in solidarity,
michael
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He writes:
I beg to disagree with the idea that the PPP method is "imaginary" and the Atlas method is "actual". As I explain in the attachment, the PPP exchange rate takes into account the price difference of goods and services between countries,or the purchasing power of a country's currency vis-a-vis the currencies of other countries (or the US dollar), whereas the market exchange rate does not take into account the price difference.
Take a simple example of Japan and the US. Say the market exchange rate is 110 Yens = One US$. Now take an equivalent basket--in quantity and quality--that contains a burger with fries and a drink. It costs 450 Yens in Tokyo and US$ 2.50 in New York. The PPP exchange rate is then 180 Yens = One US$ (450/2.50). There is nothing imaginary about the PPP exchange rate since it gives you the purchasing power of a country's currency vis-a-vis the US dollar.
The important point is that the market exchange rate seems to be a valid conversion factor for settling payments between countries on account of trade, debt, aid, etc. and the PPP exchange rate seems to be a valid conversion factor for comparing the "standard of living" of people in different countries.
Now please turn to the data shown in my attachment Table. In the GNI differences between the high income and middle + low income economies for any year (1996, 1998, or 2002), our focus should be on the ratios of the GNI of high income countries to the GNI of middle + low income countries under the Atlas and PPP methods separately. I see little change in the ratios between 1996 and 2002: the GNI gap between the high income countries and the middle + low income countries does not change over time (compare the 1996 and 2002 data).
GNI (Atlas Method): in 1996 the ratio is 4.41 to 1.00 and in 2002 the ratio is 4.18 to 1.00.
GNI (PPP Method): in 1996 the ratio is 1.36 to 1.00 and in 2002 the ratio is 1.30 to 1.00.
The fact that the ratios of GNI between the high income and middle + low income countries in each year differ so much under the two methods is simply because the Atlas Method does not take into account the price differences between countries and PPP Method does. There is no indication that the income gap between the rich and poor countries has narrowed. However, the income gap is larger with the market exchange rate compared to the income gap with the PPP exchange rate.
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The attachment:
Gross National Income (GNI) of Countries, 1996, 1998, 2002
GNI (Atlas Method) GNI (PPP Method)
Billion US Dollars Billion US Dollars
1996 1998 2002 1996 1998 2002
High Income 23,772 22,592 25,596 20,574 20,745 27,516
Middle Income 4,141 4,401 5,056 8,305 8,834 15,884
Low Income 1,597 1,842 1,070 6,809 7,678 5,269
World 29,510 28,835 31,720 35,688 37,136 48,462
Source: World Bank, World Development Indicators, 1998, 2000, 2004.
Notes:
1. Definitions:
· Gross National Income (GNI) = GDP plus net receipts of primary income (wages and salaries plus property income) from abroad. GNI is a new term used for the good old Gross National product (GNP): GNI and GNP have the same formula.
· Gross Domestic Product (GDP) = Sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output.
2. Internationally Comparable Values of GNI and GDP:[1]
The World Bank uses two methods for estimating internationally comparable values of GNI and GDP.
· The Atlas Method: Each country’s GNI and GDP estimates (made in local currency) are converted by using the “market” exchange rate for its currency in US dollars. The market exchange rate between currencies is a product of several factors, including trade and capital flows. It is used for financial transactions between countries (trade, debt services, etc.). It should not be used to compare the GNI and GDP of countries in the context of differences in their standard of living because the market exchange rate does not take into account the price difference between countries for goods and services.
· The Purchasing Power Parity (PPP) Method: The PPP exchange rate is simply the number of units of a country’s currency required to purchase the same quantity of goods and services (included in GDP) as one US dollar purchases in the United States. In other words, this exchange rate reflects the purchasing power of each country’s currency vis-ŕ-vis the US dollar. The PPP exchange rate for the poor countries tends to be higher than the market exchange rate because prices of goods and services, especially the non-traded ones, tend to be lower in poor countries than in rich countries. In other words, the purchasing power of poor countries’ currencies vis-ŕ-vis the US dollar is generally higher than reflected by the market exchange rate. The PPP exchange rate is useful in comparing the differences in the “standard of living” between countries at one point in time and over time.
[1] In both methods, the real (and not nominal) value of GNI and GDP is estimated by taking into account the inflation rates in the country and the United States in each year. A three-year average of exchange rates adjusted for inflation using the country’s GDP deflator is used to convert to the US dollar.
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Michael A. Lebowitz Professor Emeritus Economics Department Simon Fraser University Burnaby, B.C., Canada V5A 1S6
Currently based in Venezuela. Can be reached at Residencias Anauco Suites Departamento 601 Parque Central, Zona Postal 1010, Oficina 1 Caracas, Venezuela (58-212) 573-4111 fax: (58-212) 573-7724
