Monday, November 20, 2017

Jon Hellevig — Despite Sanctions Russia’s GDP Shoots over \$4 Trillion – The Difference between Nominal GDP and PPP GDP Explained

According to fresh figures from the IMF (October 24), Russia’s GDP is expected to exceed \$4 trillion first time ever. By this measure, Russia is the 6th largest economy in the world, virtually on par with Germany, who scored \$4.15 trillion.
At the same time, China has solidified its position as the world’s indisputably largest economy. With its \$23 trillion, China’s economy is already bigger 1/5th than the U.S. economy with its \$19 trillion [based on PPP]....
Emerging countries, and not only China, are developing quickly as they play catch up, while the developed countries are topping out in comparison.

Hellevig explains PPP versus nominal GDP in terms of the economic goods that are real and financial goods that are monetary. Economic comparison is best done using actual output rather than nominal value. Most of the post is about this. It is worth reading in full. Here are the highlights.
These GDP figures are calculated according to the PPP method. PPP stands for purchasing power parity and it aims to capture the value of the real economic output contrary to the method of rendering GDP in nominal USD figures. The nominal method, converts a country’s GDP calculated in the local currency to the USD using the market exchange rates. The figures calculated with the nominal method is what the media tends to report. But, the Nominal GDP method contains several grave errors. There’s a huge calculation bias in favor of the countries possessing the dominant world currencies, that is, the Western countries. Thanks to the dominant currencies, their GDPs tend to be inflated in value as compared with the countries with currencies that are not widely used globally. This way, the economies of the Western countries would seem bigger than they are if one only goes by the nominal market exchange value....
Before we proceed further, I must note that any GDP (Gross Domestic Product) calculation is a statistical exercise based on a host of assumptions on how to arrive to the total value of everything produced. Therefore, the step from Nominal GDP to PPP method is just one of the thousands of assumptions, the one method is not based on more exact input data than the other.
The volume of the economy is expressed in a monetary form, because that is the only way you can make all the millions of products statistically comparable, but what we really need to know is how much of each product has been produced, how many cars, how many houses, how many tomatoes etc. But, by using the USD exchange rate as the multiplier we lose the comparability. (Global GDP comparisons are always given in USD).
If one kilo of tomatoes costs 90 rubles or 1.5 USD in Russia and 4.5 USD in the States, then according to the Nominal method the U.S. economy would be 3 times bigger by this parameter, even though both countries would produce the same amount of tomatoes. In fact, on average, almost everything is 3 or 4 times less expensive in Russia, therefore, by converting the Russian prices to USD according by the market exchange rate, Russia’s economy would seem 3 to 4 times smaller than it actually is. This is where the PPP method comes in to remove the calculation biases and currency fluctuations. The PPP method looks beyond the US dollar, striving to capture the actual volume of goods and services produced in a country. In comparing the size of the economy of different countries, that is precisely what we want to do, to measure their real output of goods and services.
The starting point for the PPP GDP is the Nominal GDP calculated in the local currency of any country. This is then adjusted by the PPP coefficient, which is the average price difference between products in the given country and the U.S. The local GDP figure is multiplied with the PPP coefficient and this way we reach the more accurate comparison of the actual volumes of the economies. We are still using the USD as the currency for comparing all the world’s economies, but have adjusted them to eliminate the market exchange rate biases.
Another way to express this is to say that we check how much of any given product we can by for one dollar in various countries.…
I often find myself in online arguments with Nominal GDP apologists, where I go through all these arguments and many more. But, they just go on and on, till we come to the final argument that would shut them up – literally. I tell them that Russia’s nominal GDP in 2016 was \$1.28 trillion and it is expected to reach \$1.47 trillion by 2017. That’s a 14.5% growth, I point out, and then I ask them to explain how Russia has reached this absolutely spectacular growth. “That’s not real growth, it’s just the exchange rate difference when the ruble appreciated,” they frown. – Exactly, that’s what it is. That’s what the Nominal GDP is, an illusion based on fluctuating and biased exchange rates.