Executive summary

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There are two potential ways to make cross-country comparisons using estimates of income derived from National Accounts programs of different countries. Each requires a different deflator in order to transform measures of the dollar value of production (or income produced) measured in different currencies (dollars, sterling, euros), into measures of relative volumes of production (sometimes referred to as 'real' value added) or relative real income. These deflators are referred to as PPP deflators.

PPP programs can be devised to measure either purchasing power parities or producing power parities. The measure required depends on the purpose of the analysis.

Indices of purchasing power parity are used to compare real income levels across countries based on a nation's ability to buy goods and services. Purchasing power parity comparisons deflate the relative levels of nominal income (often referred to as gross domestic product (GDP)) using price indexes derived from prices for final domestic expenditures (primarily consumption, investment and government expenditures). When domestic prices, rather than domestic and traded prices, are used to calculate real income, the resulting measure is referred to as real Gross Domestic Income (GDI).

Indices of producing power parities are also used to compare real estimates across countries. Producing power parity estimates are used to examine production-related phenomenon—differences in countries' ability to produce (as opposed to consume), goods and services. Producing power parity comparisons employ relative estimates of real GDP. In nominal dollar terms, GDP is equal to the income generated in production. When GDP is used to compare the volume of production across countries, a deflator is required that compares the prices of production—not the prices of expenditures.

In a world without trade between countries, the purchasing power and producing power parities will be identical, since then the commodities that a nation produced would be those that the country consumed. But in a world where trade occurs, prices that are made up of commodities produced need not correspond to the prices of commodities consumed.

In this note, we examine the differences in the purchasing power and producing power parity measures for Canada relative to the US, elaborate on differences between the two, and discuss problems of estimation.

This paper analyzes PPP concepts based on GDI and argues that these are appropriate for comparing the well being of Canadians relative to Americans. In doing so it examines several questions:

1. Why is it important to use real GDI rather than real GDP?

1. Real GDP and real GDI differ with respect to the manner in which changes in the terms of trade (differential movements in export and import prices) are treated. The GDP deflator treats terms of trade changes as price effects and, as a result, it corresponds to a volume index measured in products produced. The GDI deflator treats terms of trade changes as volume changes and leaves them in the real income measure. Consequently, it produces a volume index measured in terms of products that can be absorbed by the domestic community through expenditures.

1. Because Canada is a small open economy that trades extensively, terms of trade changes exert significant influence on Canadian's ability to transform their earnings into consumption and investment. During periods of rapid terms-of-trade change, growth in real GDI can outpace real GDP growth. International comparisons of real income growth based on real GDP will understate Canada's gains in real income when the terms of trade improve.

1. How large is the purchasing power of the Canadian economy relative to the American economy?

1. The purchasing power estimate varies depending on the year in question. During the 1960s Canada's purchasing power was near parity with the United States. During the 1970s and early 1980s, Canada's purchasing power declined. The late 1980s and 1990s saw little change in the PPP estimate, which settled in the 80%-to-85% range. During the resource boom after 2002, Canada's purchasing power increased, rising above 90% of the U.S. level by 2008.

1. Can PPPs be devised to compare productivity between countries?

1. Yes, but a set of PPP estimates that are suitable for comparing real GDI cannot be used to produce estimates of real GDP. Real GDP can be used to compare productivity between countries; however, national statistical systems are not set up to readily provide the necessary information for calculating a producing power estimate that is suitable for comparing GDP on an ongoing basis.

1. The traditional method for calculating real GDP-based PPPs requires detailed knowledge about export and import prices as well as domestic prices. It is differential movements in export and import prices that must be removed from aggregate nominal income to arrive at the real GDP measure. PPP estimates that assume the same deflator, like a market based exchange rate, for exports and imports apply the same deflator to both aggregates and do not account for terms of trade adjustments.

1. An alternative method using estimates of gross outputs and intermediate inputs can be used to calculate GDP-based PPPs. However, these estimates continue to suffer from a lack of reliable data sets containing coherent, comprehensive and comparable information across countries. As a result, they are less accurate than GDI-based PPPs.