Tuesday, August 17, 2010

How Rich Is Canada Relative to the U.S.?

According to Statistics Canada, Canada's real GDP per capita is catching up to America's: it went from 82% in 1999 to 92% in 2008. However, according to the IMF, during the same period, it went from 81% to 82% (other international organizations, like the OECD and the World Bank, show similar numbers). What's going on?

The reason why these estimates have come to differ so greatly is that Statistics Canada estimates that the purchasing power of each Canadian dollar was 90 U.S. cents in 2008, while the IMF reckoned that it was only 81 cents. In contrast, in 1999, both agencies pegged the CAD's real value at 0.84 USD. Of course, this begs the questions: why did the difference arise, and who's right?

Statistics Canada gives two reasons for the diverging figures, both of which suggest that its numbers better reflect the relative standing of the Canadian economy:

1. The International Comparison Program (ICP) is the main reference for establishing the true purchasing power of various currencies. It does so by collecting prices for a variety of goods in each participating country. The last round of the ICP was carried out in 2005, and determined that the CAD's purchasing power was about 0.82-0.83 USD. However, Statistics Canada used extra data and recomputed the figure by tweaking the basket of goods being compared, so that it better reflects North American consumption and investment patterns. The adjusted value was 0.87 USD.

2. After the 2005 benchmark, these statistics are adjusted every year to reflect differences in inflation between countries. For example, if inflation is higher in Canada than in the US, then the relative purchasing power of the CAD would decrease. Question: inflation of what? If Canada and the US did not trade at all, the answer would be easy: the inflation of all goods and services in each economy. But due to international trade, the G&S produced in a country do not correspond to the G&S consumed in that country. What basket of goods and services should be used depends on the purpose of the calculations:

- If one is trying to figure out economic (i.e. real GDP) growth for a given country, one should use production prices: the goal here is to compute the change in the volume of G&S produced. The relative prices of imports and exports are held constant.

- If one is instead interested in international comparisons of material quality of life, the consumption prices are the relevant ones. The relative prices of imports and exports follow changes in the market.

In Canada's case, this makes a big difference: as energy prices have risen considerably, a given volume of Canadian exports is now worth more imports than it used to. This has not been the case for the US. Thus, since 2005, while Canada's economic growth per person has roughly matched America's, Canadians' material quality of life has been increasingly more rapidly than Americans'. This is the second reason why international organizations, using the former measure, do not show Canada catching up, while Statistics Canada does.

(By the way, the second measure above - the trade-adjusted value of GDP - is sometimes termed Gross Domestic Income (GDI). Every year, GDP=GDI at that year's prices, by definition: your income is the value of what you produce. But because the previous year's GDP and GDI are not generally the same at current prices, real GDP and real GDI growth rates differ. So point 2 is simply saying that the international organizations' estimates reflect Canada's real GDP growth rather than its real GDI growth.)

To make a long story short: there is good reason to believe Statistics Canada's findings that Canadian economic standards are catching up to American ones (although I'm bit skeptical about the point 1 adjustment being so large)! This is consistent with the mood in the two countries, even during the 2003-2007 expansion: while Canada and the U.S. posted similar growth rates (and had similar population growth rates as well), Canadians were much more upbeat than Americans about the economy. After the next round of the IPC in 2011, international organizations will recognize part of the catch-up (the portion related to point 2), as the exercise will update the relative prices of all goods.

Interesting side note: although Statistics Canada puts the CAD's purchasing power at 0.90 USD, it is lower for private consumption goods and services (what you and I actually "feel") - only 0.84. The numbers vary wildly across categories of goods: food, alcohol and tobacco are a lot more expensive in Canada, while health care (even the private portion, like eye care and dentistry) and education are a lot cheaper. However, for government purchases and capital investments, the values are 1.01 and 0.98. The former reflects cheaper health care in Canada, while the latter may be partially due to Canada mainly using value-added taxes instead of sales taxes.


Bernard von Schulmann said...

It is very hard to accurately estimate the number not only because of issues of purchase parity, but also because the nature of what is private and what is public is different in both countries.

Finally, the demographics are different between the two countries. Canada has a labour force participation rate than the US. Our household composition is also different, a larger household has a higher purchasing power of each dollar but fewer to spend per person. Age also plays into this, Canada is at the moment aging faster than the US.

Ultimately it is very, very hard to give a good answer to this. My best way of measuring it is through sales of certain consumer items such was what is the best selling car/light truck, how quickly do DvD players sell (though that may no longer be useful)

Election Watcher said...

If what you're saying in the 2nd paragraph is that GDP PPP per capita doesn't exactly correspond to economic well-being or the health of the economy, then I agree. However, demographic differences between Canada and the US are pretty small (and persistent over the short and medium terms), so I think GDP PPP per capita comparisons between the two countries are still quite meaningful. Still, you make a good point.

You're also right in saying that GDP PPP per capita is hard to measure. I don't think what you mention in the first paragraph (private vs. public) poses a great difficulty for that metric, since GDP includes both public and private goods and services. But I definitely agree that it makes PPP values for certain sectors much more difficult to interpret.

I actually think that hard-to-measure differences in quality are a more serious issue than the ones you've mentioned. While those are unlikely to be systematic between the two countries for day-to-day goods, they can be significant in certain areas like education.

I completely disagree with the method you propose in the last paragraph. Retail consumer items are not representative of the economy overall. With the same nominal income, I'd much rather live in a place where I'd pay less for the same education and rent, even though I'd pay more for cars and dvd players.

I'm glad the topic piqued your interest! Sometimes I wonder if anyone cares, given that the media almost never goes beyond perfunctory reports about basic indicators.

Election Watcher said...

It just occurred to me that your public/private comment might refer to the fact that GDP per capita doesn't correspond to personal disposable income. While that's definitely true, GDP per capita is a better measure of economic well-being. One is better off with $5,000 less if the government will pay for $8,000 worth of goods and services (that you would consume anyway) on one's behalf.

And of course, our discussion has ignored the usual GDP caveats about unpaid work, resource depletion and environmental degradation. But again, I don't think these factors are too important when one is comparing Canada and the US.

Bernard von Schulmann said...

Some important differences between the US and Canada:

Americans volunteer more
Americans donate a lot more money
Canada provides more the the state and more importantly, Canadian provinces provide more than US states

These are all differences that change what wealth is and how it is expressed in people's lives. PPP does not do a good job of capturing this.

Interestingly, the Economist some decades ago as a lark decide to use the Big Mac as a measure of PPP and they found out that it actually is a very consistent and reasonable measure of PPP, one that is close to what the statistical agencies come up with. This says to me that the margins of error in how GDP by PPP is measured is hardly an exact science and leaves way too large a margin of error to make comparisons of relative levels of wealth.

I still think comparing what cars sell best in each country is a decent measure of relative wealth. For many years the best selling car in Canada was some 20-30% cheaper than the best selling one in the US. This is not the case in 2009, in fact the lists are almost identical for the first time in years

Election Watcher said...

I agree on volunteer work not being captured by GDP: see my previous comment on the "usual" caveats. I was not aware that Americans volunteer more than Canadians. What is your source?

I don't understand why you're bringing up charitable donations and public services. Both are accounted for in GDP figures, and the consumption of charities and government spending are considered for computing PPP values as well.

The Big Mac index works well for some countries, but not for others. Is Brazil more expensive than the US? I don't think so. In that case, PPP will get you a sensible answer, while the Big Mac Index does not. And why would the fact that the Big Mac index work well discredit standard PPP measures anyway?

If a country is more car friendly, its residents will tend to buy bigger and more expensive cars. So residents of European countries that are as rich as Canada have much cheaper cars than Canadians. Parking in Canadian cities tends to be much more expensive than parking in American cities (except the BosWash corridor). Vehicles are taxed differently in each country, as is fuel. The credit crunch has been more severe in the US, and that affects car sales disproportionately. Demographics, which you initially mentioned as a problem for GDP, also greatly impacts car sales. The list goes on and on.

And the above assumes that you're making the car comparison in a methodologically sound way. For example, I hope that you are looking at a representative basket of car sales. Just looking at the top model would make your measure very unreliable. In addition, price comparisons should be done carefully. For example, if you're comparing the Canadian price and the American price at market exchange rates, your measure is completely bogus.

Note that both methodological problems (choosing the right basket and measurement issues) are precisely what PPP is designed to deal with. You criticize PPP for dealing with those problems imperfectly, and yet propose a metric where the same issues (and a host of others, as mentioned above) arise...

PPP measurements are not perfect (and neither is GDP as a concept). But it's the best measure we have: more precise than the PPP based on a single good (e.g. Big Mac), and way less biased than the quality of sales of a single category of goods (e.g. cars).