China’s Incredible Shrinking Economy

ITHACA, NY -- The World Bank recently announced that the Chinese and Indian economies are 40% smaller than previously estimated. Since these are the fastest-growing large economies, the Bank’s revision has clipped half a percentage point off world growth over the last five years, according to the IMF.

The new numbers set off a firestorm of debate, and have brought conspiracy theorists out in force. But when the dust settles, the new data may be less revolutionary than some people believe. They may also have the unintended benefit of shifting a key policy debate in a more productive direction.

The new data are based on improved estimates of purchasing power parity (PPP). The basic idea is that, when comparing incomes across countries, variations in purchasing power should be taken into account. Market exchange rates are not a good indicator of these differences, because they can fluctuate for other reasons.

The World Bank and some other organizations have, collectively, gathered a massive amount of data – covering 1,000 similar products in 146 countries – to construct comparable international prices. Price levels in China and India, among other developing countries, turn out to be much higher than previously estimated. Hence, their real per capita incomes are lower relative to other countries.