Purchasing Power Parities Between CPI and NA for spatial comparisons Alain Gallais, Insee (France)

Overview A. Concepts and uses of PPP Should we consider the whole GDP? The specific use in European Union B. Aggregation formulas: the kinds of indices - Basic headings and above - Fisher type indices and EKS(-S) technique C. The management of spatial CPI in Europe - 6 surveys split on 3 years - 4 groups of countries in Europe D. The specific products and the other final uses - specific products in FC - GFCF, non-market services 2

Concepts:“Purchasing Power” A first definition for exchange rates and BoP Comparison of prices on tradable goods and services => define the theoretical exchange rates => determine if a currency is undervalued or overvalued. A second definition for time series and NA “Purchasing Power of household gross disposable income” = household gross disposable income / total CPI. Synthesis for international statistics “True” prices that allow to obtain spatial comparisons of “real” GDP per head by deflation, rather by official exchange rates. => “true” relative wealth of nations. Approximation by MNE Relative prices of , or of . Not the same results => need to be comprehensive.

A. GDP from the expenditure side The GDP in Purchasing Power Standards (= adjusted on PPP) is considered from the expenditure side: actual FC of HH (of which GG or NPISH exp.) + actual FC of GG + GFCF + change in inventories + exports – imports All final uses are to be deflated. Non-tradable goods and services generally cheaper in poorer countries, because labour less expensive relatively to capital => GDP in PPS > GDP / off. exch. rates for poorer countries (“Balassa-Samuelson effect”). EU-KLEMS project: attempt from the production side. “full price”, not only “out of the pocket”

A. The uses in Europe for the regional policy OECD at the origin of concepts and formulas. EU very active because of needs for regional policy. Current programming period: 2014-2020. 76 regions (NUTS 2) benefit from cohesion funds because average GDP per inhabitant < 75% EU-28 on 2007-2009 period. Most part of structural funds.

A. Beyond Europe OECD organizes collection and compilation of PPP for non European members (United States, Canada, Japan…) and Russia. 1 survey every 3 years. OECD keeps Eurostat figures “frozen”. World Bank completes “International Comparison Program”, with less regularity (ICP 1993, ICP 2005, ICP 2011). 8 ICP groups for 200 countries:

B. The different kinds of indices – above basic headings Basic heading = finest level for which an expenditure weight is available. Above, weighted arithmetic: In order to compare 2 countries (A and B), same kinds of indices as for time series are available. Replace “Base period” by “partner country” or “base country”: Laspeyres index: LpB/A = Σ qApB/ Σ qApA (reference volume structure) Paasche index: PpB/A = Σ qBpB/ Σ qBpA (reference price structure) At the origin, the US was taken as the base country ~ constant prices (fixed base Laspeyres or Paasche index). Consistent in aggregation.

B. The Gersheckron effect Gerscheckron effect: with reference price structure, the more a country is far from the base (country) structure of price, the higher its GDP will appear. That was the case for OECD and GK technique. Same phenomenon as classical relation between Laspeyres and Paasche indices (negative correlation between volume and price): PpB/A < LpB/A

B. EKS technique ~ chain-linked Fisher indices Eurostat-OECD use Èltetö-Köves-Szulc (EKS) method for aggregating basic headings up to total GDP. All countries are treated symmetrically. 5 steps: calculation of Laspeyres-type PPPs matrix (country x country), calculation of Paasche-type PPPs matrix, calculation of Fisher-type PPPs, calculation of EKS PPPs matrix, standardisation of EKS PPPs matrix. EKS technique: unweighted geometric means of direct and indirect bilateral indices (=> transitive). EKS1B/A = [(FB/A/FA/A)(FB/B/FA/B)(FB/C/FA/C)(FB/D/FA/D)]1/4 =[(FB/A)2(FB/C/FA/C)(FB/D/FA/D)]1/4 or :

B. Calculation of a basic heading Below a basic heading, unweighted geometric. A product is representative or not (for a country). Abusively, PPP literacy says “Laspeyres type” and “Paasche type” indices for unweighted geometric means on representative products of one country: Laspeyres type index: Paasche type index: Same 5 steps as above: calculation of Laspeyres type indices, Paasche indices, then Fisher indices for all pairs of countries, made transitive by EKS technique and standardised.

Exercise

C. 6 surveys in 3 years Between two surveys, national CPI are used for extrapolation of all basic headings price indices.

C. 4 groups of countries in EU 28 EU countries + candidate and EFTA countries (in total 37) are too much heterogeneous for global lists of products => 4 groups of countries are determined, with group leaders.

C. Role of group leaders These group leaders have to collect more prices than other countries, for they have to make the bridge with other groups. They prepare also each survey in planning meetings, dispatch lists of items to countries of their groups for pre-survey, organize group meetings, finalize the lists in overlap meetings. At last, they validate the price surveys with the help of Quaranta tables.

C. Examples of products specifications Project of merging HICP and PPP collections.

C. Example of a Quaranta table (validation tool) From Vincenzo Quaranta, former responsible for PPP in ISTAT (Italy was leader of southern group) Basic heading Expenditure weight XR: exchange rate NC: national currency CUP: conventional unit for expressing parities PLI: price level index Asterisks code representativity Purchasing Power Parities

D. FC - The specific calculation of rents What is missing for pure price comparisons? – rural, urban, big cities areas… (no consensus)

D. GFCF - Pricing construction models Usually subcontracted to consultants. “Model pricings” include margins, not only costs. Results often volatile. In italic, some models for OECD non-European countries.

D. GFCF - Pricing equipment goods Also subcontracted to consultants. At least 80 products to price, on a list of 116 items with 235 alternative specifications. Also more volatile than FC collection.

D. Non market services by the inputs The input-price approach requires a breakdown of non-market services expenditures by cost components. All efforts focus in practice on compensation of employees (other aggregates deflated by reference PPPs).

D. compensation of employees Occupations strictly defined by skill-level (ISCO). Compensation of employees described in detail (imputed social contributions).

D. Education: the output approach According to SNA 1993 and 2008, OECD and Eurostat adopted in 2007 an output approach for education: number of pupils by ISCED level, quality adjusted on performance of the education system according to PISA, after neutralization of family and socio-economic background (and an affine transformation). PISA assesses 15 year olds' competencies in the key subjects: reading, maths and science. Over 70 countries and economies have participated in PISA.

D. Health: output approach too (since 2011)

D. Health: use of “products” linked to DRG Use of “quasi prices” (non market but quasi market, relevant for deflation)

D. Other final uses Last aggregates in the expenditure side are deflated by (official) exchange rates or by reference PPPs: The initial goal of PPP is not applied! Reference PPPs are also used for some delicate products finally consumed:

Results… FR is less rich than NL But consumes more!