It’s possibly about time that we introduced The Guardian to the concept of exchange rates. To the little wrinkles and bits and bobs of exchange rates perhaps. For they’re claiming that the economy of California is larger than that of the UK. Which is might well be of course, it’s a notably richer place than most of the UK. Something that comes from the US being a more capitalist economy perhaps.
However, it’s not really quite like they think it is:
California’s economy has surpassed that of the United Kingdom to become the world’s fifth largest, according to new federal data made public on Friday.
Despite having a population of only 40 million compared with the UK’s 65 million people, California’s gross domestic product of $2.7tn has overtaken the UK’s $2.6tn.
The so-called Golden State’s GDP rose by $127bn in the period from 2016 to 2017, while the UK’s economic output fell slightly over that time when measured in US dollars, due in part to exchange rate fluctuations. British GDP has fallen steadily from $3tn in 2014, according to World Bank figures.
That due partly to exchange rate fluctuations, hmm. Putting “sterling dollar exchange rate” into the box of our favourite monopolist I get a little chart telling me that it was about $1.60 in 2014 (obviously, variations within the year) and about 1.35 now. So, a 15% decline in the exchange rate then.
$3 trillion to $2.6 trillion is a 13 % fall in GDP. We are measuring in USD recall, so we’ve found that the exchange rate difference more than covers the change in size of UK GDP.
It’s not “due in part” it’s “more than entirely due to” which is rather a different statement, isn’t it?
All of which is why we don’t use market exchange rates in the manner that The Guardian just has done. Instead we use purchasing power parity adjusted ones when we desire to compare across economies in this way. Sure, market prices are, by definition, always the correct prices. But we’re also aware that they can wander away from what we’re really trying to measure here, the value of production (or consumption, or incomes) in two different places. In the long term they’ll converge on PPP rates. And it’s also PPP rates which determine the incomes or consumption of the people, the thing we’re trying to measure.
The £/$ PPP rate is 0.70 or so, something which changes much less rapidly than market exchange rates. Or $1.43. So, the UK economy is now rather larger when expressed in the correct – for our purposes at least – exchange rate. Perhaps 5 or 6% larger, which usefully takes us past the size of California’s economy again.
But we should go one step further here as well. California’s part of a currency bloc, the $, and prices vary within that block too. PPP exchange rates are different in Mississippi than they are in California. Not that we do normally make these adjustments but we should do if we’re to be accurate. Our best guide to this being the variance in living costs – what a US$ is worth in each state.
$100 is worth, compared to the national price level, only $88 in California. It’s not entirely right to do this but it’s good enough, that means that the PPP exchange rate for California is 12% lower than that for the US as a whole. Or, the £/$ PPP exchange rate for GB/CA is 12% higher than that for GB/US.
Which is our final answer here. It’s not a perfect one, by any means. But when we try to compare what we want to compare, the sizes of the two economies using an exchange rate which measures the important thing – what’s the standard of living? – the UK economy is significantly larger than that of California. Of course, then we should get to per capita where CA wins. But that’s not what The Guardian was doing, is it?