WHO SHRUNK CHINA? New evidence that the country’s real GDP per capita has been underestimated
Average real incomes in China are 15% higher than suggested by the World Bank’s global comparisons of price levels and real GDP per capita across 146 countries. That is the conclusion of research by Professor Peter Neary and colleagues, published in the December 2013 issue of the Economic Journal.
Their study reveals that ‘urban price bias’ is a key source of the underestimation of China’s real GDP per capita in the most recent International Comparison Program (ICP), conducted in 2005. The sampled prices were in only in China’s cities – and since urban prices are typically higher than rural prices, average national prices were overestimated and real GDP was underestimated.
The ICP, which is carried out under the auspices of the United Nations Statistical Commission and conducted at the World Bank, is a major statistical initiative designed to produce internationally comparable data on national aggregates such as GDP, private consumption and gross fixed capital formation (investment).
The 2005 ICP covered 146 countries, and included China for the first time, providing the first official estimates of the price level and real GDP per capita in China along with other participating economies.
But when the 2005 ICP results were published early in 2008, many economists and researchers around the world expressed serious concern and doubts about the high price level for China and the resulting low level of real GDP per capita. The size of the Chinese economy, as well as that of the world economy, were considered to be seriously underestimated.
China’s real GDP per capita of $6,757, as reported in the World Development Indicators, was reduced to $4,088 in the ICP estimates. In the light of these serious downward revisions to the real GDP per capita of China, India and other countries, the World Bank had to revise upwards its estimates of poverty with people earning less than $1/day and $2/day.
Since the release of the new real GDP per capita estimates for China, several attempts have been made to identify the factors leading to such serious downward revision for China. This new study examines and seeks to answer the question ‘who shrunk China?’
The authors identify ‘urban price bias’ as a major source of the puzzle. The prices made available to the ICP were sampled in cities only. Since urban prices are typically higher than rural prices, this implies that average national prices were overestimated, and so real GDP was underestimated.
The researchers develop a systematic adjustment to the price and GDP data based on comparisons with prices in other developing Asian economies. Depending on the index number approach used, the impact of adjusting China’s prices on the estimate of real consumption in China is in the range 8% to 28%, and the estimates in the higher range based on the use of flexible-weight indexes are preferred by the authors.
Translating these effects on real consumption to real GDP on the expenditure side, where prices for investment and government expenditure are left unadjusted, the study estimates that real GDP per capita on the expenditure side was $5,349, which is roughly 15% higher than the World Bank estimate of $4,088.
In addition to offering insights into the China puzzle, the research makes two significant contributions to the methodology used in the ICP.
It contributes to a better understanding of the effects of using fixed-weight indexes in comparison with the flexible-weight indexes used in the ICP as well as with those derived from indexes that allow for substitution possibilities through estimated expenditure functions.
The results confirm that fixed-weight indexes overstate real consumption for poor countries and understate it for rich countries. Significant differences between estimates of real consumption based on fixed and flexible-weight indexes are found.
The authors also develop a fixed-weight index measure of real GDP from the output side that explicitly accounts for intermediate uses of goods and services, and uses trade data to compute correction factors for export and import prices.
The use of export and import ‘PPPs’ (correction factors for deviations from ‘purchasing power parity’) in international comparisons is a major departure from the current ICP practice of using market exchange rates as reference PPPs.
Co-author Professor Peter Neary of Oxford University comments:
‘Our research is innovative in its efforts to uncover the main source of underestimation of real GDP of China in the 2005 International Comparison Program.
‘It systematically disentangles the sources of this underestimate, which include: urban price bias in consumption goods and services; differences arising from the use of flexible- versus fixed-weight indexes; and aggregation of consumption, investment and government services.
‘A significant downward bias of 15% at the real GDP level is attributable to these factors.
‘We hope that the real GDP measure from the output side and the use of import and export deflators in international comparisons proposed here will have considerable influence on how international comparisons of prices, purchasing power parities and real GDP are carried out in future rounds of the International Comparison Program.’
Notes for editors: ‘Who Shrunk China? Puzzles in the Measurement of Real GDP’ by Robert Feenstra, Hong Ma, Peter Neary and Prasada Rao is published in the December 2013 issue of the Economic Journal.
Robert Feenstra is the University of California, Davis. Hong Ma is at Tsinghua University. Peter Neary is at Oxford University. Prasada Rao is at the University of Queensland.