Today’s frontpage story from WSJ overhypes the relative
importance of advanced economies for global growth vis-à-vis emerging markets:
The whole analysis is misguided because they (WSJ and Bridgewater
Associates) use market exchange rates to compare GDP across countries. It is usually not
appropriate to use market exchange rate for international comparison of GDP
data (especially when it involves rich and poor countries). Hypothetical example that illustrates one of the major drawbacks of using
market exchange rates: suppose you get a cardiac surgery in the US and it costs you $65,000, while similar surgery costs $10,000 in India (at a top notch hospital)
– if you don’t correct for domestic price differences, the same operation will
contribute $65,000 to US GDP but only $10,000 to Indian GDP. (There is a good
chance an Indian born doctor will be doing the surgery in the US as well J)
Another problem with market exchange rates has to do with
the inherent volatility of floating exchange rates. For instance, the Japanese
currency was trading at 78 yen per dollar a year ago (Aug 2012) but is now
trading at around 97 yen per dollar (Aug 2013). So, if you converted GDP data a
year ago using market exchange rates and then did it again this year, you will
get dramatically different results.
Here is a far better piece (from The Economist) that actually
uses PPP exchange rates to compare GDP and contributions to global growth.
See this piece regarding GDP conversions using PPP exchange
rates: