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Public Disclosure Authorized Estimating Internationally Comparable Per Capita Income Numbers Public Disclosure Authorized Public Disclosure Authorized International Economics Department June 24, 1994 Public Disclosure Authorized Table of Contents I. Introduction ........................................................................... 1 IT. Issues in measurement of income in national currencies ..................... 2 ill Issues in choice of a common numeraire ....................................... .5 IV. Country comparisons by composite indicators ................................ 11 V. The Bank's approach to country comparisons ................................ 13 VI. Conclusion .......................................................................... 17 Annexes I: Production Approach to Purchasing Power Parities ........................ 19 IT: GNP Estimates and ICP Aggregation Procedures ............................ 21 Til: The Standard Atlas Method of Estimating GNP in U. S. Dollars ......... 24 IV: Consistent use of SDR Deflator in the Bank's GNP Comparisons ........ 27 References ................................................................................... 29 Estimating Internationally Comparable Per Capita Income Numbers I. Introduction 1. This paper reviews the methodological and data issues in estimation of per capita income on an internationally comparable basis, and sets out the Bank's current and prospective practices in generating such numbers for operational uses. 1 Compilation of these estimates requires measurement of income in national currencies, which raises various national accounting issues. The national currency estimates of income must then be denominated in a common currency for inter-country comparability, which raises issues in the choice between exchange rates and purchasing power adjusted conversion factors. Also, it is generally recognized that no single indicator can be an adequate basis for comparing countries. Per capita income, for instance, only relates to one aspect of the development process, which requires a broader comparison of a plurality of indicators for a more comprehensive assessment. In considering these numerous issues, the Bank's main priority has been to find a simple, transparent and readily available basis to compare economies for such operational purposes as determination of country eligibility to preferential categories of lending. It has at the same time been recognized that for most analytical purposes per capita income measures have to be supplemented by broader socio-economic indicators. 2. Section ll reviews the various issues in estit~ation of gross national product (GNP) per capita in national currencies. Section ill discusses issues concerning the conversion factor with focus on the relative merits and practicality of the purchasing power adjusted income comparisons under the United Nations International Comparison Programme (ICP). Section IV notes limitations of single indicator comparisons and assesses the case for composite indicators such as the Human Development Index (HDI) of the United Nations Development Programme (UNDP). Section V outlines Bank practices in per capita GNP comparisons that essentially reflect national estimates of GNP converted at official exchange rates with modifications made as needed on an exceptional basis. The concluding Section VI notes prospective modifications of these practices in Bank comparisons of per capita GNP. Earlier staff reports on this subject Methodological Problems and Proposals Relating to the Estimation of Internationally Comparable Per Capita GNP Figures (SecM83-1120, December, 1983) and Per Capita Income: Estimating Internationally Comparable Numbers (SecM89-73, January 17, 1989) -- referred to hereafter as Board Papers-- were discussed by the Executive Directors on January 5, 1984, and February 10, 1989, respectively. 2 D. Issues in measurement of income in national currencies 3. GNP as the aggregate of domestic and net foreign incomes of a nation 1 s residents is the generally preferred conceptual basis for country income comparisons. The results are, however, little affected for most countries if one uses instead the concept of gross domestic product (GDP), which excludes net factor income from abroad.2 GNP comparisons on a per capita basis adjust for differences in population size, but not for other demographic factors such as differences in age-sex compositions of the national populations. Also, GNP per capita does not reflect the evolution of the country 1 s natural resources and nor does it distinguish between the ultimate uses of products generated during the period. Supplementary indicators thus have to be considered to assess relative levels of national welfare or development. 4. GNP comparison is substantially affected by coverage and quality differences as well as variations in institutional practices and capabilities implicit in the various national accounts data. In measuring GNP, market economies in principle follow the System of National Accounts (SNA) rule of including all marketable goods and services. However, actual practices differ widely in coverage and valuation especially of output from subsistence and informal economic activities. There are also systemic differences between countries that have long experience with SNA practices and those in transition from the alternative Material Products System (MPS) that only includes goods and the so-called material services. For instance, differing treatment of services and depreciation of capital assets is reflected in a substantial difference between SNA based GDP and MPS-based Net Material Product (NMP), the latter being generally between 15 to 30 percent lower for most Historically Planned Economies (HPEs). 3 These intrinsic disparities in national currency estimates of GNP together imply that country income comparisons can only be tentative so that relatively small differences in the national levels of per capita GNP have to be interpreted with caution. 2 The relative merits of various national accounting categories as alternative basis for international comparisons were extensively discussed in the 1989 Board Paper (op. cit., Annex 1, pp. 14-25). 3 World Bank, "Measuring Economic Growth and Inflation in Transition Economies", Summary Report: Accounting for Economies in Transition (International Economics Department (IEC), RPO 676-18, 1993). 3 Subsistence and informal activities 5. The disparate coverage and quality of national accounts data are especially pronounced for many of the lower income countries with a weak national capability for gathering even the most basic economic statistics. Data gathering in these countries is frequently limited to the formal monetized economy although informal and subsistence activities account for a relatively high proportion of their total incomes. The non monetized subsistence sector, which produces for own consumption rather· than marketing, is generally incorporated in the GNP estimates of most countries, but by various procedures. Coverage is more disparate for the monetized but unrecorded activities that are referred to as the informal sector; this sector comprises a wide variety of occupations that mostly engage the self-employed, including those in the underground economy operating at the margin of the law by evading taxes and regulatory frameworks. 6. Indications are that a more realistic assessment of the production in subsistence and informal activities will have a considerable impact on income comparisons across countries. However, measurement of such activities has been difficult for even the higher income industrialized economies where economic statistics are more plentiful. For instance, depending on the method of imputation, the estimated GNP share of informal activities has varied from 5 to 12 percent for Sweden and 7 to 15 percent for the U.K. for the same year. 4 Since monetization and market-orientation rise with the level of development, the problem of GNP comparability posed by disparities in the coverage of subsistence and informal activities is as a rule greater for lower income countries where the difficulties of measurement are also much greater. 7. For lower income countries, one study of a selection of countries places the relative share of unrecorded informal activities at well above 25 percent of GNP for most of Africa. 5 The seriousness of the gaps in coverage is illustrated in the periodic efforts to improve national accounts that have led to major revisions of the national currency estimates of GNP. Even an ordinal ranking of country incomes is made 4 See, J. J. Thomas, Informal Sector Activity (London, 1992). 5 See, World Bank, "The Measurement of Traditional Activities in the National Accounts". Paper prepared for Economic Commission for Africa Seminar on the Revision of the SNA, Addis Ababa, 29 September - 3 October, 1986. 4 difficult when the available data are subject to such drastic changes as the recent upward revisions of the GNP series by over 25 percent for Madagascar and over 30 percent for Argentina. 6 While the problem is likely to persist in view of the generally weak national statistical capabilities of many lower income countries, the International Labour Office (ILO) has reported plans by a large number of these countries to collect data on the informal sector and related topics such as small enterprises, cottage industries and household economic activities. 7 Historically Planned Economies (HPEs) 8. The long-standing problem of international comparability