PPP demystified

It is clear from the comment section to the previous post that there is a lot of confusion about PPP.  Let me try to illustrate the basic ideas with an example, since my words don’t seem to be making an impact.

Assume that Saudi Arabia has a nominal GDP of $1000 billion, of which $600 billion is non-oil output and $400 billion is oil output.  Let’s assume that the domestic and international prices of oil are the same for Saudi Arabia, but that other goods are 3.5 times as expensive in the US as in Saudi Arabia.  In that case the Saudi GDP in PPP terms would be:

3.5 X $600b + $400b = $2500b

You might think about there being a “multiplier” of 3.5 for non-oil output, and a multiplier of 1.0 for oil.  The overall multiplier is 2.5 = $2500b/$1000b.

Now suppose you want to find the non-oil GDP in PPP terms (which I assumed was $2100b), how do you do that?

You started with the total output (from the IMF or World Bank) in PPP terms, which is assumed to be $2500b.  Then you subtract the output from the oil sector, using international prices.  In this case I assumed the domestic and international prices were identical.  Now suppose the domestic price of oil in Saudi Arabia were less than the international price.  In that case you’d want to subtract out oil at the international price, not the domestic price.  Do all PPP prices or all nominal prices; don’t mix the two.

Some commenters wanted to subtract the oil sector from nominal Saudi GDP.  But I’m not interested in nominal Saudi non-oil output; I want PPP non-oil output.  And if you apply the overall 2.5 multiplier to the non-oil sector, you get the wrong answer, as the actual multiplier is 3.5 for the non-oil sector (by assumption), and 2.5 for the total economy.

This is from a recent article in the Economist:

Cheap oil is forcing Gulf monarchs, who have hitherto bought their people’s acquiescence with cushy jobs and handouts, to trim the public payroll. And since Gulf monarchies cannot find enough jobs for their own people, the safety valve of emigration to work in the Gulf has closed to other Arabs. The largest Gulf state, Saudi Arabia, needs to create about 226,000 new jobs every year, according to Jadwa Investments, a Saudi research firm. But in 2015 employment rose only by 49,000.

Gulf states have set quotas for the employment of nationals, but many companies complain that local graduates lack the skills and work ethic required. “I know of firms that pay Saudis to satisfy the law, but tell them to stay at home,” says one businessman.

Now of course the foreign workers in Saudi Arabia are a different story.  But many of them are low skilled construction workers, maids, etc.  So I still find it kind of amazing that Saudi resident workers seem to be more productive than German workers, even if you exclude the entire oil production industry from the Saudi data. But that’s just me.

Or maybe (more likely) the IMF/World Bank/CIA PPP estimates are all inaccurate.

Also note that having lots of money doesn’t magically solve productivity problems. Countries in the “middle income trap” are often saving enough so that they ought to be catching up to the developed world.  The fact that they are not doing so suggests that productivity problems are much deeper than a lack of money.

If I had to argue against my anti-Saudi prejudice, here’s what I’d say:

Some places are unsentimental and very smart.  They realize that they can have living standards far above New York City through international labor arbitrage. They understand that NYC does not have “nice things” like good subways and good roads and good airports, because they insist on using union workers and local firms that are not skilled at building subways.  So the subways cost three times more than even in Europe.  These unsentimental smart places like Singapore and Dubai realize that they can bring in the best foreign firms and very cheap construction labor from Asia, and build great infrastructure for low prices.  If you then price the output of the infrastructure at America prices, it looks really impressive. So maybe the Saudi’s really are highly productive, because they do this sort of labor arbitrage.  They sell oil at American prices, and hire Bangladeshi construction workers at 5% of American wages.  Sounds good to me!

When I read Dems (and Trump) talk about the need to build infrastructure in order to create “jobs”, I’m reminded of Milton Friedman’s famous joke.  If you want jobs, use spoons.  If you want NYC to have nice infrastructure, use Bangladeshi workers.

PS.  I just saw this, from the WSJ:

The Wall Street Journal reached out to 45 economists who have served on the White House Council of Economic Advisers, under both Republican and Democratic presidents, to ask about this year’s presidential election. Most Democratic appointees said they supported Hillary Clinton, while no Republican appointees openly supported Donald Trump.

I know, the experts have “screwed things up” so why not give outsiders an opportunity?  Yes, instead of being screwed up as we are in America, we can have a policy-making apparatus run by non-experts, and get screwed up in the way that non-expert dominated places are screwed up, as in North Korea, or Venezuela, or Zimbabwe.

When you are a country that is already in the 97 to 99 percentile of the global economy, in terms of overall economic success, I’m not sure you want to just kick out all the experts and try something completely new.  Your upside if it works might be Singapore or Switzerland.  But your downside risk . . . ?

I wrote this back in 2011:

Now let’s start down through Dante’s seven circles of Hell:

1.  The US is much richer than Mexico.  So much so that millions of Mexicans will risk the horrors of human trafficking into the US to get crummy jobs picking tomatoes all day in the hot sun.

2.  China in 2011 is still considerably poorer than Mexico.  The Chinese take much greater risks to get here.

3.  China today is so much richer than China in 1997 that it’s like a different planet.  The changes (even in rural areas) are massive.

4.  The China of 1997 seemed like paradise compared to the China of the 1970s.  Throughout Hessler’s book, people keep talking about how horrible things were during that decade and how prosperous they are now (1997 in Sichuan!)

5.  The China of the 1970s was nowhere near as bad as during 1959-61, when 30 million starved to death.

It’s a loooooong way down to the lower percentiles.

PPS.  Yes, I know, there were nine circles.  I have a bad memory.

Are Saudis more productive than Germans?

I’m sure this post is wrong, but I’d be interested in finding out the precise way that it’s wrong.

I was recently looking at an international ranking of GDP/person in PPP terms, and noticed something strange.  The per capita GDP for Saudi Arabia ($53,624) is higher than for Germany ($46,893).

I know what you are thinking: Oil, lots of oil.  But is that the explanation?

The GDP for Saudi Arabia was $1,683 billion in 2015.  As far as I can tell the Saudis produced about 10.25 million barrels of oil a day last year, or a total of roughly 3.75 billion barrels.  Oil seemed to average about $50/barrel last year, for a total of about $187.5 billion in oil output.  That means the non-oil sector of the Saudi economy produced about $1,495.5 worth of output.  If we divide that number by the Saudi population (about 31.3 million in 2015) we get $47,780/person in output, even excluding the entire output of their oil industry.  That’s more than Germany! These are all IMF figures, but the World Bank isn’t much different.

What did I miss?

1.  I subtracted nominal oil output from total PPP GDP.  That might seem like comparing apples and oranges, But oil is internationally traded, and I used international oil prices.  So the oil sector needs no PPP adjustment.

2.  Lots of Saudi output is produced by foreigners.  Yes, but the 31.3m population figure includes foreigners.

3.  Saudi non-oil output is only possible because the oil wealth finances it.  So does that mean that if we give Bangladesh foreign aid equal to 12.5% of their GDP, they would be able to boost per capita output to German levels?  I don’t think so.

4.  The IMF’s PPP estimates are way, way off.  But the other sources reports similar or even higher levels of Saudi GDP (PPP).

I vote for #4.  But it still seems odd that multiple sources would produce similar numbers that are all wildly incorrect.  If so, why?  The IMF and the World Bank employ highly skilled economists.  Wouldn’t that be a major scandal?

Or are Saudis actually more productive than Germans?  If so, isn’t that a huge story?

Is China focused on NGDP?

This morning I noticed a discussion of NGDP growth in China, which has recently picked up slightly:

Screen Shot 2016-08-25 at 12.36.30 PM

The commentator at Bloomberg.com suggested that the acceleration in NGDP growth may help to explain why the PBoC has not done any monetary easing in recent months.

Many observers are skeptical about China’s RGDP numbers. It does seem plausible that the RGDP numbers are smoothed, and thus that NGDP more accurately reflects cyclical movements in the Chinese economy.

Question for my British readers:  How is Brexit impacting the UK economy so far? This will be a test of “uncertainty” theories of the business cycle—the claim that recessions can be caused by an increase in uncertainty, which hampers investment. Brexit was the mother of all uncertainty shocks. I’m agnostic on those theories, but on balance I think they are modestly overstated. Over at Econlog, I predicted a 0.5% rise in the UK unemployment rate as a result of Brexit. This BBC article suggests the immediate impact has been fairly mild—so far.  (Very little post-Brexit data is available.)



Here’s Jim Geraghty:

Meet Donald Trump’s new immigration stance, which is to . . . praise how tough President Obama has been on deportations. Huh? What?

“We’re going to obey the existing laws. Now, the existing laws are very strong. The existing laws, the first thing we’re gonna do, if and when I win, is we’re gonna get rid of all of the bad ones. We’ve got gang members, we have killers, we have a lot of bad people that have to get out of this country,” he said on Fox News. “As far as everybody else, we’re going to go through the process. What people don’t know is that Obama got tremendous numbers of people out of the country, Bush the same thing. Lots of people were brought out of the country with the existing laws. Well, I’m gonna do the same thing.”

[Host Bill] O’Reilly then mentioned detention centers, prompting Trump to quickly shoot down the idea of keeping undocumented immigrants in detention centers.

“You don’t have to put them in a detention center,” Trump said.

“I never even heard the term. I’m not gonna put them in a detention center,” he added. “We want to do it in a very humane manner.”

Great news, immigration hawks! Trump will emulate those tough policies of . . . Obama and Bush! Aren’t you thrilled? Haven’t you passionately campaigned for the status quo all these years?

Still on “vacation”, so let’s just have a poll.  What’s funnier:

1.  The fact that Trump has never heard of immigration detention centers.

2.  The fact that he doesn’t know that Obama puts illegals into detention centers.

3.  The fact that Trump has decided to run to the left of Obama on immigration.

4.  The fact that Trumpistas believed that Trump was sincere on immigration.

P.S.  If you see Harding on the street, steer clear.  His head might explode.

Where is the “honest dialogue”?

Here is Ben Bernanke in 1999, talking about the situation in Japan:

With respect to the issue of inflation targets and BOJ credibility, I do not see how credibility can be harmed by straightforward and honest dialogue of policymakers with the public.  In stating an inflation target of, say, 3-4%, the BOJ would be giving the public information about its objectives, and hence the direction in which it will attempt to move the economy. (And, as I will argue, the Bank does have tools to move the economy.)” (1999)

One of the things that I find most infuriating about the current policy environment is the lack of an “honest dialogue” about the choices faced by monetary policymakers.

Go back to the 1990s and early 2000s and look at the discussion about inflation targeting, involving elite economists like Ben Bernanke. One common theme was that the inflation target should not be too high, but definitely needed to be high enough to keep economies out of the zero rate trap. As far as I know, there was widespread agreement on this point.

Now that we’ve discovered that a 2% inflation target does not keep us above the zero rate bound, especially in recessions, I’d expect exactly the sort of honest dialogue that Ben Bernanke suggested back in 1999. Instead, we have a profoundly dishonest dialogue, dodging the real questions:

1. When do you recall Bernanke, Yellen or any other central banker, telling government leaders that we faced a choice between a massive central bank balance sheet, and a higher inflation target? Or a choice between negative IOR and a higher inflation target?

2. Back in 2009-11, do you recall a Fed official telling Congress that the Fed was holding back on monetary stimulus, out of fear they might be embarrassed at some time in the future by large capital losses, even though those losses would net to zero for a consolidated Federal government balance sheet perspective, and even though the reluctance to pursue monetary stimulus further would result in a great deal of unnecessary unemployment? I don’t.  I recall vague discussion of “costs and risks” associated with QE, but nothing that would give Congressmen any idea of the actual choices we faced.

3.  How often did Fed officials tell Congress that we faced a choice between moving to a higher inflation target, and relying more heavily on fiscal stimulus?  I don’t recall any such discussion.

There’s a price to pay for dodging these important questions.  We are sleepwalking into a world where the central bank will ask for assistance from fiscal policymakers, and they won’t provide it, or at best they’ll provide too little to make a difference.

PS.  Just to be clear, I am not advocating a higher inflation target, because we have better options.  The problem is that we are also not going to adopt those better options, and instead will end up with something far worse.

PPS.  I’m not alone; Paul Krugman was equally frustrated back in 2010.

PPPS.  Speaking of honesty, I just finished volume 5 of “My Struggle”.  As I’ve gotten older, I have fewer and fewer experiences of the sort of “aesthetic bliss” that was common when I was younger, especially in arts like music, painting and film.  And now at age 60 I’ve stumbled upon my all time favorite novel.  (The entire set, not just volume 5)  I am profoundly grateful to Karl Ove Knausgaard.  (BTW, my dad’s name was Karl, and his mom spoke Norwegian.)

And how come reporters keep asking him about the title?  How could it be titled anything else?

PPPPS.  I won’t post much over the new few weeks, due to summer vacation.  I will have a few posts at Econlog, which have already been written.