Do NYPD has a larger budget than X military takes account for purchasing power parity? Like I know Russia’s military budget looks absurdly small until you normalize for PPP. The need to adjust for local price differences when making international comparisons of real GDP or standards of living is well recognised. Because relative prices differ across countries, a dollar spent on non-traded goods and services can go a lot further in some countries than in others. This is known as the Penn effect or the Balassa-Samuelson effect, and reflects the fact that the market exchange rate only arbitrages the price of traded goods, so international relative prices of non-traded goods can differ widely from the exchange rate.
The same applies to military spending. Soldiers in the Chinese People’s Liberation Army (PLA), for example, receive far lower salaries than the equivalent US personnel (The Economist 2021). Thus, the PLA’s salary budget, if converted to US dollars at the market exchange rate, would pay for far fewer US army personnel than what it actually pays for in China.2
In response to this, international comparisons of military spending are sometimes made using GDP-purchasing power parity (PPP) exchange rates. These, however, are designed to compare average prices, not military costs; they could overstate military spending since procurement doesn’t necessarily depend on local labour costs (Gilboy and Heginbotham 2012, Frankel 2014).
The alternative views and exchange rate concepts have long been a source of frustration for defence planners, particularly with the enormous variations they imply for China, which has been as much as 200% (Crane 2005).
In fact, neither GDP-PPP exchange rates nor market exchange rates provide the ‘correct’ ratio for converting spending across two countries into real values. The appropriate exchange rate is one that tells us the relative price or unit cost of defence services across countries – that is, a ‘military-PPP’ exchange rate.
The problem in constructing a military-PPP exchange rate is that output prices and quantities of defence services are unobservable and, perhaps unsurprisingly, few countries have shown much inclination to share the necessary input cost data. There is also a problem of substitution bias, which arises because countries will choose different combinations of inputs – such as personnel and equipment – because they have different relative prices.