The World Bank has just released updated estimates of the size of all national economies for which reliable data could be collected. A much remarked finding of the Bank’s new report is that based on one set of projections, China will soon overtake the United States as the world’s biggest economy.
In truth, the claim is somewhat misleading, as it is derived by comparing countries’ GDPs using “purchasing power parity” (PPP) exchange rates, rather than the market exchange rates we are familiar with. PPP exchange rates are intended to help gauge differences in actual living standards across countries. This involves estimating the domestic purchasing power of a unit of national currency, taking account of the fact that many goods and services consumed in local markets are not traded internationally (e.g., haircuts, restaurant meals, housing, and a wide array of consumer services). Think of it this way: a Chinese yuan or an Indian rupee typically buys “more” if spent in China or India than if used to buy something abroad. In contrast, an American dollar goes further if spent in China or India than if used to acquire items in the United States. Importantly, non-traded goods and services tend to be relatively labour-intensive, and the low labour costs found in most developing economies translate into (non-traded) products and services that are generally less expensive than in richer countries. Anyone who has travelled in Latin America or South Asia has probably experienced this.
There are a number of technical and methodological problems associated with using PPP exchange rates to compare economic output across countries. They include cross-country differences in the composition of household consumption and variations in the quality of goods/services sold in different national economies. Nonetheless, PPP-based measures of GDP are informative for some purposes, such as determining to what extent countries have succeeded in raising living standards for their citizens over time.
A better sense of the true economic weight of national economies in a global context comes from converting their GDP counted in domestic currency into a common unit, normally the American dollar, using market exchange rates. On this commonly used metric, the United States remains the world’s largest economy by a comfortable margin – representing 22% of global output, compared to 10.4% for second place China, 8.4% for Japan and 5.2% for Germany. On a PPP basis, the US is still number one (17% of world output), slightly ahead of China (14.9%), while India (6.4%) emerges as the third largest national economy when GDP is computed to adjust for domestic purchasing power.
Ten Largest National Economies
|PPP Exchange Rates||Market Exchange Rates|
|Source: World Bank, Purchasing Power Parities and Real Expenditures
in World Economies, Summary of 2011 Results, May 2014.
The table above shows various countries’ shares of global GDP calibrated in US dollars, calculated using both PPP and market exchange rates, as of 2011. On a PPP basis, Canada represented 1.6% of global economic activity in 2011; the figure rises to 2.5% when Canadian GDP is converted into US dollars using market exchange rates. Note that all of the advanced economies account for bigger slices of global GDP when their output is measured using market exchange rates.
Whether one looks at GDP based on PPP exchange rates or on market exchange rates, it is clear that the global balance of economic power is gradually shifting away from the “advanced” countries – the US, Canada, Western Europe, Japan, Australia and New Zealand – and toward the emerging markets. This was the main theme emphasized by Asian scholar Kishore Mahbubani in his keynote address at the Business Council’s 2014 Chair’s Dinner on May 20. There is no reason to believe that the growing influence of emerging markets in the international economy will reverse in the foreseeable future. For Canada, this reinforces the need for a sustained effort to build stronger trade and other commercial linkages with economies in Asia, Latin America and Africa.