How Do You Measure the Size of the Economy?

In a discussion about the U.S. budget deficit I made the remark that "even if the U.S. federal government took the entire collected taxes of the country of Canada, the 9th largest economy of the world, the budget still wouldn’t be balanced."

To which a reader named Justin remarked "I believe the 9th largest economy in the world is now Spain."

That brings up some interesting questions - How do we know which country has the bigger economy? How do we measure the size of the economy?

Typically there's a couple different ways to do it.

One is through nominal Gross Domestic Product (GDP). The Economics Glossary defines GDP as:

GDP is Gross domestic product. For a region, the GDP is "the market value of all the goods and services producted by labor and property located in" the region, usually a country. It equals GNP minus the net inflow of labor and property incomes from abroad.

A key example helps. A Japanese-owned automobile factory in the US counts in US GDP but in Japanese GNP.

The nominal indicates that the GDP is converted into a base currency (typically the U.S. Dollar or Euros) at market exchange rates. So you calculate the value of everything produced in that country at the prices prevailing in that country, then you convert that into U.S. Dollars at market exchange rates.

Currently, according to that definition Canada has the 8th largest economy in the world and Spain is 9th. So Justin is correct!

The other way of calculating GDP is taking into account differences between countries due to purchasing power parity. Wikipedia explains:

There are three lists of countries of the world sorted by their gross domestic product (GDP), the value of all final goods and services produced within a nation in a given year. GDP dollar estimates here are derived from purchasing power parity (PPP) calculations. Using a PPP basis is arguably more useful because it takes into account the relative cost of living, and inflation rates between countries, rather than just using exchange rates, which have the potential to distort the real differences in income.

There are a few different agencies who calculate GDP (PPP) for each country, such as the IMF and the World Bank. In the three listings shown on Wikipedia, Canada ranks 11th, 12th, and 11th, while Spain ranks 12th, 11th, and 13th. The disparity is likely to due to small differences in methodology.

I hope this clears up the confusion. So Canada is anywhere from the 8th to the 12th largest economy in the world, depending on who is doing the calculation!