## Purchasing Power Parity: Weights Matter

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**Canonical URL:** [Purchasing Power Parity: Weights Matter](https://www.imf.org/-/media/files/publications/fandd/back-to-basics/callen-purchasing-power-parity.pdf)

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### Two different yardsticks
- To compare output across countries, national-currency GDPs must be converted into a common currency.
- Two main conversion methods:
  - Market exchange rates: the rate prevailing in the foreign exchange market (end-of-period or period average).
  - Purchasing power parity (PPP) exchange rates: the rate at which one currency would have to be converted into another to buy the same goods and services in each country.
- Illustrative example: if a hamburger sells in London for £2 and in New York for $4, this implies a PPP exchange rate of 1 pound to 2 US dollars.
- The International Comparisons Program (ICP) generates PPPs based on a global price survey; in the last round (2011) participating countries (about 199) provided national average prices for about 1,000 closely specified products.

### PPP versus market rates — when to use which
- Market exchange rates are appropriate for variables involving financial flows (for example, current account balances).
- For real GDP growth, institutions differ:
  - The World Bank uses market-based rates to determine weights.
  - The IMF and the OECD use weights based on PPP rates (the IMF also publishes a global growth aggregate based on market rates in the WEO).
- Choice depends on the analysis' purpose; each method has advantages and disadvantages.

### Advantages of PPP
- PPP exchange rates are relatively stable over time; market rates are more volatile and can induce large swings in aggregates.
- PPP accounts for prices of nontraded goods and services, which tend to be cheaper in low-income countries (haircuts, taxi rides, event tickets), thereby better capturing consumer purchasing power and overall welfare.
- PPP is generally regarded as a better measure of overall well-being.

### Drawbacks of PPP
- PPP is harder to measure than market rates.
- The ICP is a large statistical undertaking; new price comparisons are available only at infrequent intervals.
- Methodological questions have been raised about earlier surveys.
- In between survey dates, PPP rates must be estimated, introducing potential inaccuracies.
- The ICP does not cover all countries; data for missing countries must be estimated.

### Does it make a difference?
- There is a large gap between market and PPP-based rates in emerging market and developing economies; for advanced countries, market and PPP rates tend to be much closer.
- Developing economies receive higher weights in PPP-based aggregations than with market-based weights.
- Country-weight comparisons (examples reported):
  - China’s weight in the global economy: about 18 percent using PPP exchange rates, but about 15 percent with market-based weights.
  - India’s weight: about 7 percent using PPP exchange rates, and 3 percent with market-based weights.
- Aggregate growth comparisons:
  - Using PPP, the latest WEO estimates that global growth was 3.2 percent in 2016.
  - Using market rates, global growth was 2.4 percent in 2016.
- Other implications:
  - Using both PPP and market-based weights, China contributed more to global growth in 2016; the situation differed in 2006.
  - At market rates in 2006, GDP in China exceeded the combined GDP of the next 12 emerging market and developing economies ranked by size (India, Brazil, Russia, Mexico, Indonesia, Turkey, Saudi Arabia, Argentina, Poland, Iran, Thailand, and Nigeria).
  - In PPP rates, China contributes more to global growth than all advanced economies combined (as illustrated in the source chart).
  - For per capita income comparisons among advanced economies, results can differ by conversion method: using market rates, per capita income in Japan exceeds that in France; when PPP rates are used, the situation is reversed.

### Key statistics and measures (preserved exactly as in source)
- ICP 2011: participating countries (about 199) provided national average prices for about 1,000 closely specified products.
- China’s weight in the global economy: about 18 percent (PPP weights); about 15 percent (market-based weights).
- India’s weight: about 7 percent (PPP weights); 3 percent (market-based weights).
- Global growth in 2016: 3.2 percent (PPP); 2.4 percent (market rates).

*Tim Callen; updated by Sarwat Jahan — IMF Finance & Development article excerpt.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/back-to-basics/callen-purchasing-power-parity.pdf_