PART I
Special Chapter
Comparing Poverty Across Countries: The Role of Purchasing Power Parities
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Introduction
The demand for internationally comparable estimates of poverty is considerable. For a variety of purposes, policy analysts, researchers, and international donor agencies often want to be able to compare the incidence of poverty across countries. These international comparisons can be carried out globally, regionally, or even across two countries.
How does one make such international comparisons? The basic ingredient in measuring poverty at the country level consists of nationally representative data on household expenditures (or incomes). At a minimum, such data provide us with information on the consumption expenditures incurred by households along with demographic information on the households themselves, including household size and composition. Given a poverty line – i.e., a monetary value that represents some predetermined threshold standard of living – it becomes a straightforward matter to determine the percentage of the population that survives on less than the poverty line and is, therefore, rated “poor.” Repeating this exercise in other countries would allow us to compare poverty incidence across countries.
But what poverty line does one use? Is it possible to use national poverty lines for international comparisons of poverty? The measurement of poverty using nationally established poverty lines is by now a common practice in virtually all developing Asia. These national poverty lines, and the estimates of poverty based on them, have a quasi-official status in many countries, having been either developed or endorsed by the government.
However, the poverty estimates based on these national poverty lines do not provide a good basis for comparing poverty across countries. While there is a common thread in the methodology used in determining national poverty lines across countries – poverty lines are generally made up of food and nonfood expenditure components, with the food component essentially determined by a specific energy requirement – there can be large differences in the standard of living represented by the national poverty line of different countries.1, 2 For obtaining comparable estimates of poverty, a common standard of living must be used to differentiate between the poor and nonpoor across all countries. In other words, in so far as international poverty comparisons are concerned, the poverty line chosen must represent a threshold standard of living that is constant across the countries whose poverty is to be compared.
The key question then becomes one of how such a standard of living should be defined. While there are alternative approaches, by far the most widely used is the United States (US) “$1-a-day” poverty line introduced in the World Bank’s World Development Report 1990: Poverty (World Bank 1990) and developed by Ravallion, Datt, and van de Walle (1991).3 Comparing national poverty lines for a sample of 33 countries, Ravallion and his coauthors found the $1-a-day poverty line to be “representative” of national poverty lines among low-income countries and proposed it as a common benchmark against which internationally comparable estimates of poverty could be obtained.4
Purchasing power parities (PPPs) have a crucial role to play in the construction of the $1-a-day poverty line and the estimation of $1-a-day poverty rates. For example, the conversion of the 33 national poverty lines from local currencies to the dollar – an essential step in choosing $1 a day as representative of the poverty lines of low-income countries – was not based on market exchange rates. Neither is the $1-a-day poverty line converted into local currency units (LCUs) – the step that needs to be taken for estimating $1-a-day poverty in each country – based on market exchange rates. Instead, the conversion of the 33 national poverty lines into the dollar, as well as the conversion of the $1-a-day poverty line into LCUs, is based on PPPs.
While a more rigorous definition is provided in Section 2.1 of this chapter, PPPs can be thought of as conversion factors that ensure a common purchasing power over a given set of goods and services. For example, based on market exchange rates, it took in 2005 an average of Rs44.10 to obtain $1. But this does not mean that $1 had the same purchasing power in the US as Rs44.10 did in India that year. In fact, as we will see in Section 2.1 (Table 2.1), the results of the 2005 round of the International Comparison Program (ICP) – a global statistical project that has been producing PPPs since 1970 – found that $1 had the same purchasing power as Rs15.60 for the goods and services that make up household consumption (World Bank 2008). It should be obvious that converting $1 either into Rs15.60 or into Rs44.10 will have a huge bearing on the resulting estimates of $1-a-day poverty in India.
In fact, even much smaller differences in the rates at which local currencies and the dollar are converted can have a large impact on estimates of poverty. Continuing with the example of India, a PPP of Rs13.55 – a value that is generated on the basis of steps described in Section 4 – rather than Rs15.60, would lead to a poverty rate (or headcount index) of 32.8% as compared to 44.3% if the poverty line were exactly equal to $1 (per person per day).5, 6
This difference in poverty rates – driven entirely by differences in PPPs – is quite large and should serve to illustrate the point that the value of PPPs can make a considerable difference in the estimates of poverty for any given international poverty line. Put another way, it is important to get the value of PPPs right. Indeed, as will be seen in Section 2.3, a good part of the criticism of the poverty estimates obtained from the $1-a-day poverty line can be viewed as criticism of the PPPs used both in its construction and in its conversion into LCUs for poverty estimation.7
Unfortunately, compiling PPPs is by no means an easy task. PPPs are defined in terms of a given set of goods and services. The Economist’s Big Mac index, for example, is a PPP based on only one good, the Big Mac hamburger, and the index is computed by comparing the price of a Big Mac across countries. In contrast, the PPPs compiled in the various rounds of the ICP have been based on a comparison of prices of hundreds of goods and services across countries. The purpose of these PPPs is to enable a comparison of gross domestic product (GDP) levels and the various major national accounts aggregates across countries, such as household final consumption expenditures, government consumption, and gross fixed capital formation.
The $1-a-day poverty line is based on the PPPs for household final consumption (or consumption PPPs for short).8 It is not clear, however, that consumption PPPs are the appropriate PPPs for comparing poverty levels across countries. Consumption PPPs are currency conversions that capture the purchasing power of currencies vis-à-vis the goods and services that make up the household final consumption aggregate of the national accounts. Even though this consumption aggregate pertains to the consumption of households, its PPPs may be inappropriate for poverty comparisons if poor households’ consumption patterns are significantly different from those of the general population.
More specifically, the consumption patterns of poor households may be different from those of the general population in two ways. First, poor households may consume different types of products than the general population, which will reflect differences in quality to some extent. For example, while both the poor and nonpoor may consume rice, the former may consume a lower-quality variety than the latter. Alternatively, there will be products that are only consumed by one group or the other. For example, it is virtually inconceivable to expect the poor to purchase automobiles. A further twist can appear if the prices paid by the poor versus the nonpoor differ in some systematic manner. In particular, to the extent that the poor and nonpoor purchase items in different quantities and/or at different types of retail outlets, one can expect the prices paid by the two groups to differ. For many products, the unit price can be expected to decline as purchase quantities increase. Since the poor are less likely to be able to afford large purchase quantities, they may end up paying more per unit of the product purchased. Conversely, if the poor frequent fresh-produce markets as opposed to modern supermarkets – where the retail prices may well incorporate the costs of air conditioning, parking space for cars, and other amenities for shoppers – more often than the nonpoor, they may end up paying less.
Second, even if both groups consume the same products, or even products that are similar in quality, they are likely to spend very different proportions of their total expenditures on these products. Thus for example, even if the poor and the nonpoor purchase and consume the same variety of rice, the former can be expected to spend a larger proportion of their total expenditures on rice than the latter.
In a nutshell, the practice of using consumption PPPs for international comparisons of poverty implies that the PPPs are derived via a list of products and associated prices that may not be representative of products consumed by the poor and the prices paid by them. Additionally, the consumption PPPs are derived using expenditure weights, or shares from the national accounts, i.e., they reflect the expenditure patterns of the general population and not necessarily the poor.
To what extent do these two factors affect the generation of international poverty lines and associated poverty rates? There can be no general presumption on this. Ultimately, the issue is an empirical one that can be answered only by comparing PPPs compiled using different approaches.
In this chapter, we shed light on how alternative approaches to compiling PPPs influence internationally comparable estimates of poverty. In doing so, we use not only the results of the 2005 ICP Asia Pacific, we also draw on the results of special “poverty-specific” price surveys in 16 countries (listed in Table 2.1). These surveys were executed for a research study on poverty-specific PPPs (ADB 2008a), or in other words, PPPs specially designed for poverty comparisons. In particular, we work with three sets of PPPs, each of which allows us to determine an international poverty line and generate comparable estimates of poverty across the 16 countries. The terminology used in this chapter for referring to the three sets of PPPs is described in Table 1.1, along with some other features.
Table 1.1 Forms of Purchasing Power Parities |
| Full Form |
Short Form |
Type of PPP |
Source of Prices |
Expenditure Patterns |
Household Final Consumption Purchasing Power Parities
|
Consumption PPPs |
Consumption |
2005 ICP Asia Pacific |
General Population |
| International Comparison Program Poverty Purchasing Power Parities |
ICP PPPs |
Poverty |
2005 ICP Asia Pacific |
Poor Population |
Poverty Survey Poverty Purchasing Power Parities
|
PS PPPs |
Poverty |
Poverty-specific price surveys |
Poor Population |
ICP = International Comparison Program; PPP = purchasing power parity; PS = poverty survey.
Source: Authors.
The first of these three PPPs (consumption PPPs) is essentially the familiar consumption PPP that has been used by World Bank researchers to date in generating the $1-a-day poverty line and the corresponding poverty rates. The second set of PPPs (ICP PPPs) is also based on prices collected for the 2005 ICP Asia Pacific – thus the underlying prices are the same as those used in constructing the consumption PPPs. However, they are derived in the way suggested by the Poverty Advisory Group (PAG), a group of experts brought together by the Global Office of the ICP at the World Bank; that is, they are derived using expenditure shares that reflect the expenditure patterns of the poor.
A final set of PPPs (PS PPPs) relies, like the second, on the expenditure patterns exhibited by the poor as suggested by the PAG; however, it uses prices collected by the poverty-specific price surveys carried out in the 16 participating countries. In contrast to the ICP survey of prices, the products priced by these surveys are those deemed by poverty analysts, price statisticians, and household expenditure survey statisticians from participating countries to be directly relevant to the poor. Moreover, these products have been priced in quantities in which the poor are likely to make their purchases, and at retail outlets that they are more likely to frequent.
Comparing the consumption PPPs with the two sets of “poverty” PPPs is revealing. The results show that incorporation of the expenditure shares of poor households, as opposed to expenditure shares of the general population, into PPP construction is typically not enough by itself to lead to significant changes from consumption PPPs. However, the use of prices from the poverty-specific surveys of prices can have large effects on PPPs. Correspondingly, the final estimates of poverty based on a given international poverty line can be quite different depending on the source of prices – ICP or a product bundle relevant to the poor. For example, with a poverty line of $1.35 per day, the total number of poor in 2005 across the 16 countries is estimated at 1,042 million if the $1.35 is converted to local currencies using consumption PPPs. If instead ICP PPPs are used for the conversion, this figure declines to 1,013 million. Yet a far larger decline in poverty is seen if PS PPPs are used to convert $1.35 to local currencies, with the number of poor estimated at 843 million. These findings on the sensitivity of PPPs and corresponding estimates of poverty are the main contribution of this chapter.
The rest of this chapter is organized as follows. Section 2 introduces PPPs and the role they play in generating comparable estimates of poverty across countries. Among other things, this section describes in more detail the potential drawbacks of using consumption PPPs for poverty comparisons. This sets the stage for Section 3, which discusses the methodology and key steps needed to generate PPPs that might be more appropriate for poverty comparisons. Such PPPs are called poverty PPPs. Section 4 presents estimates of poverty PPPs based on alternative approaches. Section 5 then describes the poverty estimates based on these PPPs using a poverty line representative of the national poverty lines of 13 of the 16 participating countries (i.e., including those countries whose poverty lines tend to be bunched together). As readers will note, this “Asian poverty line” is constructed in the spirit of the original $1-a-day poverty line developed by World Bank researchers. Section 6 uses these estimates of poverty to discuss various facets of poverty reduction. Section 7 offers some concluding remarks and directions for future research.
1 For a detailed description of methods used to set national poverty lines in different countries, see ADB (2004) and Kakwani (2003). See also the data appendix of Ravallion,Chen, and Sangraula (2008).
2 There are subtle differences in translation of caloric needs into monetary values. But much of the divergence in practices observed across countries is in the determination of the nonfood poverty line. There are also differences observed in the determination and/or in translating national poverty lines for subregions within a given country.
3 This poverty line was subsequently adopted by the United Nations system and by other bilateral and multilateral organizations. The $1-a-day poverty line is the main indicator for the first target of the first Millennium Development Goal.
4 These national poverty lines were not necessarily “official.” Indeed, many of them were estimates from independent researchers.
5 The PPP conversion factor of Rs13.55/$1 is obtained by multiplying the PPP conversion factor of Rs6.42/RM1 listed in Column 3 of Table 4.2 with the PPP conversion factor of RM2.11/$1 obtained from World Bank (2008).
6 These numbers are obtained using 2004/05 consumer expenditure survey data from India’s National Sample Survey Organisation.
7 The PPPs are not the only area of contention on global/international estimates of poverty. The very process by which a common poverty line has been developed has been attacked. For example, as noted above, the $1-a-day poverty line drawn up in 1990 was chosen as representative of the national poverty lines in low-income countries. Some analysts have described this procedure as arbitrary. While the issues raised by this strand of the literature are important, they are not the focus of this chapter, which is PPPs. Nevertheless, Section 2 describes a study by Kakwani (2007) which proposes an alternative approach to generating comparable poverty estimates across countries.
8 Prior to 2000, the $1-a-day poverty line was based on the 1985 consumption PPPs. Since 2000, the $1-a-day was updated to equal $1.08 per person per day at 1993 PPPs for consumption.
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