyst uses.  This week’s announcement of PPP-based GDP came after the World Bank applied a new weighting regimen to one of the four methods.  What it means, then, depends on all of those assumptions and calculations, which makes any conclusions based on that accounting problematic, at best. As the Bank itself noted, “Because of the complexity of the process used to collect the data and calculate the PPPs, it is not possible to directly estimate their margins of error.
 
            By any accounting, China’s GDP has been growing very rapidly for several decades.  The reasons are pretty basic.  They start with the world’s largest workforce producing Chinese goods and services.  And thanks to the foreign direct investments of advanced technologies and business methods, much of it from America, Western multinationals have given China the means to make all those workers more productive.  Yet, the lives led by China’s people remain a world away from the lives of Americans.  Even using the World Bank’s PPP calculations, per-capita GDP in China is just $9,844, compared to $53,101 in the United States.  
 
            One more caveat: China’s PPP-adjusted GDP may be said to statistically rival America’s – whatever that means – only because U.S. growth has been unusually slow for more than a decade.  If the American economy had continued to expand since 2001 at the rate it grew in the 1990s, our GDP would still be more than 20 percent bigger than China’s even using the World Bank’s new adjustments and accounting.  For that, we have no one to blame but our policymakers and ourselves.  
 
This post was originally published on Dr. Shapiro's blog

As the frightening impact of the global recession on the less developed world comes into stark relief and the G20 preparing to meet in London early next month, visions for saving the world and restoring global economic order have begun to surface. The New York Times editorial page argues that rich countries are going to need to help poorer ones for their own good:

Helping the developing world is within reach, but it will require capital and concessions from rich countries. The United States and Europe should drop their resistance to a vast new issue of special drawing rights — which like newly printed dollars by the Federal Reserve act as the International Monetary Fund’s own currency.

The United States and Europe also must give more voting power to up-and-coming players. China, in particular, has the financial firepower to become an important contributor to the global effort, yet it will expect more say in the fund’s business.

As the credit crunch spreads, the whole world stands in need of economic stimulus. Poor countries, however, have the resources neither to pay for their own fiscal pump-priming nor to recapitalize foundering banks and reignite the lending to their private sectors. They need outside help. For their own sake, developed countries should provide it. Quickly.

More here.

In in today's Financial Times, Former Australian Prime Minister Paul Keating calls for a permanent, much more empowered G20 and a retooled, representative IMF:

Global financial confidence, once destroyed, requires myr­iad positive events and a heavy convergence of them to counter ambient pessimism and gloom.

The recent series of government packages, notwithstanding their scale and speed, has had little demonstrable effect on the level of confidence or the outlook for ongoing activity. Indeed the number of new and significant packages may begin to peter out out as the public accounts of most countries can no longer cope with the growing burden of insolvency or assume further private sector risk. This context underlines the urgent need for the Group of 20 industrialised and developing nations meeting in London to construct a new paradigm to resuscitate the world financial and economic system.

What is needed is a new global economic and political settlement. The first priority should be to make the G20 a permanent gathering. The leaders should meet at least once a year and, in current circumstances , twice. A permanent G20 structure, representative of the major debtor and creditor countries and the most strategically powerful ones, will sound the death knell of the Group of Seven leading industrialised nations. This is two decades too late, but better late than never.

More here.

Both seem to be on to something. A more representative body for making the global economic rules will ultimately be a good thing, even if letting go to the current order proves difficult. We'll be following this issue closely, both ahead of the London G20 meeting and beyond.