Purchasing Power Parities and the Real Size of Western Asia Economies

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1 Economic and Social Commission for Western Asia Purchasing Power Parities and the Real Size of Western Asia Economies A Comprehensive Report of the 2011 Round of the International Comparison Program in Western Asia Region

2 Distr. LIMITED E/ESCWA/SD/2015/Technical Paper.2 13 May 2015 ORIGINAL: ENGLISH ECONOMIC AND SOCIAL COMMISSION FOR WESTERN ASIA (ESCWA) PURCHASING POWER PARITIES AND THE REAL SIZE OF WESTERN ASIA ECONOMIES A COMPREHENSIVE REPORT OF THE 2011 ROUND OF THE INTERNATIONAL COMPARISON PROGRAM IN WESTERN ASIA REGION United Nations New York, 2015 Note: This document has been reproduced in the form in which it was received, without formal editing

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4 Table of Contents ACKNOWLEDGMENTS... v CHAPTER 1: BACKGROUND... 1 WHAT IS THE ICP?... 3 WHAT ARE PPPs?... 3 WHY PPPs AND NOT EXCHANGE RATES?... 4 THE PRICE LEVEL INDEX... 5 CONCEPTUAL UNDERPINNINGS OF ICP... 5 USES OF PPP DATA... 6 LIMITATIONS OF PPP DATA... 7 COMPARISONS OVER TIME... 8 ICP VS CPI... 9 CHAPTER 2: PRICE COMPARISON RESULTS OF THE 2011 ICP ROUND IN WESTERN ASIA REGION WESTERN ASIA REGIONAL COMPARISON RESULTS: MAJOR FINDINGS AND ANALYSIS WESTERN ASIA RESULTS FROM A GLOBAL PERSPECTIVE TABLES OF RESULTS: PPP ESTIMATES FOR THE YEAR 2011 IN UNITED STATES DOLLARS COUNTRY PROFILES UNDER THE 2011 COMPARISON...33 CHAPTER 3: ICP A ROUND OF INNOVATION IMPROVEMENTS IN ICP METHODOLOGIES DATA QUALITY ASSURANCE OUTREACH AND CAPACITY-BUILDING INNOVATIONS AT THE REGIONAL LEVEL THE 2011 ROUND FROM A THREE DIMENSIONAL PERSPECTIVE CHAPTER 4: THE PRICE COMPARISON RESULTS of 2012 AND 2013 IN WESTERN ASIA REGION INTRODUCTION THE COMPUTATION OF 2012 and 2013 RESULTS: THE METHODOLOGY IN BRIEF TABLES OF RESULTS: PPP ESTIMATES FOR THE YEARS 2011, 2012 AND 2013 IN OMANI RIYALS ANALYSIS AND MAJOR FINDINGS OF THE REGIONAL COMPARISON CHAPTER 5: ANNEXES ANNEX1: A GLIMPSE OF THE 2011 NATIONAL SURVEY FRAMEWORKS iii

5 ANNEX2: METHODOLOGICAL FRAMEWORK FOR PRICE COMPARISONS ANNEX3: A BRIEF HISTORICAL OVERVIEW OF THE ICP ANNEX4: THE 2011 ICP CLASSIFICTION ANNEX5: REGIONAL ACTIVITIES OF WESTERN ASIA REGION UNDER THE SCOPE OF THE 2011 ICP ROUND ANNEX6: GLOSSARY REFERENCES iv

6 ACKNOWLEDGEMENTS The 2011 International comparison Program (ICP) for Western Asia region was carried out by UN-ESCWA with substantial funding from the World Bank Development Data Group. The program was managed and implemented by Majed Skaini, the ICP Regional Coordinator and Statistician at the UN-ESCWA Statistics Division, under the guidance of Juraj Riecan, the Director of the Statistics Division and the support of Wafa Abul Hosn, the Chief of Economic Statistics Section. The ICP Global Office at the World Bank provided substantial technical and administrative assistance to the program. The Bank team which supported Western Asia region consisted of Michel Mouyelo-Katoula, the ICP Global Manager, and Nada Hamadeh, a Senior Statistician who was also the team leader of a group of experts who supported Western Asia s activities including Mathieu Biokou-Djayeola, Simon Humpries, Marko Rissanen, Inyoung Song and Mizuki Yamanaka. The program also benefited from the technical contributions provided by international and regional experts including Derek Blades, Omar Hakouz, David Roberts and Sergey Sergeev. The program could not have enjoyed its present success without the support and enthusiasm of the national statistical offices of the 12 participating countries. Special thanks are due to the ICP national coordinators: Shatha Abdullah, Bahrain; Awatef Abou Gendy, Egypt; Saad Zaghloul, Iraq; Abdulwadood Maatouk, Jordan; Khalid Al Enezi and Fatima Hasan, Kuwait; Ahmad Al Maymani, Oman; Ashraf Samara, Palestine; Asma Suwailem, Qatar; Mohammad Al Farraj, Saudi Arabia; Hasan Ibrahim and Al Alim Abdulghani, Sudan; Khalifa Al Hosani and Ali Buharoon, United Arab Emirates; Hamdi Shargabi, Yemen. Thanks are also extended to the national focal points for prices and national accounts whose contribution was crucial to the program s success especially for some who were working under difficult circumstances and much resource and time constraints. This report, including the results and the associated analysis, has been prepared by the Western Asia ICP regional team led by Majed Skaini and consisting of Jala El Akoum and Maroun Laoun to whom much gratitude is extended for the substantive and administrative assistance all throughout the program s implementation in the region. The commitment and dedication of the Western Asia national teams from one side and the regional team from the other side has led to the distinguished achievements of Western Asia region in pursuing further success such as computing regional PPP results for the subsequent years 2012 and 2013, an accomplishment which the region was acknowledged for. Special thanks are also extended to member countries of the Gulf Cooperation Council (GCC) for self financing many of the ICP related activities and their continuous support which contributed to the overall success of the program and its outcomes. v

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8 CHAPTER I: Background 1

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10 WHAT IS ICP? The International Comparison Program (ICP) was established in the late 1960s on the recommendation of the United Nations Statistical Commission (UNSC). It began as a research project carried out jointly by the United Nations Statistical Office (UNSO) and the University of Pennsylvania. Comparisons were carried out in 1970 for 10 economies, in 1973 for 16 economies, and in 1975 for 34 economies. After the 1975 comparison, the ICP shifted from being a research project to being a regular operational part of the UNSO work program. It was also regionalized; comparisons were organized by region and then combined to obtain a global comparison. Comparisons were carried out in 1980 for 60 economies, in 1985 for 64 economies, and in 1993 for 83 economies. The 1993 regional comparisons could not be combined to produce a global comparison. In response, the UNSC commissioned a thorough review of the ICP before further comparisons were attempted. Subsequently, the UNSC asked the World Bank to draw up an action plan that would address the issues raised by the review. This request resulted in the establishment of the ICP Global Office within the Bank to coordinate and combine the regional comparisons and the formation of a multi-tiered governance structure headed by the UNSC to oversee and assist the Global Office. The first global comparison made under the new arrangements was ICP 2005 involving 146 economies. The second was ICP 2011 in which 199 economies participated. The results of the 2011 comparison are presented in this report. A history of the ICP appears in annex 2. Since its beginning, the purpose of the ICP has been to compare the gross domestic products (GDPs) of economies with a view toward determining their relative size, productivity, and material well-being. More specifically, the ICP s objective is to compile on a timely and regular basis internationally comparable price and volume measures with which to compare the price and real expenditure levels of GDP and its component expenditures across participating economies. The GDPs and their component expenditures of the economies are valued at national price levels and expressed in national currencies. But to be compared, they must be valued at a common price level and expressed in a common currency. The ICP uses purchasing power parities (PPPs) to effect this double conversion. PPPs are price indexes that serve as spatial price deflators. They make it possible to compare the GDPs and component expenditures of economies in real terms by removing the price level differences between them. This approach closely parallels that for GDP comparisons over time for a single economy where it is necessary to remove the price changes between the periods being compared in order to assess the change in underlying volumes. To calculate PPPs for its comparisons, the ICP holds worldwide surveys at regular intervals currently every six years to collect comparable price and expenditure data for the whole range of final goods and services that make up the final expenditure on GDP: consumer goods and services, government services, and capital goods. The surveys are organized by region and are coordinated by an agency located in the region. The intention is to produce regional comparisons that can be combined in a single global comparison for a given reference year. The main reasons for conducting the surveys on a regional basis are that the products to be priced tend to be more homogeneous within regions, expenditure patterns are likely to be similar, and language differences are reduced. In addition, there are operational advantages in having the ICP carried out by agencies that are in relatively close proximity to the economies they are coordinating. WHAT ARE PPPs? PPPs are price relatives that show the ratio of the prices in national currencies of the same good or service in different economies. For example, if the price of a hamburger is 4.80 in France and $4.00 in the United States, the PPP for hamburgers between the two economies is $0.83 to the euro from the French perspective (4.00/4.80) and 1.20 to the dollar from the U.S. perspective (4.80/4.00). In other 3

11 words, for every euro spent on hamburgers in France, $0.83 would have to be spent in the United States to obtain the same quantity and quality - that is, the same volume - of hamburgers. Conversely, for every dollar spent on hamburgers in the United States, 1.20 would have to be spent in France to obtain the same volume of hamburgers. To compare the volumes of hamburgers purchased in the two economies, either the expenditure on hamburgers in France can be expressed in dollars by dividing by 1.20 or the expenditure on hamburgers in the United States can be expressed in euros by dividing by PPPs are calculated in stages: first for individual goods and services, then for groups of products, and finally for each of the various levels of aggregation up to GDP. PPPs continue to be price relatives whether they refer to a product group, to an aggregation level, or to GDP. As one moves up the aggregation hierarchy, the price relatives refer to increasingly complex assortments of goods and services. Therefore, if the PPP for GDP between France and the United States is 0.95 to the dollar, it can be inferred that for every dollar spent on GDP in the United States, 0.95 would have to be spent in France to purchase the same volume of goods and services. Purchasing the same volume of goods and services does not mean that the baskets of goods and services purchased in both economies will be identical. The composition of the baskets will vary between economies and reflect differences in taste, culture, climate, price structure, product availability, and income level, but both baskets will, in principle, provide equivalent satisfaction or utility. WHY PPPs AND NOT EXCHANGE RATES? Before PPPs became widely available, exchange rates were used to make international comparisons of GDP. Exchange rates, however, only convert the GDPs to a common currency, they do not provide GDPs valued at a common price level. This is because exchange rates do not reflect the relative purchasing powers of currencies in their national markets. For them to do so, all goods and services would have to be internationally traded and the supply and demand for currencies would have to be driven predominantly, if not solely, by the currency requirements of international trade. But this is not the case; many goods and services, such as buildings, government services and most market services are not traded internationally and the supply and demand for currencies are influenced primarily by factors such as currency speculation, interest rates, government intervention and capital flows between economies. Consequently, as shown in Box 1, GDPs converted to a common currency with exchange rates remain valued at national price levels. Differences between the GDPs of different economies reflect both differences in the volumes produced by the economies and differences in the price levels of the economies. Price levels are normally higher in high-income economies than they are in low-income economies. When this is the case, differences in price levels between high-income economies and low-income economies are greater for non-traded products than they are for traded products. This arises because the prices of traded products are basically determined globally by the law of one price, while the prices for non-traded products are determined by local circumstances, in particular by wages and salaries which are generally higher in high-income economies. If the larger price level differences for non-traded products are not taken into account when converting the GDPs to a common currency, the size of high-income economies with high price levels will be overstated and the size of low-income economies with low price levels will be understated. No distinction is made between traded products and non-traded products when exchange rates are used to convert the GDPs to a common currency: the exchange rate is the same for all products. Exchange rate converted GDPs can be highly misleading on the relative sizes of economies and levels of material well-being as a result, what is known as the Penn effect. PPP-converted GDPs do not have this problem because, as will be explained below, PPPs are calculated for individual products first. They 4

12 therefore take account of the different price levels for traded products and non-traded products. It is PPP-converted data, and not exchange rateconverted data, that should be used to compare the size of economies and their levels of material wellbeing. PPPs are specifically designed for international comparisons of the volumes of goods and services that enter into the GDP at a single point in time. PPPs are not relevant for measuring the growth of GDP: that is correctly measured by each economy s estimates of GDP at constant prices. Nor are PPPs relevant for comparing monetary flows or trade flows. International comparisons of flows, such as development aid, foreign direct investment, migrants remittances or exports and imports of goods and services are made with exchange rates not with PPPs. THE PRICE LEVEL INDEX The Price Level Index (PLI) is computed as the ratio of each economy s PPP to its exchange rate. Just as the PPPs, PLIs can be computed not only at the level of products, but also at the level of product groups, aggregates, and GDP. At the level of GDP, PLIs provide a measure of the differences in the general price levels of economies. The PLI is generally expressed as a percentage with the PLI of the base economy or the region in question as 100. PLI can be explained from 3 different perspectives: PLI can be used as a measure of the price level: Economies with PLIs greater (less) than 100 have price levels that are higher (lower) than that of the region. The PLIs of economies can also be compared directly. For example, if the PLI of one economy is 120 while that of another economy is 80, then it is valid to infer that the price level in the former is 50% (120/80) higher than that in the latter. PLI can be used as an indicator of the worth of currencies: An economy with PLI greater (less) than 100 reflects the fact that its national currency is worth less (more) in real terms (using PPP conversion), and hence the exchange rate overestimates (underestimates) the purchasing power of the national currency. PLI can reflect the moving trend of the power of the currency across the years: If the PLI of an economy is decreasing (increasing) over the years, it reflects an appreciation (depreciation) trend of the purchasing power of the national currency across the years. A random trend is reflected through a PLI fluctuation between the years. CONCEPTUAL UNDERPINNINGS OF ICP At its most basic level that of individual products the ICP uses principles and techniques similar to The Economist s Big Mac index. The Magazine has been publishing the index for over 20 years. McDonald sells Big Mac hamburger in 120 nations, which provides a crude way to compare price levels across countries, holding quantity, quality, service delivery and outlet type constant. The practice, known as Burgernomics is based on the theory of PPP. Assume a world consisting of two countries (A and B) and only one product (Big Mac). Assume also per capita GDP as measured by per capita Big Mac consumption in monetary terms in country A is 120 per cent of that of country B, but the price of Big Mac in country A is 20 per cent higher than that in country B. In monetary terms, before accounting for price level differences, an average citizen living in country A would appear better off compared to an average citizen in country B. However, in terms of real volume of Big Mac consumed, the economic welfare of citizens in the two countries will be similar. That is because although the average citizen in country A seems to consume 20 per cent more Big 5

13 Mac in nominal (monetary) terms, he/she faces 20 per cent higher prices at the counter that offsets the 20 per cent premium in his/her nominal Big Mac consumption. It is only when price levels are equalized (or parity is established between their currencies) that comparison of real per capita Big Mac consumption between the two countries can be done. That is the essence of the PPP concept underlying The Economist s Big Mac index, which represents the microcosm of the basic principles of ICP. Unlike the Big Mac index, the ICP-generated PPP rates are based on price comparisons for 155 basic expenditure categories covering a comprehensive nationwide sample of goods and services. In that, all expenditure components of GDP, including household consumption, purchases of capital goods and outlays by government are represented. Prices are usually collected for several specifications of goods and/or services in each of the 155 categories. The number of products priced for that purpose may vary from 1000 to 5000, depending on the regional comparison. The calculation of purchasing power equivalents for various countries is carried out by collecting prices of comparable and representative items in different countries and aggregating price ratios of those items by their respective GDP expenditure weights. USES OF PPP DATA PPPs and the price and volume indices they generate are used for research and analysis, for statistical compilation and for administrative purposes. The principal users are international bodies such as the World Bank, the International Monetary Fund (IMF), the United Nations and its affiliates, the OECD and the European Commission. Improvements in the timeliness, frequency and coverage of ICP comparisons, however, have stimulated a growing demand for PPP-based measures from a variety of national users, in particular government agencies, universities and research institutes. At the same time, there has been a switch in users focus. The ICP was set up to compare the GDPs of economies in real terms and PPPs were seen primarily as a means of converting nominal expenditures to real expenditures. Volume comparisons are still the ICP s primary purpose. But now international users and national users are showing an increasing interest in the PPPs as measures of relative price levels between economies at all levels of aggregation and in the national annual average prices underlying them. As result of this interest, the Global Office has had to establish a set of rules governing access to unpublished results and basic data. Researchers and policymakers, at both international and national levels, use PPPs as inputs into economic research and policy analysis that involve comparisons between economies. In this context, PPPs are employed either to generate volume measures with which to compare the size of economies and their levels of material well-being, consumption, investment, government expenditure and overall productivity or to generate price measures with which to compare price levels, price structures, price convergence and competitiveness. PPP-converted GDPs are used to standardize other economic variables such as carbon emissions per unit of GDP, energy use per unit of GDP, GDP per employee or GDP per hour worked. Multinational corporations, for example, use PPPs to evaluate the cost of investment in different economies. One major use of PPPs is poverty assessment with the World Bank s international poverty threshold. National poverty assessments differ because the purchasing powers of national currencies differ from one economy to another. Therefore, to establish an international poverty line, purchasing power needs to be equalized over economies. This is done by converting the international poverty line from dollars to national currencies with PPPs. Data from household surveys are then used to determine the number of people living with per capita consumption below this poverty line. 6

14 The eradication of hunger and poverty are the first goals of the United Nation s post-2015 development agenda. Other goals refer to health, inclusive and equitable quality education and the availability of water and sanitation for all. The World Health Organization uses PPPs when comparing per capita expenditure on health across economies. Similarly, the United Nations Educational, Scientific and Cultural Organization use PPPs when assessing the per capita expenditure on education of different economies. A related use is the estimation of the United Nation s Human Development Index, in which PPP-converted gross national income per capita is one of the three variables that constitute the index. PPPs are used for statistical compilation. International organizations use PPPs to obtain totals and averages for groups of economies, such as the ICP regions. Real GDP and its components are aggregated across the economies comprising the groups to obtain totals for the groups. The shares of economies in these totals are used as weights when economic indicators, such as price indices or growth rates, are combined to obtain averages for the groups. Both the IMF and the OECD use PPP-based GDP and GDP aggregates to provide estimates of regional and world output and growth in their respective Economic Outlooks. PPPs are employed for administrative purposes by the European Commission and the IMF. The European Commission uses the PPPs of its member states when allocating the structural funds, the aim of which is to reduce economic disparities between and within member states. The principal indicator influencing the allocation is PPP-deflated intracountry regional GDP per capita. The IMF uses PPPs when deciding on the quota subscriptions of its member countries. Quota subscriptions determine the financial resources member countries are obliged to provide the IMF, the amount of financing they can obtain from the IMF, their share in a general allocation of special drawing rights and their voting power in IMF decisions. PPP-converted GDP has a weight of 20 per cent in the quota formula. Another administrative application is the setting of PPP-adjusted cost-of-living allowances by employers whose employees have to work in different parts of the world away from their home station, for example: international organisations, multinational corporations, diplomatic services, and government and non-government aid agencies. Assume an expatriate worker earning 15,000 Saudi Riyals (SAR) in Saudi Arabia gets an offer to relocate to Qatar with a salary or 18,250 Qatari Riyals. Using Exchange rate conversion, the worker s salary is equivalent to USD 4,000. The offer in Qatar on the other hand is USD 5,000. Using PPP conversion rates, the salary offered in Qatar would be equivalent to SAR 8,729, which is a lot less than what the worker is already earning in Saudi Arabia. LIMITATIONS OF PPP DATA PPPs are statistical constructs rather than precise measures. Like all statistics, they are point estimates lying within a range of estimates the error margin that includes the unknown true value. The error margins surrounding PPPs depend on the reliability of the expenditure weights and the price data reported by participating economies as well as the extent to which the goods and services priced reflect the consumption patterns and price levels of each participating economy. As with national accounts data generally, it is not possible to calculate precise error margins for PPPs or for the real expenditures derived with them. The 2011 ICP included economies ranging from city states to large and diverse economies, such as China, India, and Brazil that include many people living in remote rural areas. These and similar economies had to produce national average prices for goods and services that were comparable with those of other economies in their region. The accuracy of the PPPs for these economies depends upon the extent to which the goods and services they selected for pricing were representative of their entire economy and on their ability to provide nationally representative average prices. The need to measure prices for internationally comparable 7

15 goods and services means that they are more likely to reflect prices in urban areas. In practice, many household goods and services are available only in towns, so the urban price is also the rural price. If the urban-to-rural price differentials are similar across economies, any bias will tend to cancel out in the estimation of PPPs; if not, results for some economies may be biased, either up or down, depending on the degree to which urban and rural areas are overrepresented or underrepresented. Caution should be exercised when comparing economies by the size of their real GDP or their real GDP per capita. Such comparisons require that all the economies employ the same definition of GDP and that their measurement of GDP is equally exhaustive. Although the first requirement is broadly met as the GDP estimates of most ICP participants are compiled more or less in line with the SNA 93, the measurement of GDP is not sufficiently uniform over all participants to satisfy the second requirement. In particular, the GDPs of participants with large non-observed economies could be underestimated. Bearing in mind that there may be errors in the population data in addition to those in the price and expenditure data, small differences between real GDPs and real GDPs per capita should not be considered significant. It is usually accepted that differences of less than five per cent lie within the margin of error of the PPP estimation. Rather than ranking economies, it is preferable to group them by broad size categories. Care should also be taken when making comparisons of price levels or per capita expenditures at lower levels of aggregation. Margins of error increase as the level of aggregation decreases. Furthermore, some prices, such as for housing and health services, are more difficult to measure, and services in general are more difficult to price than are goods. Comparisons of these components have wider measures of error than, for example, those for food products, beverages and everyday items for household use. COMPARISONS OVER TIME ICP comparisons are designed primarily to make international volume comparisons of GDP at specific points in time. They are not designed to track changes in the relative volume levels of economies between these points. Each ICP comparison produces indices of real GDP that show the relative volume levels of GDP among participating economies for its reference year. When the indices for consecutive reference years are placed side by side, they appear to provide points in a time series of relative GDP volume levels over the intervening years. This apparent time series of volume measures is actually a time series of value indices. This is because the volume indices for each reference year are calculated with the prices and expenditures of that year. Changes in the volume indices between reference years are thus due to changes in relative price levels as well as changes in relative volume levels. As a result, the rates of relative growth derived from the indices are not consistent with those obtained from GDP volumes estimated by the economies themselves. To trace the evolution of relative GDP volume levels of economies between reference years, it is necessary to select one of the years as a base year and to extrapolate its relative GDP volume levels over the intervening years to the other reference years. Extrapolation is done by applying the relative rates of GDP volume growth observed in the different economies. This provides a time series of volume indices at a constant uniform price level that replicates exactly the relative movements of GDP volume growth of each economy. The underlying assumption is that price structures do not change over time. But relative prices do change over time and, if such changes are ignored over long periods, a biased picture of the relative economic developments of economies can result. The choice of base year can also influence the picture that emerges. On the other hand, the PLIs of different reference years do provide a means of observing the 8

16 movement of price levels over time, although they have to be interpreted with care. First, they are influenced by exchange rate fluctuations. Second, independently of exchange rates, they are volatile. This is typically so at lower levels of aggregation where sample sizes are small. Usually such volatility diminishes, if not disappears, with aggregation. Volatility particularly arises when the basket of goods and services to be priced changes from one comparison to another in order to accommodate market developments between reference years. In this respect, for example, the basket for food and non-alcoholic beverages is relatively stable, while that for electronic products is altered substantially each time it is surveyed. Volatility of this type also diminishes with aggregation. For these reasons, PLIs are better suited to monitoring the changes in relative price levels between economies at higher levels of aggregation. ICP VS CPI The ICP provides Purchasing Power Parities, used as conversion factors replacing exchange rates, in converting various economic aggregates from different countries into a common currency unit. It is the primary tool used to evaluate the spatial value of money across countries. However, the consumer price index provides a statistical measure of changes in prices of consumer goods and services over a given period of time. It is the primary tool used to evaluate the temporal value of money within a country. Regarding the scope and coverage side, the PPPs under the ICP have a much wider coverage of goods and services. In fact, the PPPs are designed to convert nominal value aggregates in national accounts into real value aggregates that are comparable across countries, and therefore cover all entities that make up the GDP of a country. There are three different accounts from which the GDP statistics can be derived: the expenditure, production and income accounts. The ICP focuses on the measurement of differences in price levels across different countries based on the data and entries for the expenditure side of the national accounts. The principal reasons for advocating this approach are the advantage of defining the unit price more meaningfully for the expenditure items, the similarity with the consumer price index number construction, and the availability of price and expenditure data from different countries. Moreover, the PPPs computed under the ICP relate to all the components of GDP on the expenditure side. The scope of ICP, and the resulting PPPs, is thus much wider than that of the CPI. PPPs for the major expenditure aggregate, household consumption, are the closest in product coverage to the consumer price index. Thus PPPs for the household expenditure category may be considered as spatial measures of price differences similar to the CPI, which measures temporal changes in prices. In most countries the CPI price data are collected using standard survey methods to record the prices of goods and services that enter the consumption basket. The consumption basket is based on surveys of consumer spending. A schedule of goods and services to be priced is determined and prices for these goods and services are obtained from selected retail outlets or other sources. Special sampling issues arise in the selection of outlets from which price data are collected. In the case of PPP, the commodity listing, with specific product quality specifications, is arrived at by the ICP experts. This commodity listing is prepared in consultation with experts from different countries participating in the international comparison exercise. The choice of commodities reflects the principle of "identical products". This has been the guiding principle of ICP work since its inception. Identical products ensure that quality issues do not enter into the PPP measurement and the results provide a measure only of price differences. On the other hand, there is an identifiable similarity in the general approach to aggregation. A two-stage approach is used in both cases. In the first stage, elementary unweighted indices, or basic heading PPPs, are derived. The index number formulae used in both CPI and PPP computation at 9

17 this level of aggregation are essentially identical when the geometric mean of price ratios is used. However, there are differences in the methods used at the second stage, for aggregation at levels above the basic heading level. These differences are mainly due to the transitivity requirement for PPPs, which is not an issue for the CPI. Expenditure share weights, for the aggregation of price differences above the elementary level or basic heading level, are a common requirement for both CPI and PPP. The CPI weights are usually based on data collected through household expenditure surveys. This is one of the reasons why many countries tend to use a fixedbased approach to CPI construction, in which weights are revised periodically. Weights used in the calculation of PPPs refer to the shares in the national accounts, which are prepared annually. 10

18 CHAPTER II: Price Comparison Results of the 2011 ICP Round in Western Asia Region Results of the 2011 ICP Price Comparison from the Regional and Global Perspectives 11

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20 WESTERN ASIA REGIONAL COMPARISON RESULTS: MAJOR FINDINGS AND ANALYSIS This section of the report includes PPP results and related analysis with 2011 as reference year, where all the data and analyzed aggregates refer to Table 1 provides a summary of results referring including purchasing power parity rates and price level indices at the GDP level as well as other key statistics such as population and total GDP in local currencies. The PLI is the ratio of PPP to market exchange rate, and it provides an indicator of how much the purchasing power of a country s national currency is underestimated or overestimated. The results of the Western Asia regional comparison are presented in a series of tables that will follow. It may be mentioned that the ICP for Western Asia region delivers a set of PPPs for GDP and its various subcomponents for all the 12 countries participating in the exercise. The PPPs are then used to convert local currency values to a common currency (United States Dollar). The results are called real values. When national currency GDP is converted by PPPs the result is referred to as real GDP or real output. In contrast, exchange rate-based estimates are referred to as nominal. The practice is in line with the convention of calling constant price series real and current price series nominal in national accounts data time-series presentation. In ICP lexicon, the term real is used in reference to PPP-based estimates. Comparison of the Real GDP and its Major Components Saudi Arabia and Egypt are the two largest economies in Western Asia Region accounting for over 53 per cent of the region s total real GDP. Saudi Arabia alone accounts for 33 per cent of the region s total real GDP, and since its PLI is almost equal to 100, its share of the region s GDP does not differ much when its local currency-denominated GDP is converted by exchange rate. However, Egypt accounts for 20 per cent of the region s total GDP in PPP terms compared to a 12 per cent share in exchange rate. In contrast, UAE s 18 per cent share of the region s GDP in exchange rate terms drops to 12 per cent when converted by PPP terms. This is due to the fact that the PLI of Egypt and UAE are 56 per cent and 145 per cent respectively. Measured in PPP terms, the individual share of most of the remaining countries is equal to or below 9 per cent, with Bahrain and Jordan below 2 per cent and Palestine below 1 per cent. The Actual Individual Consumption (AIC) is the total value of the individual consumption expenditure of households, non-profit institutions serving households, and general government. Egypt earns the largest share of over 34 per cent of the total regional real AIC (see table 2). Saudi Arabia accounts for 25 per cent and the United Arab Emirates for 12 per cent. In contrast, when exchange rate estimates are used, Saudi Arabia takes the lead with a share of 27 per cent, followed by UAE and Egypt respectively with approximate shares of 20 per 13

21 cent. The significant difference between the relative position of these three countries in PPP and exchange rate estimates reflects the underlying difference in their price levels. Egypt s price level is the lowest in the region and stands at 59 per cent. In contrast, the United Arab Emirates records a staggering PLI of 170 per cent and Saudi Arabia a PLI of 109 per cent. Saudi Arabia dominates the region s investment with a 40 per cent share of the real Gross Fixed Capital Formation (GFCG) (see table 3). The GFCF measures a country s investment expenditures, which mostly comprise purchases of equipment and construction services. Saudi Arabia is followed by the United Arab Emirates and Qatar which account for 17 and 11 per cent of the region s real GFCF respectively. Combined, these three countries account for two thirds of the total real GFCF. When observing PLI at the GFCF level, Palestine appears to be the most expensive country in the region with a price level of 150 per cent. However, Palestine has the smallest share of just 0.32 per cent of the regional output in PPP terms below Bahrain and Yemen whose shares are just below 1 per cent each. The Collective Consumption Expenditure by Government (CCEG) consists of expenditures incurred by general and local government for collective consumption services such as defense, justice, general administration and the protection of the environment. Saudi Arabia s share represents the largest share of the regional total of government expenditure when PPP estimates are the basis of comparison, accounting for 27 per cent; Egypt follows closely accounting for 26 per cent while Iraq takes third place with a share of 19 per cent. It is worth mentioning that the CCEG has the biggest price level difference among all the components of GDP, as percentages vary from as low as 32 per cent for Egypt, to 268 per cent for UAE which represents the highest price level in the region. This is translated in a significantly different relative position of countries when exchange rate values are used: 14

22 the share of Saudi Arabia leaps to 36 per cent followed by Iraq and UAE with respective shares of 13 and 12 per cent, while Egypt records a share of only 9 per cent. Comparison of the Real Per Capita GDP and its Major Components In terms of real per capita GDP, Qatar is the richest country in the region with USD 146,521, which is more than 8 times the regional average. It is followed by Kuwait (USD 84,058), UAE (USD 60,886), Saudi Arabia (USD 48,163), Bahrain (USD 43,360) and Oman (USD 42,619) (see table 5). These top 6 richest countries are all members of the Gulf Cooperation Council (GCC). The per Capita GDP of all non-gcc countries falls below the regional average. Jordan is richest among the non-gcc countries with USD 11,169, followed by Iraq, Egypt, Palestine, Yemen and finally Sudan which appears to have the lowest real per capita GDP in the region amounting to USD 3,608, almost 5 times less than the regional average. In terms of ranking, there is no significant difference between PPP and exchange rate; Yemen replaces Sudan in nominal terms, Saudi Arabia and Bahrain switch ranks, and Iraq precedes Jordan. The significant difference is mainly in the magnitude of the per capita estimates. For example, whereas Qatar s per capita value is 59 times that of Sudan when exchange rate estimates are the basis of comparison, it is only 41 times richer when PPP estimates are used instead. Qatar is 4.6 times richer than Oman (the poorest among GCC countries) in exchange rate terms, but it is only 3.4 times richer when the comparison is based on PPP estimates (see table 5). 15

23 When looking at the real per capita Actual Individual consumption (AIC), UAE tops the list followed by Kuwait and Qatar while Sudan ranks as last. This scenario differs when exchange rate conversions are considered; Kuwait loses a position to Qatar which ranks second and Sudan and Yemen switch places and rank 11 th and 12 th respectively. The range of difference in real per Capita household consumption among the 12 countries is much less than that in real per capita GDP. Per capita real consumption in UAE, for example, is almost only 13 times greater than that of the lowest ranking economy (Sudan), compared with a factor of 19 times when nominal per capita consumption is the base of comparison (see table 6). For the per capita Gross fixed capital formation (GFCF), there are no significant changes in the ranking of the participating countries when comparing their real with their nominal per capita figures. Qatar tops the list and presents an incomparable high investment value (see table 7), its per capita figure is 3 times higher than that of UAE which occupies the 2nd place in both the real and nominal terms. However, the disparity in the level of GFCF is staggering when comparing higher with the lower-income countries; In real terms, the per capita GFCF for Qatar (ranked highest) appears to be over 166 times greater than that of Yemen (ranked lowest). Regarding the per capita Collective consumption expenditure by government (CCEG), Qatar takes the lead again followed by Kuwait in second place in both PPP and exchange rate terms. It is worth mentioning that whereas UAE scored the 3th place in terms of exchange rate estimates, it occupied the 7 th place (descending ranking) when PPP conversions were applied. Sudan appears to have the smallest per capita CCEG in both real and nominal terms, preceded by Yemen with a more than 30% higher 16

24 per capita value in real terms whereas in nominal terms Yemen s per capita CCEG is only 15 per cent higher than that of Sudan (see table 8). Comparison of Price Level Indices A price level index (PLI) is defined as the ratio of PPP to the corresponding exchange rate. It is usually presented in percentage terms. PLIs are used to compare price levels between economies. They indicate the price of GDP (or its components) in an economy if it was purchased after acquiring local currency at the prevailing exchange rate. PLIs are generally low in the poorest economies. But it is also possible to see countries at the same level of development showing different PLIs. As stated earlier, from the national perspective, a country s PLI which is greater than 100 per cent reflects an overestimation of the purchasing power of the country s local currency whereas from the regional perspective, it reflects a prevailing price level higher than the regional average. Table 9 shows the relative price levels of each country for GDP and a selected number of its components - actual individual consumption, collective consumption expenditures by government and gross fixed capital formation. The PLI of 1.45 for UAE at the GDP level means that the overall price level is 45 per cent higher in UAE compared with the region as a whole. The corresponding index for Egypt is 0.56, which means that the overall price level in Egypt is 44 per cent lower compared with the regional average and as a consequence, the purchasing power of the Egyptian Pound is greater in PPP terms than it is in exchange rate terms. It also means that the purchasing power of one US Dollar in Egypt is equivalent to an average of (1.448/0.559) 2.59 US dollar in UAE. The PLI for each of the other aggregates is also expressed relative to the regional average, which is set equal to

25 At the GDP level, UAE tops the ranking of PLI, followed by Qatar, Kuwait, Palestine, Bahrain, Oman and Saudi Arabia - all but one are GCC members, noting that Palestine is ranked fourth in the region with a PLI of The five remaining countries - Sudan, Iraq, Jordan, Yemen and Egypt - have price levels that are lower than the regional average, with Egypt being the least expensive. One feature of PPP conversions is its ability to distinguish price levels for different segments of GDP, down to basic headings, as the difference in prices are captured by their respective PPPs. The distinction is not possible in exchange rate conversion as the same rate is applied regardless of the item of expenditure. The PLI ranking in GDP more or less holds for individual as well as government consumption. In terms of individual consumption, Qatar and UAE switch places - Qatar moving up from second to first place, while UAE drops down from first to second place. In the same manner, Sudan climbs to the 6 th place pushing Oman and Saudi Arabia to the 7 th and 8 th places respectively. For collective government consumption, Palestine and Sudan drop respectively from ranks four to seven and eight to eleven. Conversely, Bahrain, Saudi Arabia and Jordan move up respectively from ranks five to four, seven to five and ten to eight. As for the GFCF, only two countries Kuwait and Bahrain reserve the same ranking. UAE, Qatar, Oman and Saudi Arabia move down, while Palestine, Iraq, Jordan, Yemen, Sudan and Egypt move up. It is apparent that the price disparity among countries is quite high: at the GDP level, the price level in UAE is higher than that of Egypt by a factor of over 2.5 (1.45/0.56=2.59). The disparity increases at the levels of actual individual consumption and collective government consumption. For actual individual consumption, the PLI for the most expensive country (Qatar) differs from that of the least expensive (Egypt) by a factor of almost 3 (1.75/0.59=2.97). For collective government consumption, the disparity is a lot higher: PLI for UAE, the most expensive country, differs from that of Egypt, the least expensive, by a factor of over 8 (2.68/0.32=8.38). In GFCF, the difference between the most expensive country (Palestine) and the least (Saudi Arabia) is somewhat lower, a factor of 1.7 (1.50/0.89=1.69). The picture of the region painted by PLI is hardly surprising, despite of some abnormality especially regarding Palestine. More affluent countries have relatively higher price levels. Detailed data at the basic heading level show that services are generally relatively expensive in more affluent countries. For collective government consumption, since it consists mostly of wages and salaries, the price disparity there is pronounced. In GFCF, the disparity is more subdued because a large proportion consists of imported items for which importers, regardless of their level of income, face similar prices in international markets. However, some customs regulations might create a disparity in the prices. This is the case in Palestine where taxation policies cause an abnormal increase of the prices of fuel and imported machinery. 18

26 WESTERN ASIA RESULTS FROM A GLOBAL PERSPECTIVE Figures 1 and 2 show the sizes of the ten biggest economies in the world, in exchange rate and PPP terms respectively. Even from the first glimpse, it is obvious how exchange rate conversions underestimate the total expenditure on GDP of developing countries. As previously stated, exchange rates do not take into consideration the relatively low price levels in developing countries and thus underestimate the GDP of these countries. When compared with exchange rate-based estimates, PPP measures that are based on standardized price levels result in higher GDP estimates for countries with relatively low price levels. Figures 1 and 2 show how the relative economic sizes of China and India increase significantly when PPPs rather than exchange rates are applied. Figure 1 which is exchange rate-based shows India as the tenth largest economy in the world whereas when PPP conversion factors are used, as in figure 2, India becomes the third largest economy behind the United States and China. In the same manner, exchange rate conversions identify China as the second largest economy in the world behind the United States with a GDP of USD 7,322 billion. However, although China still holds its global position when PPPs are applied, its GDP is equivalent to 87 per cent of that of the United States, compared to 47 per cent in exchange rate terms. Italy drops out of the top ten when estimates are PPP-based. Conversely, Indonesia, which is not in the top ten in exchange rate terms, becomes the tenth largest economy in the world when PPP estimates are applied. Fig. 1: GDP expressed in exchange rate terms United States China Japan Germany France Brazil United Kingdom Italy Russian Federation India (Billions US$) Fig. 2: GDP expressed in PPP terms United States China India Japan Germany Russian Federation Brazil France United Kingdom Indonesia (Billions US$) 19

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