8th May, 2014
China may already have supplanted the US as the world’s biggest economy, according to calculations based on updated World Bank measures of the purchasing power parity (PPP) values of GDP in almost 200 countries. Those who believe the world’s tectonics are shifting back to a structure that pre-dates the Industrial Revolution may claim that world history has finally come full circle. This would be an indelicate rush to judgement, however, and there is much more to the PPP view of the world than meets the eye.
From a statistical standpoint, the problem that gives rise to the use of PPP in estimating GDP is self-evident. In poorer countries, such as China, costs, including wages, prices, and therefore spending on non-traded goods and a full range of personal, business and government services are lower. Further, the market value of currencies, including the renminbi, is subject to numerous influences, including those from government policies, relative interest rates, currency speculation, and capital flows. Consequently, statisticians try to allow for these distortions and show purchasing power in China and its peers in a more flattering light.
Yet, although the economist’s view of relative economic size does tells us something important about living standards and, importantly, the locations and levels of poverty around the world, investors and mere mortals should view the comparisons with considerable caution. A technical reason is simply that not everyone has the reputation for data reliability as, say, the OECD, which is one of the many agencies that come under the World Bank’s PPP statistics umbrella. not least because of concerns about data reliability and comparability. The key problems, however, are more substantive. The quality of many goods and services sold in China and in the US, for example, varies significantly. The consumption baskets of Chinese and US households are dissimilar. The construction of GDP data in China and the US is quite different. Food, for example, accounts for about a third of Chinese consumption, whereas housing accounts for a similar proportion in the US. In China’s investment-dominated economy, rapid capital formation has boosted GDP substantially but with significant hidden and unattributed costs in the form of bad debts, and also environmental degradation. Bad debts, for example, are now starting to become part of a consensus view about the broad-based deterioration in the Chinese property market, which I have called the most important sector in the world, and which I think will live up to this billing in the next year or so.
Bad debts will have to be accounted for one way or another, but they are better absorbed and discounted in societies, such as the US, where recognised accounting practices, default and write-off mechanisms, and the rule of law are institutionalised and respected.
In time, therefore, the upgrade to China’s PPP could well be adjusted down again. This is precisely what happened in 2005, when the World Bank-sponsored PPP exercise lowered China’s share of world output from 15.8% to 10.9%. For now though, the just published 2011 version has reversed this, and China is now or soon will be the world’s largest economy. Nevertheless, we should not attach too much significance to the new PPP ‘Weltanschauung’ for two macroeconomic reasons that diminish the significance of size, per se.
First, with a population four times that of the US, China should be able to produce GDP that rivals or surpasses the US. The surprise is that it has only happened quite recently, given that China dropped off the global radar screen a long time ago with a population that was historically 8-10 times that of the US. This serves as a reminder that size isn’t everything and emphasises a context in which the causes of economic development and China’s political economy figure prominently. And they certainly cannot be extrapolated as though on a spreadsheet.
Second, if the new PPP estimates are viable and accurate, China, and many of its emerging country peers, have climbed up the ranks of middle income countries much further than we thought. China’s new PPP income per head is over $10,000, compared with $4000 in 2005, and $5,400 when measured at today’s market exchange rates. The average Chinese person’s income is still only 20% of what it is in the US, even though in some tier 1 cities, such as Beijing and Shanghai, income per head is probably the equivalent of people in Portugal. Curiously though, China’s rapid progress up the upper middle income ladder has brought it close to the threshold, estimated in today’s money at around $12,000-14,000, where most emerging and developing countries have become trapped. This highlights the importance for China to pursue economic rebalancing and reform but in the context of what seem impossible political reforms that should seek to build robust legal, social and economic institutions that transcend the interests of the Party and State.
In one sense, though, size may matter. Geopolitically, it could embolden a sometimes reluctant, but sometimes truculent China in the conduct of international relations in Asia and vis-a-vis the US. It could encourage China to flex its muscles in seeking changes in international institutions, regional trade arrangements, and in global currency and capital markets. It does seem odd, though, that China reportedly tried to distance itself from the new PPP data for fear of possible tension with the US, and of being expected to play a more responsible global role. A confident China wouldn’t balk at that prospect. A China that lacked confidence might use its weight in less predictable ways.