The year in which Britain’s economy was overtaken by the United States is a matter for debate. Last week most newspapers were picking 1872 as the watershed. If so, the British can’t claim to have been diverted by glorious goals at the first-ever international football match (England versus Scotland; it finished 0-0), although they might have grounds for blaming the weather (1872 was the wettest year on record for England and Wales).
More in keeping with the economic symbolism, 1872 was also a leap year. But by any token, the Americans were catching up with the British fast and would soon confirm their position as the leading economy.
This month the talk is about another significant moment, with China’s economy expected to overtake America’s this year. And the forecast is stirring debate, including why the Chinese aren’t too happy about grabbing top spot.
Why the fuss over the figures?
With $16 trillion in gross domestic product generated last year, the American economy was almost twice the size of China’s if measured by market exchange rates. But the International Comparison Programme (ICP) coordinated by the World Bank uses purchasing power parity (PPP) for its calculations. These put the Chinese much closer to the Americans, suggesting that China’s economy will surpass the US this year.
Purchasing power assessments acknowledge that prices aren’t the same in different countries. One of the favoured examples is the cost of a haircut. A trim in China is generally a lot cheaper than in America. But because Americans aren’t likely to head over to China to get one, there isn’t the pressure on market exchange rates to equalise the two prices.
At the end of April the ICP announced that it thinks that the renminbi goes further in buying many other goods or services, so purchasing power in China is larger than it previously thought. Before, the estimate was that the Chinese economy was less than half of America’s in PPP terms. Under the new assumptions it was $13.5 trillion in 2011, not far behind the US at $15.5 trillion. But because of faster growth over the last three years China should overtake its rival this year – and not in 2019 as was formerly assumed.
What was the international reaction?
Initially the headline writers took charge. “Catching the Eagle”, “Crowning the Dragon” and “China’s Century Starts Here” were florid examples.
But then the economic commentaries started to appear on the inside pages, countering the front-page fanfare. One warning – from Michael Pettis, a professor at Peking University’s Guanghua School of Management – was about the dangers of faulty comparison. Comparing the US with countries that generate their GDP in similar ways, like Canada, can be illuminating, he says. But matching the US with China is more troublesome because the composition of their GDPs is very different. Specifically Pettis points to how the Chinese have habitually rolled over bad debt rather than recognise fuller losses on investment. “If you really want to compare the two economies more usefully you would have to do at least two adjustments: you would have to adjust China’s GDP upwards for price differentials and also adjust it downwards for unrecorded losses,” he suggests.
The ICP report admits that there can be problems using purchasing power to compare developed economies with developing ones. Its surveys typically incorporate a margin of error of 15%. But there is also the accuracy of the basic calculations to consider, especially because of scepticism about China’s GDP data. Some believe the estimates are too low because so much Chinese economic activity is going on in grey areas and is unrecorded. Others claim the opposite – that the numbers are overstated – because GDP scores are pumped up by senior officials wanting promotion. Both trends mean that Premier Li Keqiang is said to have looked first at three other indicators – electricity consumption, rail cargo volume and bank lending – when he wanted a read on the economy during his time as a provincial Party chief. And since taking more senior office, Li seems to be encouraging mention of other parameters (like employment figures). Xinhua was back on topic in an editorial this week that urged China “to part ways with the GDP obsession”.
To get to the PPP calculation from the growth data you also have to choose an exchange rate for conversion into dollars. There is scope for disagreement here too. Although the renminbi has strengthened substantially against the dollar for years, the griping about fair value has never subsided completely. In fact, it has picked up again at the beginning of the year, when the Chinese currency started to weaken against the dollar.
So perhaps it’s not surprising that there have been disagreements about when China’s economy is going to take top spot from the US in PPP terms. Last year the IMF plumped for 2016, for instance. Arvind Subramanian at the Petersen Institute has even argued that the Chinese grabbed first place in 2010, although he acknowledged last week that the forecast might have been a little premature. But not by much, he says, and only because growth had been better in the US, and slower in China, than he anticipated.
More feedback: relative indifference
Aside from picking holes in the data, another response to the ICP report was “so what”. This was an accounting exercise that makes little difference to citizens of either country, commentators claimed. But mostly the view is that it was bound to happen, simply because there are so many Chinese. (On a similar basis India has leapfrogged to third place, although this has generated much less media coverage.)
This demographic argument also has a flipside – that China is still a poor country in per capita terms. And certainly, biggest doesn’t mean best from the perspective of hundreds of millions of individual Chinese.
Even factoring in purchasing power, they are 99th globally on a per head basis, behind countries like Libya, Azerbaijan and Surinam. The gap on the Americans is also huge, with China trailing by a factor of five in per capita terms.
How about the reaction in China?
You might think that the news would be heralded as a sign of the “great rejuvenation of the Chinese nation” dreamed about by Xi Jinping or celebrated for its symbolism, rather like Beijing’s boisterous hosting of the 2008 Olympics.
The Chinese Communist Party has likewise lent heavily on growth for its political legitimacy – so surely it was moment to remember, and even crow about?
And yet there was relatively little mention of the report in the Chinese media, bar a few short pieces noting the outline numbers. The official response was actually rather sour, with China’s National Bureau of Statistics rejecting the conclusions. Despite involvement in the study, the bureau “expressed reservations” about its methodology and “did not agree to publish the headline results for China,” the report’s authors admitted.
Here the Chinese were being true to form as there was little fanfare when they overtook Germany as the world’s biggest exporter or when they passed Japan as the number two economy.
When rankings based on purchasing power parity were first introduced in the early 1990s, the Chinese reaction was also mixed, recalls Zha Daojiong, a professor from Peking University. There was pleasure at seeing their economy climb the global rankings, Zha told Asia Society’s China File last week. But others were suspicious, suspecting a ruse to trick the Chinese into working less.
When China took the number two ranking from Japan in 2010 there were similar rumblings. Western countries were “killing China with praise”, Chinese Industrial Economy News believed. The anxiety seemed to return last week: taking the leading spot was a confidence booster, the Global Times admitted, but it would put more pressure on the government to top-up welfare spending.
Some of this ambivalence has historical roots. For years China played it low-key on the international scene, obeying Deng Xiaoping’s maxim to “hide your brightness, cherish obscurity”. Today Beijing is speaking with a louder voice. But it will still have concerns that the country’s evolving economic status means that it is looked at differently on the international scene. Having the largest economy might be helpful in calling for more say at financial institutions like the IMF, or encouraging for those who want to see the renminbi challenge the dollar’s dominance as an international currency. But China likes to position itself as a developing economy on a range of issues, arguing that it is a poor country, not a rich one.
Climate policy is a good example, with the Chinese insisting that their developing country status means that per capita emissions should be the focal point for reduction plans, and not absolute emissions, in which they are the leading polluter.
Here the emphasis is more on China’s challenges than its achievements. Having a fifth of the world’s population is also portrayed as much as a burden as a benefit. Xinhua said the same again this week, warning that “this country has come a long way, but it remains – undeniably – a developing country with too many fish to fry”. Beijing Youth Daily questioned whether the country could afford its new economic status. After reaching number three and number two in the rankings, China was exposed to new pressures, it complained, especially on trade policy and being asked to take more responsibility in international issues.
Does having the largest economy mean that China is the dominant economic power?
Not really, says Jeffrey Frankel, a professor at Harvard University’s Kennedy School of Government, who spoke up for comparisons based on market exchange rates rather than purchasing power.
Frankel says it’s the combination of a large population and average income that gives a country its economic and political status, which is why Monaco, Qatar and Luxembourg (with some of the highest per capita incomes but very few people) aren’t lauded as economic powers.
Market exchange rates also add a crucial international dimension to the comparisons. “For these questions, and most others involving total economic heft, the indicator to use is GDP at market exchange rates, because what we want to know is how much the renminbi can buy on world markets, not how many haircuts or other local goods it can buy back home,” Frankel says.
That leaves the same two countries at the top of the rankings but it also defines the order in which they appear. “The answer to that question is that China can buy more than any other country in the world – except the US,” Frankel told Project Syndicate. Similarly, even if the US overtook Britain in economic terms in the 1870s, most historians wouldn’t claim that the British were replaced as the pre-eminent global power until 1914 at the earliest.
Columnists have been saying something similar about the timescale for China’s ascent, with Martin Wolf even querying its claims to economic power status in the Financial Times.
One reason? Because it imported 31% less than the Americans last year – “It is the size of the market a country offers that determines its clout in global bargaining,” Wolf reckons. “China is not the world’s largest importer yet.”
Wolf then looks at some of the other parameters of economic power. China’s $4 trillion of forex reserves are huge but there are limits to their usefulness as Beijing can’t just sell down its holdings – much of it in US-dollar denominated debt – without their value dropping substantially.
Nor will the Chinese challenge American supremacy in the global financial markets until they reform their financial system and ensure their banks are strong enough to compete without protection.
After that Wolf runs through a series of other indicators like productivity and technology, before turning to “softer” determinants like popular culture. In every case China trails the US.
In an accompanying piece, David Pilling acknowledges that China is a middle-income country (“at best”) with per capita income trailing Peru. But he also highlights how China’s rise has had a huge impact by cutting the cost of manufactured goods and driving the prices of many global commodities. Pilling then cites comments from Martin Jacques (author of the influential When China Rules The World) that the Chinese have raced past economic milestones much more rapidly than anyone could have expected a generation ago. As far as Jacques is concerned “there’s still a denial about China, an inability to see the underlying trend”. Jacques adds: “A lot of this is below the radar. So when you get a moment like this – a sorpasso – it’s a wake-up call.”
Of course, this raises further questions about the development model underpinning China’s rise, which is now in need of an overhaul if its economy is to avoid the ‘middle-income trap’.
That leaves Xi Jinping’s government wrestling with some fundamental challenges, like how to deal with the realities of a dwindling workforce and higher wages; how to make sure that capital is invested less wastefully, with less of a role for the state in the economy and more for the private sector; and how best to respond to the widening gulf between the richest in society and the rest.
Plus there’s the key issue of how to deliver further growth without fatally degrading the country’s environment.
How China manages this transition is the fundamental challenge facing its leadership, notes Arthur Kroeber of Gavekal Economics. “Because of its sheer bulk, China is indeed wealthy and poor at the same time,” he concludes, “and the responses to that paradox are a far more fascinating target of study than the mere size of the economy.”
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