Why China doesn't want the biggest economy in the world - just yet
June 02, 2014 00:00
By Suwatchai Songwanich
China's GDP is about to catch up with the US economy in terms of purchasing power parity (PPP) according to a study by the ICP (International Comparison Programme) under the auspices of the World Bank. However this is disputed by China, which did not part
The report estimates that China’s gross domestic product, or GDP, will reach $17.9 trillion by the end of 2014 compared with $17.5 trillion for the US. This contrasts with an assessment by the IMF that puts current US GDP at $17.5 trillion and China’s at $10 trillion.
So which is right? The key difference is that the ICP measures GDP using PPP rather than market exchange rates. This is on the basis that currencies are volatile and not a reliable indicator of the cost of living in a country.
One illustration of PPP theory is the cost of a Big Mac. If the price of a Big Mac is $4.62 in the US but only $2.74 in China, there would be a differential of 41 per cent, implying perhaps an imbalance in exchange rates. The use of PPP is an attempt to iron out such differences and compare growth without price distortions.
Beijing’s official response to the ICP report was to express reservations about the methodology and to say it did not endorse the results as official statistics.
While this may seem surprising, there are a number of theories why China reacted this way. The Financial Times said it is because China does not want the responsibility of being the world’s biggest economy.
Moody’s Thomas Byrne said PPP-based GDP is simply a measure of welfare and living standards. It should not be taken as a measure of economic growth. He says the best and most reliable comparative measure of GDP between countries is expressed in USD. Using this measure it will take 10 years for China to catch up to the US if it grows at 7 percent a year and the US grows at 2 per cent.
Economics professor and Beijing-based blogger Michael Pettis also points out that there are many differences in the way GDP is calculated in China and the US and there is a strong chance that China’s GDP has been over-estimated. For example he says the US has the largest services, manufacturing and agricultural sectors in the world and this would be unlikely if its economy was smaller than China’s.
Another plausible reason why China may not want to accept the claim that it is poised to become the country with the biggest economy in the world is that this might imply that the yuan is under-valued – and the Chinese government would certainly not want that!
Given such issues, what is the value of the ICP report? In my view, it is a remarkable confirmation of the tremendous advances China has made. Chinese people are much better off than they were even a few years ago, and China now ranks among the world’s top six economies measured by GDP per capita using PPP. (The others are Qatar, Macau SAR, Luxembourg, Kuwait and Brunei). It is also one of the top five economies in the world in terms of individual consumption per capita (again on a PPP basis) – the others are Bermuda, US, Cayman Islands, Hong Kong SAR and Luxembourg.
China is also the country with by far the largest share of global investment, at 27 per cent, followed by the United States at 13 per cent. This investment will provide China with a huge advantage in the future as it will help it to build up a leadership position in many areas. By way of comparison, India, Japan and Indonesia have global investment shares of 7 per cent, 4 per cent and 3 per cent respectively.
While all the evidence suggests that China is not yet the biggest economy in the world, that will certainly change in the future.
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