A background on Gross Domestic Product Purchasing Power Parity (GDP PPP) from the World Bank – World Development Indicators:
Comparable measures of economic activity, wealth and living standards are useful for many purposes. Foreign investors, traders and potential immigrants want to know an economy’s market size, productivity and prices. The globalization of markets for goods, services, finance, labor and ideas reinforces the interdependence of economies and the need to measure them on a common scale. Countries cannot share responsibilities for global public goods—the environment, security, development assistance and global governance—without meaningful assessments of the real size of their economies and the wealth of their people.
But comparing the real size of economies is not easy. Even in an integrated global economy, large differences in the costs of goods and services persist. Exchange rates can be used to convert values in one currency to another, but since they do not fully reflect differences in price levels, they cannot measure the real volume of output. Exchange rates are determined by the demand for and supply of currencies used in international transactions, ignoring domestic economic sectors where prices are set in relative isolation from the rest of the world—thus the familiar experience of international travelers, who discover that they can buy more, or less, of the same goods in different countries when converting their money using the prevailing exchange rates.
To measure the real size of the world’s economy and to compare costs of living across countries, we need to adjust for differences in purchasing power. Finding a way to adjust for those differences has given rise to the efforts to measure purchasing power parities (PPPs), which convert local currencies to a common currency, such as the US dollar. Purchasing power parities are needed because similar goods and services have widely varying prices across countries when converted to a common currency using market exchange rates. Differences are greatest in sectors not commonly traded internationally, such as housing, construction and health and education services. Price differences are smaller for widely traded products, such as machinery and equipment, after allowing for taxes, distributor margins and transport costs. PPPs include the prices of tradable and nontradable goods, using weights that reflect their relative importance in total GDP.
Since 1970 the International Comparison Program (ICP) has conducted eight rounds of PPP estimates for the major components of countries’ gross domestic product (GDP)—the most recent for 2005. High-income countries regularly take part in such programs, but 2005 was the first time since 1993 that comprehensive price surveys were carried out in developing economies. An unprecedented number, 101, took part. These new PPPs provide a better and more complete view of the world economy.
In 2005 the ICP report brought together the results of two separate PPP programs. The first is the global ICP program conducted by the ICP Global Office within the World Bank. The program was organized in five geographic areas: Africa, Asia-Pacific, Commonwealth of Independent States, Latin America and Western Asia. In parallel, the Statistical Office of the European Communities (Eurostat) and the Organisation for Economic Co-operation and Development (OECD) conducted its 2005 PPP program that included 46 countries. Eurostat covered 37 countries—the 25 EU member states, the EFTA countries and other European countries. The OECD part of the program included nine other countries.
The ICP Global Office has combined the results from each of the five regions with those from the OECD/Eurostat PPP Program into an overall global comparison.
Note: The IMF is not a primary source for purchasing power parity (PPP) data. For primary source information, please refer to one of the following sources: the Organisation for Economic Co-operation and Development, the World Bank, Eurostat.