Why Purchasing Power Parity exchange rates are important for measuring Iran’s economic growth accurately
In this post I explain the logic of the Purchasing Power Parity (PPP) exchange rates (also known as the PPP conversion factors) that economists use to measure an economy’s total production. I also show why PPPs are especially important for measuring changes in the living stands of Iranians in recent decades. In this post I will repeat some of the discussion in a previous post, while adding more intuition and detail. Given the frequency with which misleading analyses of Iran’s economic performance and living standards appear in the popular and professional press, this will probably not be my last discussion of the subject.
Economists who study economic growth use PPP exchange rates to compare GDP and living standards across countries and over time (see this World Bank document for explanation of different PPP versions). Hence the preponderance of PPP-based studies in the empirical growth and poverty literatures. To correct for different valuations of products in different countries, PPP’s use a single set of prices (that of the US) to measure output in different countries. Because most goods are not traded globally and therefore command different prices across the globe, the usual, non-PPP values can mislead, and often undervalue production in poor countries. For example, services, like haircuts and medical services, which are not tradable, are often cheaper in poor countries. Before PPP’s, GDP values in local currencies were divided by the market exchange rate.
Another difficulty that PPPs overcome is that exchange rates are sometimes not unique and large gaps exist between the the official and the free market rates, as is the case in Iran. Which one to use produces a conundrum that is sometimes resolved by the analyst’s bias. To make a strong point about how bad the economic situation is use the free market rate; to make the opposite point, use the official rate.
In Iran, because of huge energy subsidies, the gap between PPP and market rates is much wider than is usual for developing countries. According to the World Bank, in 2022 the PPP rate was 62,870 rials vs. the free market rate of 500,000 rials, differing by a factor of about 8. Clearly, Iranian living standards appear a lot less dire using PPPs. For example, the purchasing power of wages in Iran appear more dismal when we divide the current daily unskilled wage of about 4,000,000 rials by the free market rate of 500,000, yielding $8 per day or $1 per hour, one of the lowest wages on the planet. But, in reality, considering Iranian prices, this daily wage can buy 8 times more than a dollar in the US — more loaves of bread, gallons of gasoline, doctor visits, etc. If instead we divide the rial wage by the PPP rate, we get 4,000,000/62,870=$64 per day, which is only one-third of the US unskilled wage of about $200 (for more PPP based comparisons of wage see ILO’s global wage report, 2020-2021).
Advocating the use of PPPs is not to make Iran’s economy look better, though it does, and those who insist on not using them often have a political agenda. Everyone should strive for a more realistic picture of Iran’s economy if only to predict political outcomes, like the impact of sanctions, better.
PPP calculations by the International Comparison Project at the World Bank or the Penn World Tables use an extended list of commodities, all products in the case of the GDP PPP conversion factor and those in the consumption basket for the private consumption PPP rate. I do not know the level of aggregation they use but certainly much more that I have in the Table below, which is intended to provide the intuition behind the World Bank PPP rate of 62,870 rials per USD for 2022.
The numbers in the first two columns are from the Statistical Center of Iran’s monthly average prices for October 2023, and the US prices are from my neighborhood grocery store and the internet.
| Item | Rials per unit | Unit | Average US price $ | Implied PPP rials per USD |
| imported rice | 577,370 | kg | 2.2 | 262,441 |
| Lamb | 4,682,846 | kg | 17.6 | 266,071 |
| Veal | 4,912,345 | kg | 17.6 | 279,111 |
| Chicken | 822,184 | kg | 4.4 | 186,860 |
| Trout | 1,914,056 | kg | 15.4 | 124,289 |
| Milk | 309,340 | liter | 1.0 | 309,340 |
| Yogurt | 420,404 | kg | 3.3 | 127,395 |
| Eggs | 637,882 | kg | 11.0 | 57,989 |
| Butter | 298,914 | 100 grams | 1.4 | 209,031 |
| Pomegranate | 373,744 | kg | 13.2 | 28,314 |
| Banana | 683,627 | kg | 5.5 | 124,296 |
| Apple | 372,285 | kg | 4.4 | 84,610 |
| Orange | 377,974 | kg | 4.4 | 85,903 |
| Walnut | 4,609,932 | kg | 35.2 | 130,964 |
| Pistachios | 7,972,147 | kg | 22.0 | 362,370 |
| Gasoline | 30,000 | liter | 0.9 | 33,333 |
| Natural gas | 1,000 | m3 | 0.1 | 10,000 |
| Men’s haircut | 2,000,000 | each | 20.0 | 100,000 |
Note. The price of natural gas and gasoline in Iran varies significantly. Specifically, it can differ by a factor of 10 between the lowest and highest users. The price in the table is for the average consumer.
These implied PPP rates in the last column are calculated by dividing the price in Iran by the dollar price in the US. The comparison shows that, converted by the free market rate, all these items (except Pistachios) are much cheaper in Iran than in the US. Energy prices are 2-3% of their US counterparts. As a result, the implied PPPs are all below the free-market exchange rate of 500,000 rials, as would be their weighted average. The high value of the implied PPP rate for pistachios, only 3/4 of the free market exchange rate, is not surprising because it is one of Iran’s main exports. Red meat also has a high implied rate because it is not heavily subsidized (in 2022 food subsidies were substantially reduced). Were it not for the fact that it is imported at the subsidized exchange rate of 285,000 rials per USD, it might have reached the free market rate. Milk is another relatively expensive food item in the tables.
Neglecting the economics behind international comparisons can do more that underestimate Iran’s living standards, it also distorts how living standards have changed over time, especially from before the revolution, and results in very misleading comparisons, which I have pointed out before. The idea that Iran’s GDP per capita is some 40% below what it was before the revolution, as these comparisons claim, makes no sense in light of the fact that every other development indicator (literacy, life expectancy, access to clean water, electricity, and paved roads, you name it) has vastly improved. I am not aware of any other case in human history of such a deep disconnect between rising health and education outcomes and access to basic services and declining living standards as measured by GDP per capita.
This is because of the simple truth that it is not possible to improve these indicators without economic growth. And to see the growth in living standards you have to measure GDP in before and after with the same prices, as do PPPs. The argument that I sometimes hear that PPPs are not useful for comparison over times is contradicted by the abundance of growth studies that use Penn World Tables panel data to analyze economic growth.
PPP data also avoid making a simple mistake that attributes a drop in the value of the rial to a change in GDP. For example, last year when rial fell by 20% in the free market rate and for a short period reached above 600,000 rials, GDP did not decline and Iranians were not suddenly 20% poorer. In fact, survey data showed that their living standards actually increased.
In the same vein, PPP-based data offer a more accurate tracking of economic growth over longer periods, as the empirical growth literature which relies on the Penn World Tables attests. In the case of Iran, the use of PPP-based GDP values before and after the revolution is as important as in cross-country comparisons. This is because the relative prices and the consumption baskets of Iran today are very different from before the revolution, as if we are comparing two countries with different prices and production menus.
The most obvious difference is the consumption of natural gas, which was rare before the revolution but today is one of the highest in the world, 14th in the world in per capita terms and ahead of most European countries. But the rapid increase in consumption of natural gas in Iran hardly shows up in increase in GDP because of its very low price –one-fiftieth of the US. The contribution of natural gas to the GDP is 50 times larger when valued at US prices, as with PPP’s.
Similarly, the expansion of the natural gas network in the country — 36,000 km to 28 million homes — after the revolution, does not fully show up in the Iranian data. According to the Oil and Gas Journal, the cost of construction of gas pipeline over land is about $2 million per mile in the US. At this price, the cost of construction of 36,000 km (22,400 miles) of natural gas pipelines laid in Iran in the last 44 years would be about $44.8 billion, or $1 billion per year. Nothing close to this level of investment shows up in Iran’s GDP accounts for natural gas investment because of the much cheaper cost of construction. Doing the same to all construction activity would substantially increase the value added of the construction sector as a whole and reveal a more robust investment activity in Iran than is indicated by the usual GDP accounting.
To sum up, PPP data offer a better understanding of where Iran is today, its production capacity and the living standards of its citizens. Those who avoid using them in the service of furthering a political agenda, should know that bad economics never makes for good politics.
Tyranny of numbers 
Thanks for your post, as PPP $ to Rial is often mentioned without clarification.
Would you please explain why housing cost is not included in your Table and seemingly in PPP exchange rate calculations?
How would the PPP exhange rate differ after its inclusion?
Good question about housing costs. First, notice that my table used selective products for illustration. I was not computing the index. However, I think housing costs provide a challenge for PPP comparisons because it is very difficult to find the equivalent of a two bedroom apartment in, say, Manhattan, near the city’s museums and music halls with a two bedroom in north of Tehran (hedonic price indices issue). But for what it’s worth, such an apartment would sell for $4-5 million, which is far in excess of anything with a similar interior in Tehran. You will find the implied PPP exchange 1/3 to 1/5 of the free market rate. In other words, unlike pistachios, housing is much cheaper in Iran.
Thanks Dr Salehi for the post, further clarifying the application of PPP over time within the same country. Very interesting indeed.
1-I looked at Penn World table ver 10.1 and happy to see that Iran is not the only country which shows better economy if one correctly chooses to use the PPP series, and that the discrepancy to a large extend has to do with cheap access to energy (at least the below supports it):
Looking at countries with the highest per capita consumption of natural gas which produce gas themselves, one can see similar differences between rgdpe/pop (PPP series of real gdp per capita) and rgdpna /pop (constant currency series of real gdp per capita) to that of Iran, that is PPP series showing better economy momentum than constant series.
Qatar, Bahrain, Kuwait, Oman, Saudi Arabia, Iran, and Norway belong to this group. Saudi Arabia trends looks very similar to Iran, as if they had a revolution in 1981 and never recovered economically when only considering constant series. However, the PPP series shows that they re-achieved the 70s oil boom levels in 2008. Even a country like Norway would show a constant growth rate over the years in the constant series, but shows an upward deflection and accelerated growth after 1990s in the PPP series. This leads to that one would see a 20 years disagreement on what year Norway hit $30k gdp/capita threshold.
Others including Turkmenistan, Trinidad and Tobago, Brunei, Russia, the Netherland, Canada, Belarus, and Uzbekistan not so much, meaning the two series are not dramatically different and do not lead to contradictory conclusions. I understand some are post-Soviet, and hence do not have data in the same time frame as Iran and others, and some possibly are not dependent (affected) by oil/gas to the same extent or do not subsidize it like Russia, Netherland, or Canada (just guessing).
2-The database looks very rich, and includes much more than the overused constant gdp, and the gdp PPP series. For example, I was intrigued that the internal rate of return concept can be applied to a whole country. Introduction of such concepts and how applies to Iran would make fantastic future posts!
Great post Djavad, as always.
Do you believe that any measure of energy efficiency should be considered when contemplating well-being?
An apple is the same in Iran as it is in the US. However, a gallon of gas in Iran only covers, say 5 miles, while in the US, it covers 30 miles or more.
Thanks,
Hossein
Thank you for your question. In a way yes, but this is about including product quality differences, which is very hard to do. As a welfare measure GDP is off in many directions, one of them is the point you raise. At one level th problem is with the quality of Iran’s cars, not its gasoline, but one can think of it that yay. Given the vehicles, Iran’s gasoline dent take you far enough.