Purchasing Power
Pakistan has had a
very good economic year. GDP growth will likely
finish June 30 at about 8.4%, the best performance
in 20 years. Good weather certainly helped, but
Pakistan has had good weather in the last 20 years
on several other occasions. Good policies allowed
Pakistanis the chance to take advantage of favorable
economic winds. But even after this last twelve
months of growth, Pakistan is still a very poor
country. In fact according to government statistics,
per capita income is only 683 dollars. This leads
to an obvious question, how does anyone live on
683 dollars per year?
The answer is they don’t. Pakistanis don’t
live on an average of 683 dollars per year, they
live on an average of 41,000 rupees per year. Pakistanis
live in a rupee economy, not a dollar economy. Logically,
that shouldn’t make a difference. All we need
to do is convert the rupee figures into dollar using
the market exchange rate. But that would be wrong.
Why? Because price levels in the US economy in US
dollars are much higher than price levels in Pakistan’s
rupee economy. As any of the readers of this column
who have visited Pakistan or any other foreign country
know, goods and services don’t cost exactly
the same abroad as they do in America. In fact,
in poor countries with much lower average wages,
there can be huge differences in what certain items
cost.
For purposes of foreign investors and assessing
world trade, the market exchange rate is the most
reliable figure. It provides useful information
for those purposes, and can be calculated with reliable
precision, as long as the exchange rate is truly
market-based, and the foreign government can reasonably
measure its own economy.
But for those working in the field of development,
the market exchange rates were unsatisfactory. They
did not give a very accurate assessment of living
standards within a country, nor its relative standard
compared with more developed societies. For example,
we all know that although Pakistan is a poor country,
per capita income is not merely 2% of America’s.
Leading thinkers
in the development field however did not know a
way to reliably fix this problem. Within any Third
World economy there were basically two classes of
goods and services, those that could be traded with
the outside world, and those that could not. Tradable
goods, such as a 767 aircraft, or computers, or
cars, or cell phones, or wheat, would command the
same price throughout the world, and locally. But
non-tradable goods and services, cost much less.
This is because non-tradable goods had a large component
of local labor cost in them, and those labor costs
were much lower than in America. For example, the
cost of property would reflect the lower labor cost
of construction workers in Pakistan than in the
US, or university tuition would reflect the lower
cost of professor salaries, or restaurant meals
would reflect the lower labor costs of cooks. In
general, the lower labor costs reduced substantially
the costs of local products and services. The end
result is that one can buy more with a rupee than
the dollar equivalent can purchase in the US.
The World Bank tackled this problem in a systematic
way with the “International Comparison Program”,
which essentially consisted of the World Bank getting
price data on a large range of goods and services
in every country on the Earth. By then crunching
a formula, the Bank could reduce it all to what
they called a “Purchasing Power Parity Conversion
Factor”. This factor is meant to quantify
the price level in any economy relative to the US.
How to handle the significance of the price of pork
or alcohol in Muslim countries, or beef in India,
or wheat in a country that eats rice, and other
similar questions created a host of headaches in
this process.
It comes as no surprise to find that the poorer
the country, the lower the relative price level
as compared to the US. To find out what the real
standard of living in a country is compared to the
US, or to other countries, the process simply requires
converting the market rate GDP per capita to a “Purchasing
Power Parity” GDP per capita by dividing by
the conversion factor. In both Pakistan and India
that factor is .2, meaning that average prices in
South Asia are 20% of the US. Given Pakistan’s
current market GDP per capita of 680, its PPP GDP
per capita is 3400 dollars. Which means that Pakistanis
on average are at about 8% of the US level. On the
other hand, with 6% growth in per capita income
for 25 years, Pakistan would reach 14,000 dollars,
which would be the low end of a developed society,
and similar to the US in 1960.
As countries develop, their price levels rise and
gradually converge with developed countries. For
the World Bank, this means that their PPP conversion
factor needs periodic updating. The last update
was done in 2000, and a current round is in data
collection, with an update due in 2006. Comments
can reach me at Nali@socal.rr.com.
