In 2013, U.S. Gross Domestic Product (GDP), at $16.8 trillion, was nearly twice China’s $9 trillion, according to the International Monetary Fund (IMF). But when adjusting for Purchasing Power Parity, which is estimated to reflect the “real cost of living” across countries, China’s economy is projected to surpass the United States’ later this year, says the International Comparison Program (ICP). Is this realistic?

The ICP is a coalition of the world’s leading statistical agencies hosted by the World Bank in Washington, D.C. According to the Financial Times, “In 2005, the ICP thought China’s economy was less than half the size of the U.S., accounting for only 43 percent of America’s total.” And based on projections that China’s economy will grow by 24 percent from 2011 through 2014, while the U.S. economy expands by 7.6 percent during the same period, Purchasing Power Parity data indicates China is likely to overtake the United States this year, the Financial Times reports.

There is a downside to using the Purchasing Power Parity methodology. The IMF says it is harder to measure than market-based rates, it requires a huge statistical undertaking, and new price comparisons are available only at infrequent intervals that could reduce accuracy. And not everyone agrees on the methodology. As a result, economic estimates from various organizations and scholars differ.

For example, April 2014 IMF data concludes that Chinese GDP based on Purchasing Power Parity will reach $14.6 trillion this year — a figure still nearly $3 trillion less that what’s projected for the United States on a Purchasing Power Parity basis. Yet, the IMF anticipates China catching up to the United states by 2019.

Arvind Subramanian, senior fellow at the Peterson Institute for International Economics and the Center for Global Development, and senior research professor at Johns Hopkins University, said based on Purchasing Power Parity, China’s output surpassed U.S. output years ago. And that’s not all. Using this methodology or a version of it, he anticipates the Chinese economy will be twice as large as the United States’ by 2030.

Purchasing Power Parity corrects for differences in price levels across countries.

How important and accurate are Purchasing Power Parity calculations?

The Organization for Co-operation and Development (OECD) says “Purchasing Power Parity are the relevant currency conversion rates to make international comparisons of economic activity.” Unlike exchange rates, which often are volatile and quick-changing, Purchasing Power Parity corrects for differences in price levels across countries. Simply put, it looks at the number of Chinese renminbi required to buy the same quality haircut in Shanghai as a haircut in New York City.

From an individual perspective, Chinese GDP per capita is anticipated to reach $7,333 this year. However, using Purchasing Power Parity, Chinese per capita income rises to $10,695, according to the IMF. “The different approaches to valuing economic output and resources are not just of theoretical interest,” says Subramanian. “They have real world significance, especially in the balance of power and economic dominance.”

In The Spotlight

Purchasing power parity, which in the case of China significantly shows higher output, may actually provide a more realistic picture of China’s economic strengths and abilities. For example, using Purchasing Power Parity, China’s tremendous and fast-expanding shipbuilding industry output can be better understood, as well as the fact that the Middle Kingdom has recently built many of the world’s largest ports capable of handling tremendous amounts of trade measured by both cargo volume and container traffic.

Additionally, this methodology may better explain how China has come to be world’s largest manufacturer. The bottom line: traditional statistics may have undervalued Chinese capabilities and underestimated its output, along with other developing countries.

According to the Financial Times, Purchasing Power Parity “figures revolutionize the picture of the world’s economic landscape, boosting the importance of large middle-income countries.” For example, India becomes the third-largest economy having previously been in tenth place. And Russia, Brazil, Indonesia and Mexico move up compared to other countries. “The findings will intensify arguments about control over global international organizations such as the World Bank and IMF, which are increasingly out of line with the balance of global economic power,” the Financial Times reports.

But that’s not all. When considering per capita income, the new methodology increases the income in developing countries compared to developed ones, indicating that the income gap between the two groups has decreased.

This article appeared in International Insights, a Fifth Third Bank publication.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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