New Policy Improves World Living Standard Comparisons

THE JOURNAL RECORD, May 29, 1993 | Go to article overview

New Policy Improves World Living Standard Comparisons


It's official: the International Monetary Fund has decided to compare national incomes according to purchasing power rather than the exchange value of their currencies.

The resulting changes in the international pecking order _ notably the elevation of China from No. 10 to No. 2 in total output _ will not "put more food in the belly of a single hungry child," noted Robert Summers.

But the University of Pennsylvania economist who, along with his colleague, Alan Heston, pioneered purchasing power-based national accounting, thinks the decision was a long overdue victory for scholarship and common sense. It may also spare non-economists the puzzle of news reports that show Russians to be as poor as Haitians, or cast Japanese who live in rabbit hutches as the richest workers in the world.

It is relatively easy to compare the income of a resident of Des Moines with that of a Miamian. Both are paid in dollars; both buy the same goods and services at Sears' and Burger King. But what happens when the income of the Levi-wearing, Whopper-chomping American is matched to that of a dhoti-clad vegetarian in India?

Problems of comparing the living standards of nations with different currencies and very different tastes are daunting. In the past, the IMF hardly even tried: Incomes were simply totaled in each currency, then converted to dollars at prevailing exchange rates.

Thus, if the national income of Transylvania were 3 billion zorgs and Wall Street was willing to exchange one dollar for three zorgs, the income of Transylvania must be 1 billion dollars.

This approach was rationalized by the diktat of the great economist Gustav Cassel, who some 80 years ago wrote that as long as there is anything like free movement of merchandise "the actual rate of exchange cannot deviate very much from the purchasing power parity."

Some economists still craft mathematical models defining the conditions under which Cassel would be right. But as the Nobel Memorial Prize-winning economist Paul Samuelson points out, such theorems are "either trivial or absurd" in the modern context.

If Cassel were close to the mark, changes in exchange rates should track relative changes in domestic prices. In fact, notes Rudy Dornbusch of the Massachusetts Institute of Technology, there was no correlation between inflation rates and the exchange value of the dollar with other major currencies during the 1970s and much of the 1980s.

As important, the two University of Pennsylvania economists (along with their late colleague, Irving Kravis) found a systematic divergence between exchange-rate and purchasing-power calculations when rich countries were compared with poor ones. …

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