USERS AND USES OF PPPs

1. The revision and the structural funds allocations

Some 30 per cent of the total budget of the European Commission is spent on the Structural Funds, the overall aim of which is to gradually reduce economic disparities between and within EU Member States. The list of regions, which are eligible for allocation, is established on the basis of PPP-converted GDP per capita.

2. Users of PPPs

The main users of PPPs are widely perceived to be the international organisations, such as Eurostat, the OECD, the United Nations and the World Bank and the International Monetary Fund and this was undoubtedly so when PPPs first became available. Now, however, there is a growing demand for PPPs from a variety of national users. These include government agencies, universities, research institutes, public enterprises, private firms, banks, journalists and individuals who conduct studies and make policy analyses requiring comparisons of GDP and average price levels between different countries.
International organisations also use the real expenditures generated by PPPs for statistical purposes. The real expenditures are used to aggregate GDP and its component expenditures across countries to provide totals for groups of countries, such as the European Union and the OECD.

3. Applications of PPPs and limitations of their use

PPPs are not a concept that is immediately and easily understood by users. This has sometimes generated misunderstandings as PPPs are used for purposes for which they are not suited and /or PPPs are not used even when they are the right concept.
The PPPs have been calculated specifically in order to enable international price and volume comparisons to be made for GDP and its components. As such, they refer to the entire range of final goods and services, which make up GDP as a whole including many items, such as construction and government services, which are not traded internationally.
PPP and constant price measures in national accounts have been developed for different purposes and should be used accordingly:
Therefore, it is also clear that PPP converted GDP data should never be used to establish growth rates of GDP. The appropriate base for growth rate calculations is the GDP at constant prices and national currency, as it is only this GDP which is based on temporal price indices which are constructed to ensure comparability over time within a given country.
The possible "uses" of PPPs are listed below divided into three groups, "recommended uses", "uses with limitations" and "non-recommended uses":

Uses and limitations of PPP-based data

Recommended uses
  • Spatial volume comparisons of GDP, GDP per head, GDP per hour worked, size of economies
  • Grouping of countries by volume index of GDP
  • Spatial comparisons of relative price levels
Use with limitations
  • Inter-temporal analysis of relative GDP per capita or relative prices
  • Analysis of price convergence
  • Cost of living index across countries
  • Use of PPP established for expenditure categories for the deflation of other values, as e.g. household income.
Non-recommended uses
  • As a precision tool to establish rankings between countries
  • As a way of constructing national growth rates
  • As a measure to generate output and productivity comparisons by industry (unless there are industry-specific PPPs)
  • As a measure to undertake price level index comparisons at detailed level
  • As an indicator for the over- or undervaluation of a currency
  • As equilibrium exchange rates

I. Volume comparisons of GDP and ranking of countries

PPPs are statistical constructs rather than precise measures, so they provide only an indication of the relative order of magnitude of economic activity or economic well-being in a country in relation to others in the comparison. The statistical uncertainties surrounding PPPs depend on the reliability of the expenditure weights and the price data as well as to the extent to which the particular goods and services selected for pricing by participating countries truly represent the price levels in each country. As is the case with national accounts data generally, it is not possible to calculate precise error margins for PPPs and the real expenditure levels derived from them. Nonetheless, at the level of GDP, a broad and arbitrary rule of thumb is that differences in indices of real final expenditure and real final expenditure per head need to be at least five percentage points to be considered as statistically significant. At the level of the main aggregates or analytical categories, error margins are larger and differences in indices of real final expenditure and real final expenditure per head will also need to be larger to be statistically significant. Below analytical category level (currently 48 categories) data are not published, as the number of observations underlying each detailed category is not sufficient to draw statistically sound conclusions. The PPP programme is built to deliver justifiable results at highly aggregated level.

II. Comparison of relative price levels

The comparative price level index of a country is established by dividing the PPP of this country with the exchange rate. Comparative price levels at the level of GDP allow the general price levels of countries to be compared for a given year: a value over 100 indicates a higher general price level than in the EU average, a value under 100 indicates a lower general price level.

Published on 23.02.2004

Back