In nominal gdp terms South Korea seems to be ahead of Russia, but in ppp terms Russia is far ahead of South Korea. How exactly does all of this work, and which country has the larger economy?
So roughly speaking GDP is more of an International rating. Roughly financial power on the world stage.
GDP(PPP) is about domestic economy. It reflects how the money generated by a countries economy compared to cost of living in said country. So Russia which has a lower Cost of Living than South Korea rates high in PPP. China swaps positions with the US for PPP vs. GDP.
HDI (Human Development Index) relies on PPP. It also looks are life expectancy, education, gross national income per capita (PPP). Here the US drops all the way down to 17th and South Korea to 23rd and Russia to 52nd.
Generally the closer a nations nominal per capita GDP approaches western levels of wealth (30-60k USD per capita), the smaller the gap between PPP and nominal GDP. It has to do with the fact that things like labor are cheaper in poorer nations, so your money goes further.
In India, the PPP economy is three times the size of the nominal one. In South korea the PPP economy is only 20% bigger than the nominal one.
They measure different things; nominal GDP would generally be what most economics writers would refer to if they were saying Country A had a larger economy than Country B.
Nominal GDP is in fact often utilized for that specific reason, measuring the total raw value of different economies. PPP GDP exists more specifically to measure quality of life and be a rough indicator of standard of living, it can help encapsulate that for example, someone making $75,000/yr in the Philippines probably lives a very good life versus someone earning that same amount in the United States, because the Philippines has such a lower cost of living.
Both measures have their uses and values and neither one is “wrong”, they both measure specific things with a specific intention. Usually in more casual writing in say, a news outlet, when someone is making a specific comparison about the size of one country’s economy versus another, most of the time it will be nominal GDP that is used. For professional economists how they compare two economies will generally be situation based and may include lots of other measures as well.
Russia has the larger economy in terms of real production.
In international comparisons, nominal GDP is calculated using current exchange rates. A country can have a relatively strong internal economy – which means it produces a lot of stuff, which means the “purchasing power” of income within the country is relatively high – and yet its currency can exchange very poorly on international markets, so that when the total amount of stuff in the country is measured using that international exchange rate, it seems to make the economy smaller.
What this means is that Russia makes a lot of stuff, but despite that fact, the ruble doesn’t exchange well on international markets. So if you measure the economy nominally, with rubles, the total economy looks smaller than it really is.
Purchasing Power Parity, or PPP, is an attempt to compare international economic production not by exchange rates but by how much stuff can be purchased within a given country given their domestic production/income. This is an attempt to measure the “real” production of the economy, even when exchange rates are weird.
Russia is a much bigger economy than South Korea, which is to say: total production is much greater. But the ruble is weak, and the won is strong, on international markets, so South Korean production is overvalued when measured nominally with exchange rates, and Russian production undervalued, despite the fact that Russia produces more stuff.
That is backward.
Yes.
And real standard of living, corresponding with real purchasing power within the country, comes ultimately from real production, rather than with how many won can buy how many rubles on forex markets. PPP is a messy measure, but nevertheless is not as noisy as international exchange rates.
You can consult the Wikipedia article on PPP for more information about how it works. A relevant graf:
They are both international comparisons.
Nominal GDP compares how the total production of one country would trade against the total production of another countries, at current exchange rates. PPP GDP tries to compare how much total “real” production there is in one country, compared to another country, despite any weirdness in international exchange rates.
China has a larger PPP GDP than the United States, because the Chinese economy is larger than the US economy.
Total Chinese production is larger despite the RMB often being considered “undervalued” at its current exchange rate.
One problem with PPP with respect to Russia and Korea is that a very big part of the Russian GDP is in raw materials: oil, gas, nickel, diamonds, coal, alluminum, gold, tin… Those are not affected by PPP when exported, as the international market prices will be charged. So if GDP underestimates the size of the Russian economy due to an undervalued ruble, PPP overestimates it. So I guess it is, as usual, more complicated than it seems at first glance.
Nope, not in my experience. When comparing relative sizes of economies, I normally see references to nominal GDP instead of PPP GDP. YMMV.
Ah, I see. If you’re saying it’s more common for, say, business journalists to rely on nominal GDP figures, then I agree. My point, then, would simply be that nominal GDP is sometimes going to get the answer wrong – sometimes, very clearly wrong – in cases like the US compared to China, or Russia compared with South Korea.
This is the source of the OP’s confusion and question.
PPP is a messy adjustment with some shaky international assumptions, but no reasonable adjustment is going to put South Korea above Russia when trying to measure “total production” or the “larger economy”. In this particular case, the exchange rate difference is absolutely swamping the different domestic production.
Think of it this way: Russia produces three widgets for $10 each, while South Korea produces one widget for $40.
In terms of nominal GDP: South Korea has greater production than Russia; $40 vs. $30.
But in terms of real production, Russia outproduces South Korea: three widgets to one.
This is why nominal GDP is often a bit of a sham. It “rewards” nations who do things in an overpriced way by making them look better than they really are.
Or for an example with exchange rates:
Country A produces 100 widgets with an aggregate value in their currency of 100 apples. 1 apple trades in foreign exchange markets for 1 US dollar. The nominal GDP of this country is 100 dollars (or 100 apples, measured domestically).
Country B produces 99 widgets with an aggregate value in their currency of 198 bananas. 1 banana trades in forex for around 0.5101 dollars. The nominal GDP of this country is approximately 101 dollars (or 198 bananas in the domestic currency).
Maybe a widget costs 0.95 dollars in the US.
The ideal PPP adjustment here would be something like a GDP (PPP) of 95 dollars for country A, and a GDP (PPP) of 94.09 dollars for country B, which would accurately represent their relative productive capacity for creating widgets.
What makes things tricky is if country A produces 40 widgets and 60 thingumbobs, and country B produces 55 widgets and 30 thingumbobs. What is the correct relative balance between the two goods? Or between thousands of goods?
It’s basically the same problem as trying to measure inflation. What do you compare the currency units to? Bread, oil, gold, an hour of unskilled wages? What do you do if what you’re comparing to didn’t even exist at one time? Most standard measures take a weighted average of a whole bunch of goods and/or services, but then you have to ask what the appropriate weighting is.
But even with all of that potential noise, there’s still usually at least qualitative agreement between the different measures.
Yes. Exactly.
A long inflation time series basically starts with a comparison of Country 2020, which does a bit of “trade” with Country 2019. (January 2020 has a lot more in common with December 2019 than it does with December 2020.) A one-year inflation rate is conceptually very similar to the idea of a PPP comparison between those two “different countries”.
Country 2019 trades with Country 2018, which has some trade with Country 2017. And so on.
A major issue is that Country 2020 simply has no direct relationship with Country 1985. They don’t have an identical set of goods, don’t have the same technologies, don’t have quite the same population. The kinds of people who are workers in one country are retired in the other.
Even with a single good, the problem with comparing widgets across countries is that maybe the widgets are different, and they are different for legitimate reasons relative to the domestic market. These sorts of problems get multiplied many times over with attempted inflation comparisons across decades. The quality of the “same good” can easily change over time. It’s possible to try to compensate for this, too, but that involves yet more assumptions.
A PPP comparison, messy as it is, can make some genuine sense. Just don’t treat the number as some gospel truth. Same with an inflation comparison from one year to the next year. There are relatively small and limited comparisons with a lot of legitimate overlap that makes the comparison relatively meaningful. PPP is messy but it makes some real sense.
But any comparison across a long time period is quickly going to lose much of its meaning. If you listen to someone saying “real wages have done such and such over the last several decades”, and they are treating that number like it’s sacred, then that analysis is missing the messiness of the possible error, which can compound over time.