Adam Smith

Shortcomings of and Improvements to Measures of Income across Countries T he task of building measures of Gross Domestic Product (GDP) that allow for comparing standards of living across countries presents several challenges. In addition, data revisions can have surprising effects. Consider two examples: • The 2010 version of the World Bank's World Development Indicators (WDI) implies that the United States was 10 times richer than China in 2005; the previous version (2007) implied that the United States was six times richer than China for the same year. Also for 2005, India was 12 times poorer than the United States in the first version of the WDI and 18 times poorer in the latest version. • A popular source of real GDP data used in countless studies, the Penn World Table (PWT), 2 is not free of inconsistencies either. For example, differences between the latest two versions—both covering data for the year 1996—reach a standard deviation of 7.7 percent in annual growth rates for countries in the bottom third of the income distribution. 3 These discrepancies are relevant for policy decisions. For example, the European Commission uses GDP per capita, adjusted for purchasing power parity (PPP), in deciding how to allot structural funds; these funds— 25 percent of the EC's total budget—are used to smooth disparities between and within member states. 4 Also, assessing the success of policies designed to fight extreme poverty across the Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life. world depends on the measure used to define the poverty line. 5 For example, when the World Bank decided in August 2008 that the official poverty threshold would rise from $1.08 of income a day to $1.25, an additional 430 million people around the world were automatically classified as being impoverished. There are alternative ways to measure output in an economy: adding up the value added in each sector of the economy (production approach) or adding the value of total expenditure, i.e., consumption, investment, government spending and net purchases from abroad (or current account). Most of the national accounting is done using the latter. One obvious difficulty in comparing income across countries stems from the fact that different countries use different currencies. The use of official exchange rates would not provide an adequate comparison. For example, if the Mexican peso …