Douglas Shackelford is the Dean of the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill and the Meade H. Willis Distinguished Professor of Taxation.
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A new report from the World Bank suggests that the United States and China were very close in purchasing power parity (PPP)-adjusted gross domestic product (GDP) by 2011. Combined with growth data over the past few years, this report would imply that PPP-adjusted, China is a larger economy than the United States.
The reason this news came as a surprise was the methodological change to the PPP adjustment, not a surprising change in China’s economic output. PPP adjustments are a method of converting incomes from one country into equivalent incomes in another. While it would be easiest to just use the market exchange rate, some people observe that Chinese incomes pay for relatively more, in China, than one might expect from their value in dollars. PPP is the method that tries to account for this.
It is a difficult task; each country is a different economy with different goods available to consumers, and you don’t want to adjust away differences that reflect real differences in quality. Are consumer goods in China cheaper because they’re inferior, or are they cheaper because it’s genuinely easier to supply them in China? These fuzzy, often-subjective questions make a real answer impossible. That is why a single adjustment can suddenly catapult China into the global lead.
Comparisons of real incomes within the US have similar problems over long time frames, for the exact same reason. For example, the Census Bureau attempts to do that here. The United States of 1967 are a very different place than the United States of 2014. In many respects, that economy might be even more unfamiliar to us than China’s. We didn’t improve upon 1967’s economy by creating more of the same items – then it would be easy to measure real growth. Instead, we improved upon 1967’s economy by creating different goods.
For that reason, it is extremely hard to usefully decide how real incomes have changed in that time frame – and the farther in time you go, the more that difficulty compounds. Ultimately, purchasing power depends a great deal on what you want to buy – and a single numerical narrative can’t tell the whole story. There is good reason to believe that adjusting incomes for inflation generally overstates past standards of living relative to today’s.
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