World Bank Shrinks Chinese Economy by 40%

World Bank Shrinks Chinese Economy by 40%

OK, that title is somewhat misleading. There are many things the World Bank stands accused of, but being able to shrink the Chinese economy by 40% is certainly not within its capabilities. Rather, what we have here is a change in the way that the World Bank measures economic activity that has resulted in drastic changes in the estimated size of the Chinese as well as the Indian economy. As you probably now, there are two main ways of measuring national income for the purposes of international comparison. First, you can convert the national income of various countries into dollar terms by using market exchange rates. However, this tends to ignore quantitative differences in the amount that citizens of various countries can actually buy at home. Hence, the World Bank and other institutions often use purchasing power parity (PPP) terms to estimate what can actually be purchased at home. The Economist's "Big Mac Index" is a well-known application of PPP. After all, isn't your standard of living determined by what you can actually buy? Improvements in measuring the actual purchasing power of those in China and India have resulted in the World Bank greatly reducing the estimated size of those economies on a PPP basis.

The upcoming report by the World Bank on this topic should be eagerly awaited by many interested in development for it can hopefully shed more light on the progress made by China and India by using a more accurate set of indicators from those two large emerging economies. Also, more robust measures ought to give a better picture of just how many Chinese and Indians fall under the poverty line. The latter consideration is an important one as the combined weight of 2.3 billion persons should be a major factor in determining the progress made--or lack thereof--in combating poverty. Important and intriguing stuff:

The economies of China and India are 40 per cent smaller than previously thought, according to new estimates published by the World Bank this week. The ranking of 146 economies by buying power in US dollars was based on the prices of 1,000 goods and services in what the World Bank described as “the most extensive and thorough effort ever to measure purchasing power parity across countries”. PPP, rather than market exchange rates, is regarded as a better measure of the relative cost of living, since it is based on goods and services households can buy with their domestic currency.

The new PPP estimates show a 40 per cent drop in the wealth of the Chinese people to $5.3bn, accounting for nearly 10 per cent of world output. China remains the world’s second-largest economy but, in terms of per capita gross domestic product, it is only 9.8 per cent of the size of the US, according to the research. Robert Zoellick, the World Bank’s president said he was “not drawing any policy conclusions” about the new estimates, which suggest that there are hundreds of millions more Chinese living on the World’s Bank’s poverty line of less than $1 a day. ”We must be careful about drawing conclusions about poverty from these statistics”, he said but added that the figures ”could help Chinese leaders refine their development work.”

Nevertheless, if China is less wealthy than previously thought, it could mean that those US policymakers who regard it as a political and economic threat, can relax. For example, the US Government Accountability Office, using the old estimates, reported this year that China’s economy in PPP terms would be larger than the US by 2012. The recalibration of China’s economy suggests it will be many more years yet before China can rival the US in military or economic terms. The World Bank said the shrinking of China’s economy was due to exaggerated estimates based on less reliable data in the past.

It was the first time that China had participated in the World Bank’s International Comparison Program and the first time since 1985 that India had participated. India’s economy also shrank by 40 per cent, according to the the tables, which ranked it the world’s fourth largest economy, accounting for 4 per cent of output. The world economy is also smaller than previously thought.

The Financial Times sheds more light on this important change and its potential consequences:

China and India are poorer than we thought; rich countries produce even more than we realised. Those are the obvious conclusions from an unprecedented exercise, carried out by a World Bank-led coalition. The “International Comparison Program” attempts to compare the size of the world’s disparate economies on the basis of purchasing power. On this basis, China’s output is just 9 per cent of global gross domestic product, down by more than a third from the previous estimate of 14 per cent. India’s share of global GDP is down from 6 per cent to 4 per cent. The total output share of developing economies is down by a sixth. These are huge revisions to the figures.

The obvious questions are: how could the old figures be so wrong? And can we trust the new figures? The simple answer is that calculating purchasing power is hard even in principle. The Economist’s famous “Big Mac” index captures the theory but not the slog: if a Big Mac costs $4 in the US and 12 yuan in China, then the purchasing power of the yuan is 3 per dollar – but only if you are buying hamburgers. Statisticians cannot stop at the Big Mac but must work out both the contents and the price of a representative basket of goods. With populations of more than a billion, being truly representative is almost impossible.

China has never participated in an exercise on remotely this scale before. India has not done so since 1985. Small wonder that the facts have changed substantially. So while the new figures can never be more than statistical estimates, they are far more credible than the finger-in-the-wind guesses that preceded them.