12. What exchange rates do you use to convert military expenditure to US dollars? Do you provide figures based on Purchasing Power Parity (PPP) exchange rates?
SIPRI uses market exchange rates, or where applicable fixed official exchange rates, to convert local currency military expenditure data into US dollars (whether current or constant prices). Market exchange rates are determined by the supply and demand of currencies used in international transactions. However, the prices of many goods and services on domestic markets are determined in partial or complete isolation from the rest of the world. Therefore, the MERs do not always accurately reflect differences in price levels between countries. Fixed, official exchange rates may be even less reflective of the actual purchasing power of a currency within the country that uses it.
An alternative is to use purchasing power parity (PPP) conversion factors (or PPP exchange rates). The PPP dollar rate of a country's currency is defined by the World Bank as 'the number of units of a country's currency required to buy the same amount of goods and services in the domestic market as a U.S. dollar would buy in the United States'. The only PPP rates available for all countries are GDP- based basket of goods and services that are major components of the gross domestic product. Such GDP-based PPP rates are designed to control for differences in price levels and thus to provide a measure of the real purchasing power of the GDP of each country.
Using GDP-based PPP rates instead of MERs for currency conversion results in much higher output and expenditure figures for many developing and transition countries since they have relatively low prices for non-traded goods and services—thus giving the currency higher purchasing power. A unit of local currency therefore has greater purchasing power within a developing country (which is better reflected by using PPP rates) than it has internationally (which is what is reflected by using MERs). For those such developing and transition countries for whom data was available for 2014, the median increase in military expenditure figures from using PPP rates instead of MERs was by a factor of 2.13. Three-quarters of these countries would see their relative figures increase by at least 79 per cent. However, for most of the 'developed' countries in Western Europe, Canada, Australia, New Zealand and Japan, the use of PPP rates on GDP and military expenditure figures leads to a fall in these totals relative to the USA, by a median amount of 9 per cent. For countries in Central Europe and East Asia that have more recently entered the ranks of rich nations, the picture is somewhere in between. However, the reliability of such PPP rates is lower than for MERs, since PPP rates are statistical estimates, calculated on the basis of collected price data for a basket of goods and services for benchmark years. Between benchmark years, the PPP rates are extrapolated forward using ratios of prices indexes, either GDP deflators or consumer price indexes. Like all statistical estimates they are subject to a margin of error.
Furthermore, GDP-based PPP rates are of limited relevance for the conversion of military expenditure data into US dollars. Such PPP rates are designed to reflect the purchasing power for goods and services that are representative of spending patterns in each country, that is, primarily for civilian goods and services. Military expenditure is used to purchase a number of goods and services that are not typical of national consumption patterns. For example, the price of conscripts can be assumed to be lower than the price of a typical basket of goods and services, while the prices of advanced weapon systems and of their maintenance and repair services can be assumed to be much higher. The extent to which this data reflects the amount of military goods and services that the military budget can buy is not known. Due to these uncertainties, SIPRI uses market exchange rates to convert military expenditure data into US dollars, despite their limitations.
