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2005 results from the OECD-Eurostat Purchasing Power Parity Programme

Final results for the Organisation for Economic Co-operation and Development’s Purchasing Power Parity (PPP) Programme have become available for the 2005 round, which is the eighth and most recent. The results cover 55 countries, including the member countries of the OECD, the member states of the European Union, CIS (Commonwealth of Independent States, such as Armenia) countries, Western Balkan countries (such as Albania) and Israel.

Purchasing power parities versus exchange rates

Purchasing power parities (PPPs) are price relatives used to enable comparisons of gross domestic product (GDP) between countries. GDP is the most frequently used measure of macroeconomic activity. It captures the value of all final goods and services produced during a period within the boundaries of a country. GDP per capita is a measure of the average level of economic activity per person. Because countries report their national GDP levels in terms of their national currencies and national prices, meaningful inter-country comparisons cannot be effectively made without first converting currencies and price levels into a common standard of measurement. This is the role of PPPs. Once PPPs are calculated, comparisons between countries can be made on the basis of real volumes of goods and services.

In the 2005 round, about 3,000 goods and services were priced (the PPP surveys collect prices for final goods and services that reflect goods and services that GDP is comprised of in countries taking part in the PPP programme). These include consumer goods and services, government services and investment goods.

When comparing between countries, exchange rates are sometimes used to convert different currencies into a common one to enable comparison. However, conversion using exchange rates has limitations, as the price levels of goods and services often differ from country to country in a way that exchange rates do not reflect (for example, non-traded goods and services are generally not as vulnerable to exchange rates as traded goods and services).

Results are given based on exchange rates and PPPs. These comparisons are often referred to comprising nominal and real GDP per capita, respectively. Nominal refers to comparisons where exchange rates have been used to convert GDP per capita to the same currency, as no account has been made for domestic price levels in the countries of comparison. Real comparisons are those made using PPPs, which directly reflect the relative prices of final goods and services in different countries. As such, differences between nominal and real GDP per capita results reflect differences in domestic price levels.

When exchange-rate based results are higher than PPP-based results, price levels are higher in the country of comparison than that of the OECD average. Exchange rates overstate the purchasing power of consumers in that country compared with the OECD average. The PPP conversion corrects this bias. PPP results for GDP are also accompanied by comparative prices level results, which outline whether a country's domestic price level is higher than the OECD average, after converting for exchange rates.

The exact methodology used to calculate PPPs, and discussion of New Zealand's participation within the programme, is outlined in the previous Price Index News article New Zealand's involvement in the Purchasing Power Parity Programme.

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Interpreting results for small differences

When reporting PPP results, the OECD classifies countries into broad groups based on GDP per capita converted using PPPs (real GDP per capita) which are per capita GDP figures converted into a common currency and common price level. When GDP is converted using exchange rates, it is only converted into a common currency but not a common price level (nominal GDP per capita). The OECD is quick to point out that small differences in the results between countries should not be over-emphasised, because they are within the sample's bounds of error. Therefore, countries should be compared based on which income group they fall into, although the lines drawn between groups can be somewhat arbitrary. Income groups are expressed as a range in percentage terms (with 100 percent being the average OECD real GDP per capita based on PPPs).

Income groups have traditionally been grouped into high, high-middle, low-middle and low. For the 2005 round however, six groupings were formed. These groups comprised more than 125 percent of the OECD average, between 100 and 124 percent, between 75 and 99 percent, between 50 and 74 percent, between 25 and 49 percent, and less than 25 percent. Previous rounds have had different demarcation points.

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New Zealand’s income grouping

New Zealand has usually been grouped in the low-middle income group. In 2005 New Zealand was ranked in the 'between 75 and 99 percent' group, along with Cyprus, Greece, Israel, Italy, Slovenia and Spain. The highest group (greater than 125 percent) contained Ireland, Luxembourg, Norway and the United States. The lowest group contained those countries with less than 25 percent of the average OECD real GDP per capita.

Interestingly, the 2005 results showed that New Zealand’s nominal GDP per capita (based on exchange rates) index value of 89 (compared with the OECD average of 100) was higher than its index of real GDP per capita (based on PPPs) value of 84. This suggests that New Zealand had a relatively high price level compared with other OECD countries for the years relating to the 2005 results (2004–2006). This is different from the previous two sets of results published for the 2002 and 1999 rounds of the PPP programme, where New Zealand’s nominal GDP per capita was lower than its real GDP per capita, suggesting New Zealand had a lower relative price level compared with other OECD countries.

Figure 1 shows GDP per capita results for the seven non-European OECD member countries, the United Kingdom and the OECD average (equal to 100).

Figure 1

Graph, Final Expenditure on GDP per Capita for Selected Countries 2005.

Figure 1 shows that nominal GDP per capita will not necessarily give an accurate picture of a country's volume of goods and services per capita. In this figure, Mexico increases from an index number of 25 (nominal GDP per capita) to 39 (real GDP per capita), indicating that Mexico has relatively low price levels. The United Kingdom falls from 124 for nominal GDP per capita to 108 for real GDP per capita, indicating that the UK’s price levels are relatively high. In general, countries in higher-income groups (higher real GDP per capita) tend to have higher price levels, while countries in lower-income groups tend to have lower price levels. Australia was ahead of New Zealand in the 2005 results, recording an index of real GDP per capita of 112.

Figure 2 displays real GDP per capita data with comparative price levels (nominal GDP per capita divided by real GDP per capita). A comparative price level of greater than 100 indicates a country’s nominal GDP per capita will be higher than its real GDP per capita.

Figure 2

Graph, Indexes of PPP-based GDP per Capita and Comparative Price Levels 2005.

In the figure above, it is clear that the nominal GDP of countries such as Japan, Australia, the UK and New Zealand were higher than real GDP per capita, while those for the USA, Canada, Korea and Mexico were lower. New Zealand’s comparative price level (at 105) is reasonably close to the average of the 30 OECD member countries.

In 2002, New Zealand was ranked in the low-middle income group (which contained countries between 50 and 99 percent of the OECD average), along with Cyprus, the Czech Republic, Greece, Hungary, Korea, Israel, Malta, Portugal, Slovenia and Spain. New Zealand’s real GDP per capita (an index value of 87) was much higher than its nominal GDP per capita (65).

In Figure 3, New Zealand’s nominal GDP per capita was lower than its real GDP per capita. This suggests New Zealand had relatively low price levels at the time.

Figure 3

Graph, Final Expenditure on GDP per Capita for Selected Countries 2002.

Japan’s index of nominal GDP per capita was 132, which falls to 104 for its real GDP per capita. Korea is the inverse of this situation, rising from an index of 49 for its nominal GDP per capita to 72 for real GDP per capita. New Zealand’s index of nominal GDP per capita is 65, which rises to 87 for its real GDP per capita.

In figure 4, New Zealand’s comparative price level was lower than 100, meaning that New Zealand had relatively low price levels (and therefore GDP per capita would have been under-represented using exchange rates). The US, the UK and Japan recorded comparative price levels higher than 100, with Japan recording the highest of those three at 127.

Figure 4

Graph, Indexes of PPP-based GDP per Capita and Comparative Price Levels 2002.

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Some other countries of interest

Luxembourg usually comes out on top for real GDP per capita. In 2005 its index of real GDP per capita was 240 and in 2002 it was 224. One of the reasons for Luxembourg’s high ranking is the large share of workers who work within the borders of Luxembourg, but live elsewhere. As such, they contribute to GDP (as they contribute to production within the national borders of Luxembourg) but are not included in the total population figures, which raise per capita GDP.

Most countries’ income group positions in terms of real GDP per capita, expressed as percentages of the OECD average, remained largely unchanged in the 2005 results compared with the 2002 results. There were some notable exceptions: in 2002, Italy’s index of 104 dropped below the OECD average in 2005, falling to 95. Switzerland dropped from 130 in 2002 to 122 in 2005. Norway had an increase from 144 to 163. New Zealand decreased from 87 to 84 over this period.

Back to Price Index News: July 2008

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