Will China’s Economy Be #1 by Dec. 31? (And Does it Matter?)

A ChinaFile Conversation

On April 30, data released by the United Nations International Comparison Program showed China’s estimated 2011 purchasing power parity (PPP) exchange rate was twenty percent higher than was estimated in 2005. What does this mean? China's economy could become the largest in the world by the end of 2014, unseating the economy of the United States some five years ahead of earlier predictions by the International Monetary Fund. But does that matter?


There are two really fundamental challenges to coming to terms with China’s place in the global GDP rankings: ignorance and apathy. We don’t know, and we don’t care.

First our ignorance: GDP is really hard to measure. Just look at the huge revisions routinely made to GDP reports for the United States or the Eurozone, where statistical agencies have better resources, and face less political interference, than their Chinese counterparts. The measurement issues affecting China’s GDP reports are notorious: My favorite quip about them comes secondhand from Tom Orlik, Bloomberg’s China economist, who told me he once heard from a Chinese local government official that the government measures the economy using fiscal revenue instead of GDP because “GDP is opinion, fiscal revenue is fact.”

Ranking China’s GDP against that of other countries is messier still, since you have to pick an exchange rate to convert this sketchily-measured aggregate into U.S. dollars. The U.N. International Comparison Project’s estimate of the purchasing power parity (PPP) exchange rate is the product of admirable and interesting research, but is still just one of many estimates. The Conference Board, where I used to work, was projecting in 2010 that, using their best estimate of a PPP exchange rate, China would overtake the U.S. as the world’s largest economy in 2012.

Which takes us to the second challenge, our apathy. Say you prefer to use a market exchange rate to compare China's economy with that of the United States instead of messing around with PPP’s, which would make its economy around two thirds of the size of the economy of the United States. So what? China would still be superlative in many ways: the world’s largest producer and consumer of steel, the largest consumer of energy, the largest importer of soybeans, the largest emitter of greenhouse gases.

Regardless of whether China makes a smooth transition to domestically-oriented growth or makes a hard landing, its footprint is such that focusing on GDP, or growth, has become a distraction from more fundamental issues. Damien Ma and I collectively call these scarcity: insufficient natural resources to feed an investment- and energy-intensive economy; insufficient land to produce the food Chinese consumers demand; a shrinking labor supply that forces wages up, squeezes low-end manufacturers, and pushes the economy out of export-oriented industries. There is more insight to be gained from thinking about these issues, in our opinion, than in wondering whether China becomes the world’s largest economy today, five years from now, or five years ago.

Let me briefly piggyback on Bill's comments with a couple points.  First, in hindsight, perhaps we should have titled our book the more tongue-in-cheek "China as #1: So What?" That is to say, the obsession over headline GDP is neither here nor there, even though it will inevitably dominate headlines. That a country four times the size of the United States would, short of cataclysmic economic fallout, someday grow into the world's largest economy should not elicit a modicum of surprise—it's basically a matter of when, not if. But whether China is still a $9 trillion economy in market exchange rate terms or closer to $14 trillion in PPP terms doesn't say anything about how to think about today's Chinese political economy. Aggregate GDP, as Bill said, is but one indicator that reflects some sense of general welfare, but is far from sufficient as an indicator to examine where China stands economically, socially, and politically. China is big, has always been that way, but its size is both a blessing and a curse.

Second, China has had a tremendously successful record in adding GDP every year for as long as I can remember. But when I talk to Chinese interlocutors, policymakers, and others, nobody seems particularly concerned about growth in and of itself. No one is obsessing over GDP figures, except maybe certain bureaucrats in the National Bureau of Statistics. And even the government itself is trying to slowly extricate itself from recent decades of GDP fetish. I suspect many Chinese will see this news and retort that "yeah, well, per capita GDP we're still about 1/6 that the United States." This is one problem in looking at China, it can be both an enormous economy and an unbalanced country in terms of development. It's somewhat akin to the European Union—both Poland and Germany can exist at the same time.

Third, instead of worrying themselves over GDP, the Chinese, both the public and officialdom, are preoccupied over all sorts of other sociopolitical issues. From accessing healthcare and higher education to safe milk and clean water (even core values), these are the central challenges that the "world's biggest economy" now have to deal with, and to deal with them urgently. We referred to them collectively as various dimensions of scarcity—some are policy-induced, some are secular trends—that will determine how China actually develops, rather than whether it grows in GDP terms.

The funny thing is that when a country gets wealthier and heftier economically, a different set of problems tend to arise that require a different set of policies. Richer countries have to deal with the costs of the "gangbuster growth" era and the dramatic social changes that have accompanied that growth. The tricky thing for China is that it is both wealthy and poor simultaneously, and it is being asked to grow and clean up at the same time. Not an envious position to be in.

China as Number One? Using purchasing power parity (PPP) as a measure, the World Bank’s International Comparison Program says that by the end of 2014 China is going to surpass the United States as the largest economy.

When the Bank formally adopted the PPP methodology back in the early 1990s and thus elevated China’s ranking, there were two general strands of reactions in the Chinese media. One was that this represented Western recognition of China’s real bargaining power, against the backdrop of sanctions imposed in response to China’s handling of domestic instability in the summer of 1989. The other was that the new ranking might as well be a Western propaganda ploy to trick China and the Chinese people to be less hard-working and, by extension, China should instead double its efforts to grow its economy.

China’s leaders, throughout the 1990s, constantly championed the notion that China needed the rest of the world to continue to develop and, by the same token, the rest of the world needed China just as much. Translated into policy, China worked to join the World Trade Organization, applied, twice, to host the Olympics Games, and constantly used ‘linking up with the international track’ as a domestic slogan to drive home the necessity of reform.

Then, in 2010, China was pronounced to have passed Japan as the second largest world economy, measured in GDP. The Chinese media and society took the new ranking in greater strides. It was just another day. As a matter of fact, by then, millions more ordinary Chinese are traveling to the United States, Europe, Japan, as well as the rest of the world. Aggregate numbers hardly passed the test of the human eye: gaps in standards of living are only too visible to ignore.

This time around, it is more likely for the Chinese society to react to the new ranking by the World Bank as just another announcement. After all, just the choking smog that routinely blankets a third of the landmass of China is powerful enough to remind ourselves that China is still way behind in terms of the quality of daily life.

Some pundits, both Chinese and foreign, may begin to connect the new ranking with China’s status, role, and responsibility in the global and regional economic and political systems. But, it is hard to see those articulations resonate with choices on the ground. In this sense, China—both its government and people—has indeed matured.

This does not and indeed should not imply that the time has come for China to disembark itself from the international track. As Chinese government leaders like to repeat these days, reform has to be an agenda in a continuous tense, not the past perfect. For the reform agenda to be effectual, China just has to continue to internationalize.

I agree with Bill and Damien that this is a "who cares?" moment. It has been obvious for quite some time that China would soon overtake the U.S. in sheer economic size. If one doesn't accept the current PPP conversion rate then just wait five or ten years and China will be bigger at market exchange rates. But basically, all that this shift tells us is that China has way more people than the U.S.— 4.2 times as many, to be exact. So, as soon as China stopped being fantastically poorer (per capita) than the U.S., and became simply a lot poorer, its total economy surpassed that of the U.S. (And still lags that of the European Union, which is arguably the world's biggest economy, if one takes economic integration rather than political boundaries as the criterion.) Big deal.

Staying in the league-tables discussion for a moment, there are two major economic dimensions in which China still lags the U.S., Europe and Japan. The first is living standards. Even if we accept the current PPP measurement, per capita GDP in China is only 1/4 that in the U.S., and the gap in average living standards is even greater, because in the US about 2/3 of GDP consists of household consumption whereas in China that figure is barely over 1/3. In other words, for a given amount of per-capita GDP (at market exchange rates), the average American household consumes twice as many goods and services as its Chinese counterpart. China has recorded a lot of economic growth by installing a huge amount of capital equipment, the fruits of which accrue mainly to the small number of capital-owners—many of them foreign companies. It still has a lot to do in spreading the benefits of growth more broadly to its citizenry.

The second is what generally goes under the name of "innovation"—that is, the ability to create new sources of economic growth and vitality. Some headlines have declared that China is now the world's "top economic power." This is simply false. It is the biggest national economy by volume. But the center of technological change in the world is still the U.S., and arguably the United States' centrality in this role is even more pronounced now than it was ten or fifteen years ago. There is little evidence that China is anywhere close to becoming the engine-room of the global economy.

But fundamentally Damien is right that this "who's on top?" discussion misses all that is truly interesting, namely how China and other countries manage social tensions, income distribution and other problems arising from high speed economic growth. Because of its sheer bulk, China is indeed wealthy and poor at the same time, and the responses to that paradox are a far more fascinating target of study than the mere size of the economy.

I agree with the group, but would go farther. The International Comparison Program has gone off the rails. It doesn’t make sense to compare two countries’ PPP-adjusted GDP and say one is larger. Not for any countries at any time.

PPP is intended to better understand personal income. Annual income of $500 in Bangladesh is horrifying low but buys more than $500 in Australia. First, we must compare buying power across all of Bangladesh and Australia, then adjust for vastly different goods and services available—not easy. And it’s harder for larger countries. There’s an average price between New York and Louisiana we can compare to the average between Shanghai and Tibet? Strains belief.

Unfortunately, there’s a bigger problem. PPP is about purchasing power, not economic size. That comparable goods and services are cheaper in Bangladesh than Australia doesn’t mean Bangladesh’s economy suddenly got much bigger. The claim China will soon be #1 cites GDP, which combines personal and government consumption, investment, and trade. PPP struggles with personal consumption. To apply it to all of GDP is a bridge too far.

An illustration. China has grown faster than the U.S. for decades; what’s unclear is the remaining gap. There’s a $2 trillion gap in PPP-adjusted GDP in 2011 and a $7 trillion gap in standard GDP in 2013. There’s also a $35 trillion gap.

Not a typo. GDP measures what happened in an economy, not how big it is. GDP resets to zero each year. But economies don’t reset to zero - the stuff is still there. It’s there even if we hide it under a mattress and it’s omitted from GDP. The right measure of economic size is national wealth – what we have, not calendar year transactions.

Credit Suisse estimates global private wealth. At mid-2013, it has Chinese private wealth at $22 trillion and American at $72 trillion. Private wealth isn’t everything. But you can’t pass a country in economic size with $50 trillion less private wealth.

As a check, the Federal Reserve estimates U.S. private wealth at $80 trillion at the end of 2013. Net public debt cuts American wealth to $65-70 trillion. China’s government owns a great deal through state enterprises but those firms also owe a great deal. The net wealth of the Chinese state on top of the wealth of the Chinese people is uncertain, but $10 trillion appears generous.

This puts China between $30 and $35 trillion, about $35 trillion behind the US. The gap has not closed in the past three years, as the US emerged from the crisis and Chinese firms borrowed heavily. Plainly, China won’t catch up soon. It may not catch up at all.

I just want to add a wrinkle to this excellent discussion: While it is indisputably true that, from a purely economic perspective, the “Chinese GDP (PPP) to surpass U.S.” story is meaningless, it does not necessarily follow that it is equally meaningless in a political or social sense. As Professor Zha has already alluded to in his comment, there are plenty of people, both Chinese and foreign, who will trumpet this story for a variety of purposes. To me, at least, it is not clear that they will make no real difference.

For starters, the psychological impact of being “No. 1 in GDP” could be quite significant in certain Chinese intellectual and political circles. The idea that China has finally “bested” the U.S. in “national power” will very likely resonate with a deep and centuries-long national obsession—among both elites and the general populace—with measures of aggregate wealth and military power. One can, for example, easily see it fanning the flames of the increasingly vocal and influential Neo-Leftist movement, which draws much of its popular support from various strands of aggressive and often virulent nationalism. Whether these psychological effects will have any material influence on political activity, particularly in the realm of foreign policy (where, lest we forget, aggregate “national power” is actually a meaningful concept), is at least an open question. There is sufficient ideological uncertainty and conflict among China’s intellectual and political elite these days that this sort of substantively vapid but symbolically powerful “news” could nonetheless generate major waves.

In addition, this story will almost certainly provide fresh fodder for the “China as a rising threat” geopolitical narratives that seem to sell so well in the mainstream American media, and perhaps in Washington as well. The sensationalist tone of The Economist article itself is arguably an example of this. If one takes a particularly cynical view of American democracy, the general public, ill-informed and short-sighted, often seems particularly susceptible to waves of paranoia about the “rise” of foreign competitors (Japan in the 1970s and 80s, and now China), and such paranoia often translates into concrete legislation and policy via demagogic politics. Reality may not be quite so dismal, but it is hard to deny that there is at least some kernel of truth to such cynicism—in which case the social and political impact of this “news item” in the U.S. may well be completely disproportionate to its actual economic significance.

The previous commentators are basically unanimous in their belief that economically meaningless “milestones” will be psychologically dismissed by both policymakers and the general population. Were people only so rational.