Trying to Understand the PPPs in ICP 2011: Why Are the Results So Different?

Purchasing power parity exchange rates, or PPPs, are price indexes that summarize prices in each country relative to a numeraire country, typically the United States. These numbers are used to compare living standards across countries, by academics in studies of economic growth, particularly through the Penn World Table, by the World Bank to construct measures of global poverty, by the European Union to redistribute resources, and by the international development community to draw attention to discrepancies between rich and poor countries. The International Comparison Program (ICP) collects the detailed prices on which these indexes are based on an irregular basis. In 2014, the ICP published PPPs from the 2011 round that are sharply different from those that were expected from extrapolation of the previous round, ICP 2005. These discrepancies will eventually have important implications for the Penn World Table, and for international comparisons of living standards given that the PPPs are used to convert countries' national accounts--GDP and consumption, for example--from local currency to common currency units (international dollars.) The world according to ICP 2011 looks markedly more equal than the world according to ICP 2005. This paper investigates why this happened. We identify a likely source of the problem in the way that the regions of the ICP were linked in 2005. We use two different methods for measuring the size of the effect. Both suggest that the 2005 PPPs for consumption for countries in Asia (excluding Japan), Western Asia, and Africa were overstated relative to the United States by between 18 to 26 percent. Per capita consumption in international dollars of these countries was therefore too low in 2005 and more likely to be accurately estimated in 2011.