USE OF PURCHASING POWER PARITY IN INTERNATIONAL COMPARISONS

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1 USE OF PURCHASING POWER PARITY IN INTERNATIONAL COMPARISONS Prof. Radu Titus MARINESCU PhD Artifex University of Bucharest Assoc. prof. Aurelian DIACONU PhD Artifex University of Bucharest Asist. prof. Zoica NICOLA PhD Artifex University of Bucharest Doina AVRAM Ph.D Student Bucharest University of Economic Studies Abstract The authors seek to clarify in this article the main issues that are being considered in connection with the achievement of international comparisons. Of course, output indicators (gross domestic product, gross national product, per capita product, national income, personal income, available income) are indicators that integrate into international data series, provide a number of criteria and considerations to be taken into consideration. However, comparing macroeconomic indicators is not just a theoretical question, but more than just a practical issue when it comes to comparisons between states. There have been and there are a number of concepts and opinions about using the indicator in physical expression, comparing production, comparing consumption per capita or countries with quality or other quality products, and more. However, the comparison can only be made using macroeconomic indicators of results calculated within the National Accounts System. In this article, the authors question the use of the purchasing power parity of incomes available to a population in a given country over a given period of time. Wages and, broadly speaking, the income of a country s population depend on a whole range of factors: the country s economic potential, national wealth, the level of production development, the level of technology, the free market, the inflation rate And many other factors. It is therefore not relevant and advisable to compare salary levels in a number of other countries, even if they are denominated in the same currency. There is no difference if we compare the nominal salary or real terms. We say this because in the geographical area of the country considered the consumer goods market, the services and all the others have a certain quality and price. In everyday life, everyone has to consider how they meet their consumption, economy, investment, and so on, based on the revenue they own. Therefore, the purchasing power parity is set for each country, which then submits to comparability gives us some meaning. 114

2 From this point of view, it can be considered a product group, an even larger group of products but fi nally we come to the indicator that refers to the power to meet consumer and investment requirements on a wider national and individual level of capacity To satisfy the needs of existence (quality of life). That is why the purchasing power parity indicator is one that gives a more practical and realistic sense of the evolution of a country. Keywords: purchasing power parity, macroeconomics, exchange rate, price indicator, volume indicator JEL Classification: F31, O24 Introduction In this article, the authors focused on defining and clarifying the following issues: First, the structure of the production of goods and services in each country expressed in value. Then using the exchange rates that represent the price to be paid on the currency market in the same currency to obtain a unit of national currency or the amount of currency to be received in return for a national monetary unit. In many ways, when comparing gross domestic product internationally, the exchange rate can not be considered a decisive element in ensuring the comparability of indicators in absolute terms, and therefore can not be used to convert national currency statistics as it does not accurately reflect Gross domestic product, there are other domestic and international influences that determine fluctuation. The authors seek to explain and exemplify why the assessment of the purchasing power parity of each country s currencies can become comparable. This method of assessing macroeconomic indicators in one currency is recommended for use in international comparisons. The indicator is the use of price indices calculated in a country and the same prices calculated in another country. A simple example would be that if we took the market price of one liter of gasoline in each of the countries that are being compared and then converting them into one currency, we will find a price hierarchy of that product. Such a hierarchy is much more concrete not from the point of view of global macroeconomic outcomes, but also from comparing the possibility of meeting life needs based on the actual incomes obtained in each country. In this article, authors seek to express price indicators and value indices based on the weightings applicable to their calculation so that the content of the calculated indicators can be used in international comparisons. The general index calculated by the Fischer form is a difficult operation to be performed only by national and international statistical bodies. Thus, the simplest approach is that there are several methods of approaching and solving comparative procedures, reaching the purchasing power parity that is used as an indicator in international statistical institutions. Revista Română de Statistică - Supliment nr. 7 /

3 There are several methods used to establish purchasing power parity, which are not relevant in the context of the above. Literature review Heathcote, Storesletten and Violante (2009) have analyzed the scientific literature dedicated to household heterogeneity, pursuing three lines, which are considered important for macroeconomic treatment of inequality. Anghel (2015) is a reference work on monetary policy studies. Capanu, Wagner, and Mitruț (2004), Anghelache et.al. (2005) have presented the system of National Accounts and the macroeconomic aggregates, which can be used in macroeconomic studies and analyses. Goodwin (2008) researches the foundations of macroeconomic theories and argues that the revision of these theories must start from clearly defined goals and the present time is appropriate for developing a movement from past theoretical approaches. Tugcu and Ozturk (2015) are preoccupied with the macroeconomic effects related to inflation targeting policies, their study is based on evidence collected from countries characterized by higherthan-average incomes. The work authored by Wooldrige (2006) is dedicated to introductory approaches on econometric studies. King and Watson (2012) develop on the correlation between inflation and unit cost associated with labor force usage. Anghelache and Anghel (2016), Anghelache (2008), Biji et.al. (2010) present the statistical instruments dedicated to economic analyses, at microeconomic and macroeconomic levels. Isaic-Maniu et.al. (2003) clarify the contents of statistical concepts. Öllera and Teterukovsky (2007) develop on the quality associated to macroeconomic variables and its measurement. Anghelache (2009) describes the macroeconomic indicators applied in international comparisons. Solomon et.al. (2006) analyze the behavior of clients from the perspective of the European markets and marketing professionals. Wu et.al. (2009) have studied the non-linear adjustment of the real pound dollar rate for a period of over a century, by using an autoregressive model, and they present a solution for the problem of parity of purchasing power. Einav, Jenkins, and Levin (2013) have studied the changes of credit scoring instruments on lending at a company, they identify the positive results of risk classification and measure the result expresses as increase in profit. Anghelache, Gheorghe and Voineagu (2013) have presented the measurement and analysis of inflation through dedicated methods and models. Grubb (2010) has analyzed the impact of the purchasing power parity on the evolution of US economics, before and after the United States of America were formed, the impact is quantified through the economic integration between states modified after the adoption of the constitution. Anghelache et.al. (2007) develop on macroeconomic analysis concepts and instruments. Atanassov and Kim (2009) evaluate the correlation 116

4 between labor and corporate governance, inclusing the legal and union-related aspects. Anghelache and Capanu (2003) present the most significant aspects regarding the macroeconomic indicators, their calculation and analysis. Bergin, Glick and Wu (2013) have studied the correlation between aggregate real exchange rates related persistence when international relative prices adjust with higher speed. Atkeson and Burstein (2008) analyze the relationship between international relative prices and relative PP parity and demonstrate the effect of international trade cost and market conditions on pricing-to-market. Research methodology and data Comparison of macroeconomic indicators is not only a theoretical issue but, to a greater extent, a practical problem related to comparisons between countries, in the concerns of national and international statistical institutions. International comparisons of the economic development of different countries can be made on the basis of physical expression indicators by comparing production and consumption per capita with a number of basic products. The comparison involves the compilation of two lists: one with the comparison countries and the baseline commodity. These products need to be representative of all countries comparing and qualitatively similar. Further, in order to draw conclusions on the level of development, a reference country is chosen and the levels reached by the other countries are compared with the level of the country taken as a benchmark. For this purpose, the relative coordination sizes (Y) are used. The calculation relation used is: Xi Yi = 100 XE, where: X i, = Indicator level in country i; Xe = indicator level in the selected country as reference (reference).. Comparison can be made using the macroeconomic indicators of results calculated within the National Accounts System. The international comparison of the level, structure and pace of development based on the macroeconomic results of the results requires solving two essential issues, namely: to achieve comparability of the indicators in terms of their content, their scope and to ensure comparability of the indicators from the point of view Of the monetary units in which it is expressed. Countries using the System of National Accounts determine macroeconomic indicators according to unit design and methodology. The assessment of macroeconomic indicators in a single currency can be done by the following processes: Revista Română de Statistică - Supliment nr. 7 /

5 Based on official exchange rates, the exchange rate is the price to be paid on the foreign currency market to obtain a unit of national currency or the amount of foreign currency to be received in return for a unit of national currency. In the context of the international comparison of GDP, the theoretical and methodological debates concluded that, for several reasons, the exchange rate can not be considered a decisive element in ensuring the comparability of the indicators in absolute terms and can not be used to convert the synthetic indicators of the national currency, because : Does not reflect the real GDP structure; Is influenced by domestic and international factors, causing fluctuations over short periods of time, and there are multiple currency exchange rates. This is a relatively easy procedure to apply, but which can negatively impact real values, as exchange rates do not usually reflect the purchasing power of currencies. This is explained by the fact that, on the one hand, the fixing of the exchange rate is influenced only by a small number of goods, namely those which are the subject of trade relations between the countries concerned, and, on the other hand, the exchange rate is Strongly influenced by various speculative operations on the stock exchange. It follows that the expression of indicators in a single currency based on exchange rates is not a recommended method for making the most accurate international comparisons on the levels, structures and pace of development of different countries. On the basis of the purchasing power parity (PPC) assessment of the currencies of the countries that compare. This method of assessing macroeconomic indicators in one currency is more appropriate for use than the official exchange rate method. It consists of using price indices calculated on the basis of the prices of material goods and services in the country making the comparison and price comparisons of the same material goods and services in the country whose currency has been decided to be used for the expression of macroeconomic indicators. PPC - Expresses the number of units of currency required to buy in a country the same volume of goods that can be obtained with a monetary unit of the base country of comparison or with a monetary unit common to a group of countries. PPCs can be calculated for the total Gross Domestic Product but also for different aggregation levels (eg gross fixed capital formation). The basis for these price indices is based on the general principles of calculating price indices. It is known that the aggregate price index is calculated using the current and base (p 1 and p 0 ) commodity prices, and as weights for both periods either the current (q 1 ) or baseline (q 0 ). 118

6 Purchasing power parity is the average ratio between the prices in the comparison country and those of the country taken as the basis of comparison, to a large number of categories of expenditure in the GDP composition, broken down by global elements (final consumption of the population,, Gross fixed capital formation, changes in inventories and net exports). PPP determination based on the prices of goods and services contained in a sample of comparable items that are selected in order to represent a welldefined classification and to be representative of the model of consumption of the countries participating in the comparison can be assimilated to a price index Territorial type. Considering two countries, A and B, where A is the base country of comparison. For an article X, the ratio of national currency expenditure of the two countries can be written as: E E B A q = q B A p p B A unde: E = expenses; Q = quantities; P = prices; q I B/A = the volume index of Article X in country B relative to country A; p PPC B/A = p power parity. B A = price ratio for Article X in countries A and B, purchasing In order to achieve the international comparison, three stages are in principle followed: - The GDP of each country is broken down into a number of primary spending groups. - Within each primary group, there are prices for selected items that should have two essential properties: comparability (which means that the factors influencing actual price formation are identical in the comparing countries) and representativeness (meaning selected articles are characteristic of Expenditure model and have a significant share in the primary group of countries comparing). The collected (observed / observed) prices are used to obtain price reports for individual goods and services, then price reports are averaged to obtain unmatched parities at the primary group level; Finally, using as weights the structures of countries GDP spending that are compared in the weighted geometric mean formula, a PPP is obtained for each level of aggregation - up to GDP. - National values of primary groups are transformed into international comparable values through purchasing power parities. The obtained results Revista Română de Statistică - Supliment nr. 7 /

7 are real values, to distinguish them from the nominal values (expressed in national currency). At aggregate level, price indices are determined by one of two usual weighting variants, by adapting: p1 q1 IP P Paasche price index p0 q1 p1 q0 IP the Laspeyres price index L p0 q0 Adaptation implies that the prices of the products of the two countries are weighted either with the quantities of a country (eg country A) or the quantities of the other country (or country of reference, country B). According to the two types of indices, the calculation relations will be: A/B IPP A/B IPL pa qa pb qa pa qb pb qb Obviously, there are some differences between the results obtained using the two price indices due to the application of different weights. For the purpose of eliminating these influences, a Fischer price index is calculated as the geometric mean of the Paasche and Laspeyres indices. The calculation relation used is: IPF A/B A/B IPP IPL pa qa pb q A pa q B pb q B Regardless of the variant (Paasche, Laspeyres or Fischer), the calculation of such a general index is a very difficult operation to be performed only by national and international statistical bodies. There are several methods of approaching and solving comparisons procedures to purchasing power parity, some of which are being promoted by international statistical institutions. The main methods and programs will be presented below. Conclusions A series of theoretical and practical conclusions emerged from the study underlying this article. First, to ensure international comparability, a country s macroeconomic performance indicators need to be adjusted 120

8 (calculated) so that it has the same content for all countries competing in this comparison. Hence, the conclusion is that economic indicators and aggregates need to be deflated in order to ensure comparability over time of the country as well as internationally as comparable real data. The level of development of a country is driven by domestic macroeconomic outcomes, and international comparisons must also provide an objective benchmark of analysis. For example, price levels and the inflation rate indices in each country are decisive in expressing actual values in real terms. Selective references 1. Anghel, M.G. (2015). Monedă. Teorie şi studii de caz, Editura Artifex, Bucureşti 2. Anghelache, C. and Anghel, M.G. (2016). Bazele statisticii economice. Concepte teoretice şi studii de caz, Editura Economică, Bucureşti 3. Anghelache, C., Gheorghe, M. and Voineagu, V. (2013). Metode şi modele de măsurare şi analiză a inflației, Editura Economică, Bucureşti 4. Anghelache, C. (2009). Indicatori macroeconomici utilizați în comparabilitatea internațională, Conferința a 57-a Statistica trecut, prezent şi viitor, ISBN , Durban Anghelache C., Isaic-Maniu Al., Mitruț C. and Voineagu V. (2005). Sistemul conturilor naționale, Editura Economică, Bucureşti 6. Anghelache, C. (2008). Tratat de statistică teoretică şi economică, Editura Economică, Bucureşti 7. Anghelache, C. şi colaboratorii (2007). Analiză macroeconomică, Editura Economică, Bucureşti 8. Anghelache, C. and Capanu, I. (2003). Indicatori macroeconomici calcul şi analiză economică, Editura Economică, Bucureşti 9. Atanassov, J. and Kim, E.H. (2009). Labor and Corporate Governance: International Evidence from Restructuring Decisions. Journal of Finance 64, Atkeson, A. and, Burstein, A. (2008). Pricing-to-Market, Trade Costs, and International Relative Prices. American Economic Review, 98, 5, Biji, M., Lilea, E., Roşca, E. and Vătui, M. (2010). Statistica pentru economişti, Editura Economică, Bucureşti 12. Capanu, I., Wagner, P. and Mitruț, C. (2004). Sistemul Conturilor Naționale şi Agregate macroeconomice, Editura ALL, Bucureşti 13. Bergin, P., Glick, R. and Wu, J.L. (2013). The Micro-Macro Disconnect of Purchasing Power Parity. The Review of Economics and Statistics, MIT Press, 95 (3), Einav, L., Jenkins, M. and Levin, J. (2013). The Impact of Credit Scoring on Consumer Lending. RAND Journal of Economics, 44 (2), Goodwin, N.R. (2008). Macroeconomics for the Twenty-First Century, Tufts University, series GDAE Working Papers no Grubb, F. (2010). Testing for the Economic Impact of the U.S. Constitution: Purchasing Power Parity Across the Colonies versus Across the States, The Journal of Economic History, Cambridge University Press, 70 (01), Revista Română de Statistică - Supliment nr. 7 /

9 17. Heathcote, J., Storesletten, K. and Violante, G. (2009). Quantitative Macroeconomics with Heterogeneous Households. Annual Review of Economics, Annual Reviews, 1 (1), Isaic-Maniu, Al., Wagner, P., Pecican, E., Ştefănescu, D. and Vodă, V. (2003). Dicționar de statistică generală, Editura Economică, Bucureşti 19. King, R. and Watson, M. (2012). Inflation and Unit Labor Cost. Journal of Money, Credit and Banking, 44 (Supplement 2), Öllera, L.E. and Teterukovsky, A. (2007). Quantifying the quality of macroeconomic variables. International Journal of Forecasting, 23 (2), April June, Solomon, M.R., Bamossy, G., Askegaard, S. and Hogg, M.K. (2006). Consumer behavior: a European perspective, Third Edition, Prentice Hall 22. Tugcu, C.T. and Ozturk, S. (2015). Macroeconomic Effects of Infl ation Targeting: Evidence from the Middle and High-Income Countries. Theoretical and Applied Economics, XXII (4) (605), Winter, Wooldrige, J. (2006). Introductory econometrics. A modern approach 2 edition, MIT Press 24. Wu, J.L., Chen, P.F. and Lee, C.N. (2009). Purchasing Power Parity, Productivity Differentials and Non-Linearity. The Manchester School 77,