TuckCenter for Global Business and Government

Slaughter & Rees Report - PPP, GDP, TFP, and Story Telling

May 12, 2014 --

Data geeks like us have had much to ponder recently. New calculations from a World Bank initiative called the International Comparison Program (ICP) indicate that by the end of 2014, the gross domestic product of China may end up exceeding that of the United States. This would herald the first change in global GDP rankings since the United States overtook the United Kingdom in the early 1870s.

The ICP converts each country’s own-currency GDP into dollar-denominated GDP using ICP-constructed “purchasing power parity” exchange rates. You cannot look up market quotes for a PPP exchange rate on your Bloomberg terminal. It is a hypothetical exchange rate that would equalize between the two countries the price of a commonly measured basket of goods and services in each country. An essential element of ICP is periodically measuring own-currency price baskets in lots of countries and then calculating the implied PPP exchange rates. Real-world market exchange rates can fluctuate dramatically for reasons unrelated to the prices of goods and services, such as capital flows and government intervention. Thus are PPP measures of GDP often thought to provide more-accurate measures of countries’ productive capacities and living standards.

Converted at market exchange rates, China’s 2013 GDP was about $9.3 trillion (“about” depends on what average yuan-dollar exchange rate you use for the year), in contrast to 2013 U.S. GDP of $16.8 trillion. In PPP terms, China’s GDP is several trillion dollars larger and is poised to be larger than America’s. One essential question to ask is, why does any of this matter? Let us offer one reason: because of how data like this help shape the stories people tell.

Countries grow for three main reasons: they accumulate more labor, more capital, or more of the mellifluous term “total factor productivity.” TFP encompasses not just the technological know-how for transforming inputs into output but also the dynamism, zeal, and what Keynes termed “animal spirits” for creating more and/or new products. The larger countries grow, the more they tend to rely on TFP for subsequent growth.

Yet TFP growth is not dictated by the seasons or by the laws of physics. Rather, it waxes and wanes for reasons economists only somewhat understand. In an illuminating recent essay, Nobel laureate Robert Shiller pointed out the essential role that narratives often play in growth. “Fluctuations in the world’s economies are largely due to the stories we hear and tell about them. These popular, emotionally relevant narratives sometimes inspire us to go out and spend, start businesses, build new factories and office buildings, and hire employees; at other times they put fear in our hearts and impel us to sit tight, save our resources, curtail spending, and reduce risk.”

The recent PPP news matters because it may well reinforce today’s prevailing story of China’s ascendancy and America’s decline. This story has taken firm root in many parts of the world. The Gallup polling firm asks the question, “Which one of the following do you think is the leading economic power in the world today?” The historical trend is quite something. In 2000, 65 percent of Americans said the United States versus only 10 percent China. In 2014? 52 percent replied China versus only 31 percent the United States (with Japan, the EU, and others in the single digits). Thus do the latest PPP GDP data provide another plot development that informs the collective psyche—and thus TFP—of the two countries.

Last week one of us was in Shanghai and can attest that, the recent Chinese slowdown notwithstanding, the story of Chinese dynamism is palpable. One executive after another projected an uplifting energy and optimism, in contrast to so many U.S. business leaders who with squared jaw seem resigned to keeping calm and carrying on. Thus was it not lost on us when on Thursday the U.S. Bureau of Labor Statistics reported that in the first quarter of 2014, productivity in the U.S. non-farm business sector declined at an annualized rate of 1.7 percent.

Stories can and do change. And stories to help shape TFP cannot be childhood fairy tales. That said, America and the world overall would benefit enormously from leaders being able to declare, with a straight face, that the sad story of the U.S. economy is no longer the dominant one and a new, more prosperous chapter has begun. Quite literally, billions around the world are waiting in rapt attention.

Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.

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