What are purchasing power parities?
Countries estimate their expenditures on gross domestic product (GDP), or the value of goods and services produced in a single year, in local currency units. Before these estimates can be used to compare the GDP of economies across the world, differences in national price levels need to be accounted for and local currencies need to be converted to a common currency. This can be done using purchasing power parities (PPPs) as the conversion factors. PPPs control for the differences in price levels between economies and equalize the purchasing power of currencies. In this way, PPPs show the relative price of a given basket of goods and services in each of the economies being compared with reference to a base economy.
PPPs are calculated by the International Comparison Program (ICP) – a global statistical initiative carried out at frequent intervals. The most recently completed ICP comparison was benchmarked to the year 2017 and covered 176 economies, and the 2021 comparison is currently underway. The calculation of PPPs uses (i) the prices of items within a common basket of goods and services and (ii) the share of expenditure on - or the expenditure weights of - these items in each participating economy. For non-participating economies PPPs are imputed based on a regression model. The World Development Indicators (WDI) database extrapolates PPPs for years not provided by the ICP.
How do PPPs differ from market exchange rates?
PPP-based conversions differ from currency conversions that use market exchange rates because the latter do not distinguish between the relative price levels of economies for traded goods, such as merchandise, and non-traded goods, such as certain services. Thus, comparisons that use market exchange rates overstate the size of economies where prices are high, as typically seen in higher income economies, and understate the size of economies where prices are low, as typically seen in lower income economies.
This is illustrated in Figure 1 which shows that when using market exchange rate-based measures of GDP, 63% of the global economy is ascribed to high-income countries and just 9% to lower-middle-income economies. Under the PPP-based measure, which controls for differences in prices, high-income economies, where goods and services are expensive, account for just 47% of global output while lower-middle-income economies, where they are less expensive, increase their share to 18% of the world’s economy. This difference reflects the undervaluing of the economic size of most global economies with relatively low prices when using market exchange rates.
What are price level indexes?
The price level index (PLI) of an economy is the PPP divided by the market exchange rate and is expressed in relation to a base reference country, region, or the world, with higher PLIs indicating that goods and services are more expensive (Map 1).
When should PPPs be used or not used?
Aside from spatial comparisons of expenditures, price levels, and the cost of living, the use of PPPs from the ICP extends to grouping economies by their volume indexes and price levels, to analyzing changes over time in relative GDP per capita and in prices, to analyzing price convergence, and to using them as deflators for other expenditures. PPPs should not be used, however, for the strict ranking of economies, for national growth rates, to compare output and productivity by industry, as equilibrium exchange rates, nor as an indicator of the under- or overevaluation of currencies. More information on the appropriate use of PPPs is provided here.
Use of PPPs in key development areas
PPPs are used to understand a range of development areas including the economy, poverty and inequality, health and education, energy and climate, labor, productivity, trade, competitiveness, infrastructure, as well as in tracking certain Sustainable Development Goals (SDGs). A number of these PPP-based indicators are featured in the WDI database and a few are highlighted below. Currently some indicators continue to be based on 2011 PPPs while others already use the 2017 PPPs.
The material well-being of people living in different countries can be measured on a common scale by adjusting for differences in the purchasing power of currencies. PPP-converted measures are used to establish the World Bank global poverty lines, which identify the levels of daily income or consumption under which people struggle to provide for their basic subsistence needs. The lowest of these, the international poverty line which identifies those living in extreme poverty, is currently set at $1.90 a day in 2011 PPP terms and was originally based on national poverty lines of some of the poorest countries. The $3.20 poverty line is derived from typical national poverty lines in countries classified as lower-middle-income, while the $5.50 poverty line represents typical national poverty lines in upper-middle-income countries. The poverty headcount ratio is defined as the percentage of the population living on less than these 2011 PPP-based levels of daily income or consumption (Figure 2). The forthcoming fall 2022 revision of the global poverty lines will use 2017 PPPs to update these values.
PPP-based measures of income and consumption are also used to measure the inequalities within countries and two indicators in WDI allow us to compare the income of the poorest 40% of a population with that of the total population. Figure 3 below shows those economies where inequalities are greatest as those furthest from the diagonal line of equality.
PPP-based GDP per employed person, or value added per employee, represents a measure of labor productivity. The indicator allows comparisons of productivity levels between countries or regions and, over time, shows the relatively rapid increase in productivity in South Asia and in East Asia and the Pacific over the last twenty years (Figure 4).
PPPs allow cross-country analyses of national expenditures made on goods and services. This type of analysis can help us understand the cost of, or the investment made, in different aspects of human development, such as health expenditures. The chart below highlights regional differences when it comes to public, private and external per capita health expenditure, using WDI PPP-based indicators (Figure 5).
The PPP-based poverty lines are also used to monitor progress towards universal health coverage. The number of people pushed below the current $1.90 and $3.20 poverty lines by ‘out-of-pocket’ health care expenditures show the number of people living in households experiencing impoverishing levels of health expenses. Without such expenditures people living in these households would have lived above these poverty lines. (Figure 6).
Energy used per unit of GDP provides a measure of energy efficiency: cross-country analysis of energy intensity levels using PPP-based measures of GDP helps identify economies which are most and least energy efficient (Map 2).
PPP-based GDP is also the denominator used for the WDI indicator CO2 emissions per unit of GDP. The change in emission intensity over time and across countries can be measured using GDP in constant 2017 PPP terms (Figure 7).
As shown in the preceding examples, the applications of PPPs extend across the socioeconomic spectrum. These applications are showcased in detail in the interactive publication Purchasing Power Parities for Policy Making: A Visual Guide to Using Data from the International Comparison Program and in the United Nations World Data Forum presentation From local prices to the global economy: how the latest data from the International Comparison Program help us understand our world today. PPPs are widely used by international organizations including the Food and Agriculture Organization; the International Energy Agency; the International Labour Organization; the International Monetary Fund; the International Telecommunication Union; the United Nations Development Program; the United Nations Educational, Scientific and Cultural Organization; the World Economic Forum; the World Health Organization; and the World Bank.
Where can the data be accessed?
The ICP publishes PPPs, PLIs, and PPP-based volume and per capita measures of gross domestic product (GDP) and its expenditure components including actual individual consumption, individual consumption expenditure by households, consumption expenditure by government, health, education, housing, and gross fixed capital formation for nearly 200 economies for each of its benchmark reference years. WDI publishes PPPs for each year based on ICP results at the level of GDP and individual consumption expenditure by households ("private consumption") and publishes PLIs at the level of GDP. For these WDI indicators the United States is the reference economy for which both the PPP and PLI is set equal to 1.