A new working paper from World Bank- Estimating real production and expenditures across nations : a proposal for improving the Penn World Tables by Robert C. Feenstra, Alan Heston, Marcel P. Timmer and Haiyan Deng;
Summary: From its inception, the Penn World Tables (PWT), building on the International Comparisons Program (ICP) of the United Nations, has sought to compare the standard of living of individuals in different countries. That is, the term "real GDP per capita" as reported in the PWT is intended to represent the ability to purchase goods and services by a representative agent in the economy. The same is true of benchmark comparisons as published by the United Nations, Eurostat, or OECD. But this expenditure-side interpretation of real GDP is quite different from the uses to which benchmark ICP and PWT data are frequently applied, such as in growth regressions, where "real GDP" is intended to reflect the production side of the economy. In this paper the authors propose a new approach to international comparisons of real GDP measured from the output side. They modify the traditional Gary-Khamis system, which measures real GDP from the expenditure side using real domestic expenditure, to include differences in the terms of trade between countries. The analysis shows that this system has a strictly positive solution under mild assumptions. On the basis of a set of domestic final output, import, and export prices and values for 151 countries in 1996, differences between real GDP measured from the expenditure and output side can be substantial, especially for small open economies
Excerpt from conclusion;
In this paper, it has been shown that there is a fundamental difference between real GDP measured from the output side or from the expenditure side in international comparisons. The difference between the two concepts is in the treatment of the terms of trade. Real GDP from the expenditure side represents the ability to purchase goods and services while real GDP from the output side measures the production possibilities of the economy. It is the latter concept of real GDP which is of interest to many studies of growth and convergence in the world economy. However, available data from the Penn World Tables are based on a mix of cross-country expenditure-side measures of real GDP for benchmark years, with national growth rates of real GDP based on output-side measures.
In this paper a clear-cut distinction between the two measures is made. It is shown that real GDPe can overstate real GDPo by as much as 100% (for Bermuda) and understate it by as much as 33% (for Hong Kong). In these two extremes and other cases, we would want to closely examine the export unit-values before treating the estimates of real o j GDP as reliable. For Bermuda, its exported sailboats may well be of higher quality than the world average, which indicates that we are overstating its high terms of trade. Conversely, the low export unit-values for Hong Kong may reflect it status as an entrepôt economy, processing and shipping goods from China and elsewhere in Asia. It is impossible to avoid using these trade unit-values as measures of prices, however, since no dataset exists for comparing actual trade prices across countries. So it is essential that we should attempt to correct the unit-values for differences in quality across countries. Recent papers along these lines include: Choi, Hummels and Xiang (2006), Feenstra
and Romalis (2006), Hallak (2006), Hallak and Schott (2006), Hummels and Klenow (2005), and Timmer and Richter (2006); and we can hope that enough progress will being made on these methods to allow implementation over a wide set of countries, products and years. In our view, that is the key theoretical and empirical issue that must be resolved before applying the techniques described herein to obtain separate measures of real GDP on the output side, and the expenditure side, in the Penn World Tables.
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