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New tools for weighing power

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COMMENTS

31 August 2010 15:50

China seizing second spot from Japan on the world economic table was a milestone in measuring changing power relativities. It was also a moment to reflect on the tools we use to compare economies. Is it to be purchasing power parity (PPP) or the US exchange rate'

PPP is the new kid on the block. The US dollar exchange rate is the way we have measured much in the world since World War II, and especially since 1971 when Nixon closed the gold window and threw the currency switch to hyperdrive.

Japan has just dropped from second to third on the league ladder using the traditional measure of the US exchange rate. But using PPP, we passed that moment quite some time ago. This illustrates a point Mark Thirlwell made when skewering the idea that PPP is some sort of new age con:

When giving presentations, I also often tell my audience that the choice of PPP vs dollar exchange rates can sometimes be decided by the presenter's agenda: want to downplay the importance of emerging markets' Then cite US$ estimates of GDP comparisons. Want to emphasise it' Then PPP. Hence the case for reporting both.

As always, Mark is the guru on such matters and he can do the serious economic lifting. The Canberra Column's contribution will be to point to the way PPP has established itself as a respectable and quoted measure in key areas of the Australian government and bureaucracy.

Back in 2003, the Howard Government's second foreign policy white paper (Advancing the National Interest) was firmly camped in the US exchange rate camp:

No country in Asia will supplant Japan's importance to Australia's prosperity for at least another decade. Japan is the world's second-largest economy and the largest in Asia by several magnitudes.

But the trade figures with China were starting to fizz, so the bubbles quickly popped from that bit of exchange rate orthodoxy. By 2006, Treasury was using PPP to re-arrange the map of Asia, awarding the number two spot to China. In May 2006, your correspondent reported the Treasury's demotion of Japan:

One other element in the budget papers is a re-ordering of the biggest league table of all – the economic order, where size is all that matters. And in this hierarchy, Japan has just been demoted. The Treasury uses Purchasing Power Parity – not the old exchange rate measure – to create new world rankings, in which China's economy has surpassed Japan. On that parity model, the US is still the largest economy, but China steps up to number two, and India becomes the fourth largest economy. The analysis argues that the growth of China and India will have the most far-reaching consequences for the global economy, and that move to China and India means a shift away from Europe and Japan. It's plausible, according to Treasury, that China will go past the United States within 15 years to have the world's largest economy.

Treasury argued that PPP should be the 'preferred basis for comparing the relative size of economies because it uses a conceptually appropriate approach to estimating prices in both the traded and non-traded sectors of the economies, in contrast to comparisons based on market exchange rates.' If Treasury says it is so, perhaps it could be so.

By 2008, Kevin Rudd was laying down the parameters for Defence in his much studied RSL speech in Townsville and PPP was called to support a central proposition:

China will be the most dynamic major economy in the first half of this century — followed by India. According to some estimates, by 2020 China will replace the United States as the world's largest economy. China's economic growth will change the way it sees its own role in the world.

No surprise then that the Defence White Paper followed its fearful description of the US as 'preoccupied and stretched' in coming decades with a PPP sentence: 'By some measures, China has the potential to overtake the US as the world's largest economy around 2020.'

The growing use of PPP over the decade was one element in Australia's attempts to envisage the changes being effected by China. Many in Canberra have accepted a rough power relativity timetable that is part prediction and part assumption. This holds that, barring a myriad of possible disasters and disjunctions, the direction we're heading produces a China as World Number One by 2020 (PPP) and the same demotion of the US on the exchange rate measures around 2030.

Choosing new predictive tools can mean choosing new conclusions. See Lowy's Power and Choice: Asian Security Futures for a masterful presentation of changing power relativities using both PPP and exchange measures.

Photo by Flickr user brotherM, used under a Creative Commons license.

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