Space-Time (In)Consistency in the National Accounts: Causes and Cures

In early 2014 the World Bank published the main findings of the 2011 International Comparison Program (ICP). The result was surprising: the world is apparently richer and more equal than we would have expected based on extrapolating from the earlier, 2005 ICP. This is an example of what I call space-time inconsistency in the national accounts. Though the 2011 findings drew attention to this problem, it is certainly present in earlier rounds of the ICP, for example in comparing the 1980 with the 2005 ICP. In this paper I show that the national accounts are in principle space-time consistent if the consumer's utility function (or the revenue (GDP) function) is homothetic and if Divisia price indices are used to deflate nominal GDP or consumption, both over time and across countries. It follows that any observed inconsistency must be due to either (a) non-homotheticity in consumption (or production); (b) approximation error when discrete chain indices are used instead of continuous Divisia indices; or (c) errors in domestic price indices and PPPs. I develop indicators of the size of non-homotheticity and chain index approximation error using detailed, unpublished data from the 2005 ICP. I conclude that errors in price indices are most likely the major cause of inconsistency.