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” “Purchasing Power of household gross disposable income” is defined as the deflation of household gross disposable income by total CPI or by the implicit deflator of household final expenditure (for time series). But this concept has been applied/extended to spatial comparisons of GDP per head, supposed to be more relevant than nominal GDP deflated by exchange rates (which may not reflect the relative prices between countries and can be very volatile), in order to estimate the true relative wealth of nations. The measure of PPP (restricted to tradable goods and services?) defines the theoretical exchange rates, and determines if a currency is undervalued or overvalued. The purchasing power of a currency unit in a country: cases of the index , of the index... (they alas do not provide the same results).

A. GDP from the expenditure side The GDP in Purchasing Power Standards (= adjusted on PPP) is considered from the expenditure side, where each final use of each product is deflated by a spatial price index. Household actual final consumption makes the main part. But GFCF is also deflated, and General Government actual final consumption, although they are often not tradable, and it is not clear if they reflect the “purchasing power” of inhabitants (we should rather consider households disposable income or actual final consumption). The non-tradable goods and services are generally cheaper in poorer countries, because labour is less expensive (especially relatively to capital), and then the poorer countries get always a higher GDP in PPS than with official exchange rates: the Balassa-Samuelson effect. The EU-KLEMS project: an attempt of a spatial comparison of volume and price from the production side?

A. The uses in Europe for the regional policy OECD has been a the origin of the concepts and the formulas, but the EU has used and developed this tool in order to manage its regional policy. During the current programming period which covers 2007 to 2013, economic and social cohesion policy across the regions benefits from 347.410 million €: - convergence, under which the poorest Member States and regions (GDP in PPS per inhabitant less than 75 % of the EU average) are eligible, accounting for around 82 % of the funds for 2007 to 2013.

A. Beyond Europe OECD organizes the collection and the compilation of PPP for its members that are not European countries (United States, Canada, Japan, Russian federation…). 1 survey every 3 years. OECD takes Eurostat figures as they are, and bilateral indices are “frozen”. World Bank for the “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 A basic heading = the finest level for which an expenditure weight is available. In order to compare 2 countries (A and B), the same kinds of indices as for time series are available. Replace “Base period” by “base country”, and “current period” by “partner 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. Consistent in aggregation. Could be total EU.

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). The opposite for a reference volume structure (negative correlation between volume and price).

B. EKS technique for ~ chain-linked Fisher indices Eurostat and OECD use the Èltetö-Köves-Szulc or EKS Method in order to aggregate basic headings up to the total GDP, and treats all the countries symmetrically. 5 steps: calculation of a matrix (country x country) of Laspeyres type PPPs, calculation of a matrix of Paasche type PPPs, calculation of Fisher type PPPs, calculation of the matrix of EKS PPPs. standardisation of the matrix of EKS PPPs. The EKS technique consists in calculating unweighted geometric means of direct and indirect bilateral indices, in order to make them transitive. No Gerschekron effect. 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

B. Calculation of a basic heading Below a basic heading, we know no weights. But the countries are requested to say if a product is representative (unrepresentative products are generally more expensive and could bias the indices). Abusively, PPP literacy says “Laspeyres type” and “Paasche type” indices for unweighted geometric means (we should rather says Jevons indices): Laspeyres type index: Paasche type index: Same steps as before: calculation of Laspeyres type indices, Paasche indices and then Fisher indices for all pairs of countries, made transitive by EKS technique and standardised (in reference to the whole group of countries).

C. 6 surveys in 3 years Between two surveys, the national CPI indices are used in order to extrapolate all the basic headings indices.

C. 3 (now 4) groups of countries in EU The 27 countries of EU + candidate countries and EFTA countries are too much heterogeneous for global lists of products. It is the reason why 3 (now 4) groups of countries are determined, with a group leader in each of them. These group leaders have to collect more prices than other countries, for they have to make the bridge with other groups: The group leaders prepare 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, 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 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? – rural, urban, big cities areas… (the countries did not reach a consensus on this taxonomy)

D. GFCF - Pricing construction models Usually subcontracted to consultants, these “model pricings” include margins, not only costs. In italic letters, some models for OECD non-European countries: The results are often very volatile.

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 the expenditures on non-market services by cost components: compensation of employees, intermediate consumption, gross operating surplus = consumption of fixed capital, net taxes on production and receipts from sales. All efforts focus on compensation of employees, the other aggregates are deflated by reference PPPs:

D. compensation of employees The occupations are strictly defined by skill-level (ISCO), the compensation of employees is to describe in detail (imputed social contributions), the numbers of people...

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 after 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. Other final uses The last aggregates in the expenditure side are deflated by (official) exchange rates or by reference PPPs: Reference PPPs are also used for some delicate products finally consumed:

The results… FR is less rich than NL But consumes more!