An Indirect Estimate of Lebanon’s Purchasing Power Parity Income in 2022

Source: World Bank

Lebanon has experienced a severe crisis in 2019 that saw its per-capita GDP or income fall by 58.22% between 2018 and 2022, to stand at 3,881 USD, driven mainly by a drastic fall in GDP of 61.44%. This has moved the country within the span of a couple of years from an upper middle-income country to a lower middle-income country.

But being a lower middle-income country means that Lebanon’s purchasing power parity (PPP) income should exceed its income based on market exchange rates. That is because PPP-based income reflects the income as valued by the same prices (law of one price) prevailing in the US since income is usually measured in USD exchange rates.

The best way to operationalize the meaning of PPP-based income is to differentiate between tradeable (goods) and non-tradeable output (services). The idea being that tradeables are priced the same in all countries (assuming the absence of trade barriers and after accounting for transportation costs); whereas non-tradeables differ among countries, as they are lower in low-income than in high-income ones[1]. This implies that the purchasing power of income in low-income countries will be higher than reported at market rates when valued at US prices

In the context of Lebanon, the market exchange rate depreciated by 2240.7% between October 2019 and December 2022, while the average price level rose by 1753.8% only. Though we expect the price of tradeables to rise by 2240.7%, however the price of non-tradeable must have increased by less, hence the lower increase in the average price level at 1753.8%. In fact, if we assume a weight of 0.25 for tradeable prices, which is equal to the share of goods in Lebanese GDP; and a weight of 0.75 for non-tradeable prices, which is equal to the share of services in Lebanese GDP; then the increase in the price of non-tradeables can be calculated to equal 1591.5%.

One way to capture this purchasing power advantage is to measure it as: (1 – the ratio of the non-tradeables price increase to the tradeables price increase) = (1 – 1591.5%/2240.7%) = (1 – 0.71) = 0.29 or 29%[2].

Therefore, the per-capita income in 2022 as measured by market exchange rates at 3,881 USD should be higher by 29% when measured by purchasing power parity. In other words, it should be 5,006.5 USD.

Though interesting, it is small comfort to the Lebanese that their purchasing power parity income is higher by 29% than otherwise. That is because they don’t actually feel it, and it is only relevant for international comparisons when applying the “law of one price”. What matters most to them is actually undertaking badly-needed reforms to jump-start growth so as to increase both purchasing power parity and market exchange rate incomes.

[1] A simple example, in this context, is that in USD terms the price of an I-phone in the US and Lebanon is more or less the same, but the price of a haircut is about twice as expensive in the US, if not more.

[2] The usual formula for the purchasing power parity conversion is: output in USD x (US price level/domestic price level).