AN INTRODUCTION TO THE INTERNATIONAL COMPARISON PROGRAMME

1. AN INTRODUCTION TO THE INTERNATIONAL COMPARISON PROGRAMME David Roberts, OECD, Paris, April 2003

2. What is the purpose of the International Comparison Programme (ICP)? To provide international price & volume comparisons of GDP & its component expenditures Or, more precisely, to measure:

3. the differences in price & volume levels • of GDP & GDP per capita • of various expenditure aggregates & sub-aggregates: • household consumption of food, clothing, housing, transport, etc. • government expenditure on education, health, public order & safety, etc. • investment in agricultural machinery, transport equipment, residential buildings, etc. • between countries within a region • between countries in different regions • in 2004

4. Why are ICP comparisons made from the expenditure side (& not the production or income side)? • inherent usefulness of such comparisons to economic research & policy development • though productivity can be compared only at the level of the whole economy • difficulties of organising comparisons from the production side • double deflation requires data on both intermediate consumption & gross output • values of income aggregates cannot be divided into meaningful price & volume components

5. The identity underlying an expenditure aggregate is Price x Volume = Value Price & volume comparisons can be made by: • either observing volumes directly & estimating prices indirectly (by dividing values by volumes) • or observing prices directly & estimating volumes indirectly (by dividing values by prices) ICP comparisons estimate volumes indirectly: • prices are easier to observe than volumes • price measures have smaller variability then direct measures of volumes

6. ICP comparisons require: • GDP to be defined in the same way • GDP to be expressed in the same currency unit • GDP to be valued at the same price level GDP estimates of ICP participants are: • compiled broadly in line with SNA 93 • expressed in national currencies • valued at national prices Necessary to: • convert the GDPs to a common currency • revalue the GDPs at a common set of prices

7. Why not use exchange rates (X-rates)? • X-rates will convert the GDPs to a common currency • X-rates are easily understood being determined by the demand for & the supply of currencies • they are market prices for currencies • X-rates are easily observed, cover all countries, readily available (newspapers) & timely (daily rates) Yes, but:

8. X-rate converted GDPs remain valued at national prices & reflect both volume & price level differences between countries • they are nominal values, similar to a time series of GDP for a single country at current prices • X- rate converted GDPs overstate the size of economies with relatively high price levels & understate the size of those with relatively low price levels • as there is a positive correlation between income levels & price levels, the gap between “rich” & “poor” countries will appear larger than it actually is

9. X-rate converted GDPs are not consistent overtime • X-rates are only partially determined by the demand & supply of currencies for international trade & tourism* • factors such as interest rate differentials, currency speculations, short-term capital movements can have a significant impact on the demand & supply of currencies causing X-rates to fluctuate • X-rate fluctuations can make it appear that countries get “richer” or “poorer”– almost overnight - even though there has been no change in the volume of production (* note that in this respect X-rates only reflect the relative prices of domestically-produced goods & services traded between countries, but many goods & services are not traded – buildings, government services & most market services)

10. Why should PPPs be used instead of X-rates? • PPPs are both currency converters & price deflators • during the process of conversion to a common currency, the GDPs are revalued at a uniform price level • PPP converted GDPs reflect only volume differences between countries • they are real values, similar to a time series of GDP for a single country at constant prices • PPP converted data are generally more consistent over time • changes in PPPs depend directly on changes in the relative rates of inflation between countries

11. What are the arguments against using PPPs? • not precise measures & subject to error • difficult to understand • limited in country coverage • not available on a timely or regular basis • not readily available • costly • X-rate fluctuation can be avoided using: • a constant X-rate or • a moving average of X-rates

12. GDP of USA as a percentage of the GDP of EU 15 (EU 15 = 100); average annual growth rates for (1985-99), 1985-90, 1990-93, 1993-96, 1996-99

13. GDP of Japan as a percentage of the GDP of EU 15 (EU 15 = 100); average annual growth rates for (1985-99), 1985-90, 1990-93, 1993-96, 1996-99

14. GDP of Japan as a percentage of the GDP of EU 15 & comparative price level of Japan (EU 15 = 100)

15. GDP of USA as a percentage of the GDP of EU 15 using (1) current X-rates (2) a constant (1985) X-rate (3) a 3-year & (4) a 5-year moving average of X-rates

16. What are PPPs? • PPPs are price relatives • they are calculated in three stages: • first for individual products • then for product groups • & finally for aggregates • at each stage the assortments of goods & services increase in complexity • weights are introduced at the third & last stage • explicit expenditure weights are not available below product group level • expenditures on the product group are used as weights

17. More precisely, the three stages are as follows: • at stage I price relatives are calculated for individual goods & services • price in euros of a kg of tomatoes in France / price in sterling of a kg of tomatoes in the UK • at stage II price relatives are calculated for product groups by averaging the price relatives calculated for the individual goods or services in the group • price in euros of a specified basket of vegetables in France / price in sterling of the specified basket in the UK

18. at stage III price relatives are calculated for aggregates by weighting & averaging the price relatives for the product groups comprising the aggregate • price in euros of a given volume of food in France / price in sterling of the same volume of food in the UK • at each stage the price relatives or PPPs show: • how many units of currency A need to be spent in country A • to obtain the same volume of a product or a product group or an aggregate • as X units of currency B purchase in country B

19. for example, if a “Big Mac” costs 105 roubles in Russia & 2.8 euros in France, then the PPP for a “Big Mac” between Russia & France is 105 roubles to 2.8 euros or 37.5 roubles to the euro • therefore, for every euro spent on “Big Macs” in France, 37.5 roubles would have to be spent in Russia to obtain the same volume of “Big Macs” • the volume of “Big Macs” purchased in Russia can be compared with the volume purchased in France by converting expenditure on “Big Macs” in Russia to euros by dividing it by 37.5

20. similarly, if the PPP for GDP between Russia & France is 45 roubles to the euro, then for every euro spent on GDP in France, 45 roubles would have to be spent in Russia to obtain the same volume of goods & services • the volume of GDP in Russia can be compared with the volume of GDP in France by converting the GDP in Russia to euros by dividing it by 45

21. Note that at the level of aggregates & GDP: • the “same volume” of goods & services does not mean “identical baskets” of goods & services • the composition of the baskets will vary between countries reflecting differences in tastes, cultures, climates, etc. because of the introduction of weights • but both baskets will provide equivalent utility

22. What are the basic data required from ICP participants? • a set of nationalannual prices for a selection of products chosen from a common basket of well-defined goods & services • a breakdown of final expenditure on GDP by product group according to a common classification • mid-year resident population & annual average of daily market X-rates • all data should refer to the year of the comparison – i.e. 2004

23. Countries are required to provide prices for products that are both: • representative of their final expenditures on GDP • comparable across countries These requirements are not complementary: • different products are representative of different countries • products that are strictly comparable across countries will not be equally representative of them all

24. The prices that countries provide should be consistent with the prices underlying their estimates of final expenditures • these estimates are national, annual & valued at market prices In other words, countries are to provide prices that are: • national prices – i.e. prices averaged over all regions of the country • annual prices – i.e. prices averaged over the months or quarters of the year • purchasers’ prices – i.e. actual transaction prices or the amounts of money willing buyers pay to acquire goods or services from willing sellers

25. Failure to observe either representativity or comparability or consistency will result in: • either an overestimation of price levels & an underestimation of volumes • or an underestimation of price levels & an overestimation of volumes

26. To summarize: • national annual purchasers’ prices provide price relatives for individual representative & comparable products • price relatives for individual products are averaged to obtain unweighted PPPs for product groups • unweighted PPPs for product groups are weighted by national expenditures on the product groups to obtain weighted PPPs for all levels of aggregation up to GDP

27. weighted PPPs are used to convert national expenditures in national currencies at national prices to real expenditures in a common currency at “international prices” • real expenditures are used to derive volume indices for product groups, aggregates & GDP • &, with mid-year resident population data, volume indices per capita • PPPs are also used to derive price level indices for products, product groups, aggregates & GDP • price level indices are defined as the ratios of PPPs to X-rates – i.e. PPPs are converted to a common currency to show how much of the common currency is needed to purchase the same volume in each country

28. The ICP “master” classification of final expenditure on GDP provides the framework for the comparison • it follows the definitions & concepts & the functional & product classifications of SNA 93 • GDP is broken down into seven main aggregates: • individual consumption expenditure by households • individual consumption expenditure by NPISHs • individual consumption expenditure by government • collective consumption expenditure by government • gross fixed capital formation • change in inventories & valuables • net exports of goods & services • The main aggregates are subsequently broken down into 155 product groups or basic headings

29. basic headings are the building blocks of the ICP comparison • it is at the basic heading level that expenditures are defined, products selected, prices collected, prices edited & PPPs first calculated • in principle a basic heading should consist of a group of similar well-defined products • it should be relatively homogeneous • in practice a basic heading is the lowest level at which explicit expenditure weights can be estimated • it can be more heterogeneous than is theoretically desirable – an important consideration when selecting products to be priced

30. Prices are collected for the following main aggregates: • individual consumption expenditure by households • individual consumption expenditure by government • collective consumption expenditure by government • gross fixed capital formation More precisely, prices are collected for selections of: • consumer goods & services • government-produced individual services • government-produced collective services • equipment goods • construction projects

31. government-produced individual & collective services are non-market services (NMS) • they are either not marketed or sold at prices that are not economically significant (i.e. prices that do not influence supply & demand) • by convention national accountants estimate expenditures on NMS by summing the costs of the inputs required to produce them • PPPs for NMS are based on input prices – the so called input price approach • while consistent with the prices underlying the expenditures, the approach does not take account of differences in labour productivity between producers of NMS in different countries

32. government expenditures on individual & collective services are broken down by cost components in the “master” classification: • compensation of employees • intermediate consumption • gross operating surplus • net taxes on production • receipt from sales • input prices are collected only for compensation of employees • this involves specifying a cross section of occupations in general government & in government-produced health & education services

33. the 2004 comparison of construction prices will be made by countries pricing a common set of standard construction projects - e.g. house, factory, road • the operations required to build a standard construction project are detailed in a bill of quantities • a bill of quantities covers the costs of inputs (labour, materials & plant), subcontracting, preliminaries, overheads plus profit, architect’s fees & taxes • when priced consistently across countries, a bill of quantities provides the purchaser’s price of an output that reflects the productivity differences between countries

34. a first step for countries participating in ICP 2004 is to agree on the common basket - or list - of well-defined goods & services from which they will select products to price • as the actual collection of prices will consist of different surveys covering separately: • consumer goods & services • occupations in general government & in government- produced health & education services • equipment goods • standard construction projects product lists need to be drawn up for each survey

35. the product list for a survey is built up basic heading by basic heading • in effect there is a product list for each basic heading • products selected for the basic heading should be representative

36. representivity is a concept that relates to products in the same basic heading • by definition explicit expenditure weights are not available for products within the basic heading • prices for representative products are usually lower than prices for unrepresentative products • countries are expected to price representative products & non-representative products • if the relative representativeness of products is not taken into account then the PPPs for the basic heading could be biased – over or under estimation of price level • relative representativeness of products in different basic headings is reflected by the expenditures on the basic headings

37. a product is representative of its basic heading if it is representative of : • the expenditure on the basic heading • the price level of the basic heading • products that are best sellers or volume sellers within a basic heading are usually representative • as they will account for a large share of the expenditure on the basic heading, their prices will better reflect the price level of the basic heading than the prices of similar products that are less in demand • more generally a product is representative if it is sold in sufficient quantities for its price to be typical for the product group from which is selected

38. the product list for a basic heading must be equally representative in order to obtain balanced or unbiased PPPs for the basic heading • prices for representative products are usually lower than prices for unrepresentative products • a country pricing more representative products will have a lower price level vis-à-vis a country pricing less representative products than it would have had both countries priced a similar number of representative products

39. ensuring that each country is able to price at least one representative product for the basic heading is a first step towards equi-representativity • this is a necessary condition but it is not usually a sufficient condition • each country is required to nominate & define at least one product that is representative of its price level for the basic heading • inclusion in the list requires at least one other country agreeing to price the product nominated • & the country who has nominated the product being able to price at least one representative product of the country agreeing to price its representative product

40. From this it follows that: • products selected for the list do not have to be available in all countries • countries do not have to price all products listed as it is not necessary that each country is compared directly with all other countries - countries can be compared indirectly through other countries • countries are required to price their own products plus a selection of the products of other countries • they are also required to identify which products are representative when reporting prices

41. products selected for a basic heading should be comparable to avoid bias from quality differences • if not, differences in quality will be mistaken for price differences leading to an under or over estimation of price levels • in theory products are comparable if their physical & economic characteristics are identical • in practice products are considered to be comparable if their physical & economic characteristics are equivalent or similar

42. comparability is a concept that relates to individual products • requiring each product selected for a basic heading to be well-defined by a product specification is a first step towards ensuring that countries price comparable items • it is essential that a country when nominating a product for the product list also provides a sufficiently detailed product specification that will enable other countries to identify the product in their markets

43. ideal product specifications are those that specify particular brands & models as this ensures countries price items of identical quality • not an option for products such as fresh food & services • not always the case that items of the same brand with the same model number in different countries are identical • generic product specifications – i.e. specifications that do not specify brands & models but list the relevant price determining & technical characteristics of the item to be priced - are the alternative • significant quality differences between items priced in different countries can arise depending on how “tight” or “loose” are the specifications

44. Number of products selected for a basic heading will depend on: • heterogeneity of the products covered • homogeneity of price ratios for the basic heading between countries • availability of common representative products across countries • importance of the basic heading as measured by its share of overall expenditure • use of generic or brand & model specifications

45. Are there any questions?