© 2015 Prof. Farok J. Contractor, Rutgers University
China’s economy in 2015 may be as big as the US economy—
if you believe the World Bank’s economists
The business press has been excitedly predicting the day when the Chinese economy will surpass that of the US in size. Just when this will happen has been a matter for debate—estimates have ranged from 2016 to 2025.
In order to compare a nation’s economic size to that of other countries, economists first calculate the size of the country’s economy in the local currency and then convert it into a common currency (e.g., the US dollar). But the exchange rate used to convert from the local currency into the dollar equivalent makes all the difference. Conventional wisdom is that the Chinese yuan is still undervalued at the end-2014 official exchange rate of 6.2 RMB (renminbi yuan) per dollar. Using the official actual exchange rate, China’s economy (at $9.92 trillion in 2014) is still much smaller than that of the US, estimated at $16.92 trillion. See Table 1 below.
However, an alternative theoretical exchange rate—purchasing power parity (PPP)—exists that takes into account the cost of living in the nation. To calculate this theoretical PPP exchange rate is tricky business (see more discussion on this below). If we assume that people in the World Bank know their stuff, they estimate China’s PPP exchange rate at something around 3.7 RMB per dollar. Here are the World Bank’s numbers for GDP per capita, PPP (current international $, 2013); Population, total (2014); and Price level ratio of PPP conversion factor (GDP) to market exchange rate (2013–14):
We also see from Table 1 that while the average per capita Chinese income is one-fifth compared to that of the average American’s, the population of China is more than four times as large. Hence the overall size of the economies appears roughly equal.
Extrapolate the 2013–14 figures by the difference between the annual growth rates for the US (approximately 3.5%) and China (approximately 7 %), and we get, for the start of 2015,
Extrapolating at these growth rates further into 2015, we can estimate—based on PPP exchange rate calculations—that China will overtake the US by about mid-year.
Ambivalence and Caveats
The Chinese are ambivalent about this. On the one hand, they swell with nationalistic pride at such calculations:
On the other, the Chinese government has a vested interest in downplaying—even denying—this impending news. Whereas the government wishes to project China as a world power, it also finds it advantageous to portray the country as a poor emerging nation, still smarting from the wounds of colonial oppression, still needing to develop (indeed, the poorer provinces like Guizhou are hardly better off than Pakistan), still not needing to observe limits on carbon emissions. It is convenient, in world forums, for China to play the role of a peaceable nation that should still enjoy the privileges and indulgences granted to developing countries, and one that presents no irritants to its neighbors.
At the same time, China’s economists may be right in questioning the World Bank’s PPP exchange rate of around 3.7 RMB per dollar—this is a theoretical metric that exists only in the mind of an economist or accountant. In brief, the PPP exchange rate adjusts for the cost of living in each nation. Since the cost of living in China is much lower than in the US, the PPP exchange rate calculated by the World Bank (around 3.7 RMB per dollar) is much lower than the officially controlled exchange rate (of 6.2 RMB per dollar in December 2014). This is what is meant by the actual RMB exchange rate of 6.2 being “undervalued” in comparison with the theoretical PPP exchange rate of 3.7. However, the Chinese suggest that their currency is not really undervalued by much—at least in terms of trade competitiveness—since manufacturing wages and prices in Eastern China have been escalating at around 10 percent annually in recent years, rendering some manufacturing operations already uncompetitive if the RMB appreciates below 6.0 per dollar. (See my earlier blog post about the RMB exchange rate: Whither the Chinese Yuan? Is the RMB Still Undervalued?).
But when economists calculate the PPP exchange rate, they consider prices and cost of living not just in Eastern China, but for China as a whole. The cost of living in the middle and western provinces is much lower than in the eastern seaboard. For China as a whole, inflation has, according to official statistics, averaged only 3.6 percent over the 2004–2014 decade (see the World Bank Data—Inflation, consumer prices (annual %).
So the calculation of the PPP exchange rate for China—and therefore the estimate for the size of the Chinese economy—very much depends on what price data and geographic coverage the economist uses. At the World Bank’s all-China PPP exchange rate (around 3.7 RMB per dollar), China will have caught up with the US as early as this year (2015). At the end-2014 official actual exchange rate (6.2 RMB per dollar), it may take an additional decade or longer.
© 2014 Prof. Farok J. Contractor, Rutgers University
Tea Parties of Other Eras
Chinese enjoying tea in the 15th century couldn’t have anticipated that the Boston Tea Party would launch a revolution across the world three centuries later.
Since the year 2000, the US has suffered a horrendous merchandise trade deficit against China, adding up to $2,947 billion over the 14-year period. This means that China has accumulated nearly $3 trillion surplus dollars—much of which they “kindly” reinvested in US assets, notably US Treasury debt. (More on this in a future post.)
In its heyday, Rome suffered a similar deficit against China and India, which they had to finance by sending bullion (gold and silver) to Asia to pay for their insatiable appetite for Chinese silk, Indian muslins, and oriental spices. More recently, in the 1800s Britain suffered another unsustainable deficit because of the insatiable appetite on the part of the British middle classes for Chinese tea—a problem they solved by forcing the purchase of Indian opium on an unwilling Chinese government, which led to the Opium wars of the 1840s. To this day, the Chinese smart at the memory of their humiliation and maintain their aggressive stance in the 21st century against their neighbors (Japan, Vietnam, the Philippines) in the seas—over seemingly inconsequential islets—a direct a result of what happened 175 years ago. History matters.