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I’ve argued that China is currently overtaking the US in the race to have the world’s largest economy, and will have an economy twice the size of the US within a few decades. I’ve picked on Lester Thurow for claiming it wouldn’t happen until the 22nd century. And now Lars Christensen has suggested it might never happen. Those are fighting words to a Sinophile like me. Here’s Lars:

However, the [World Bank] argument was completely bogus as it was based on Purchasing Power Parity (PPP) rather than on actual exchange rates (To be fair we should blame the media rather than the World Bank for this interpretation of the data). PPP based measures of GDP (per capita) might make sense if we want to measure how much an average citizen can buy for given an average income, however, it does not make sense when we want to measure the size of the economy. There we have to use measures based on actual exchange rates and if we do that then it turns out that the Chinese economy is still significantly smaller than the US economy. Hence, total Chinese GDP today is around 10 trillion USD, while US GDP is around bn 17-18 trillion USD. Said in another way the US economy is still nearly double the size of the Chinese economy. And what I will argue in this post is that China might never overtake the US as the biggest economy in the world.

I have several problems with this argument. First, if Lars really feels PPP is wrong, and that we should use nominal figures, then he should not be talking about China having recently grown at 7 to 7.5% per year. In PPP terms China may have been growing at 7.5% vs. 2% in the US, but in nominal terms the gap is far wider, due to the Balassa-Samuelson effect. China’s real exchange rate has appreciated strongly over the past decade. So if Lars is right that nominal exchange rates are the right test, then China’s been catching up to the US at a rate far faster than either Lars or I assume. And in that case China’s nominal growth could slow dramatically and yet still be growing far faster than the US (where trend NGDP growth is now about 3%, in my view.) Lars avoids this problem by assuming the Balassa-Samuelson effect will suddenly come to a screeching halt, whereas I think the yuan is headed to 4 to the dollar. He also assumes a 3% RGDP growth rate for the US, whereas I believe it will be closer to 1.2%, growing over time to perhaps 2% in a few decades.

My second argument is that it makes no sense to use nominal exchange rates to compare the size of economies. Perhaps it makes sense if you want to look at the impact on global trade (China exports far more than the US, BTW), but surely not if comparing domestic production. I recall the euro being about 85 cents around 2002, then by 2008 it peaked around $1.60. And yet the US and eurozone had roughly similar NGDP growth rates over this 6 year period. Does anyone believe that comparing non-PPP adjusted GDPs would have given a meaningful comparison of the relative size of these two economies? Did the eurozone suddenly go from having an economy much smaller than the US to one far larger, in six years?

And consider the effect of tax regimes. Suppose you adopt a VAT that provides revenue equal to 20% of GDP. Your nominal GDP at market exchange rates will suddenly jump by 20%, even though nothing has happened to the real size of your economy. Indeed the European VATs are one factor that explains why Europe often looks better against the US if you don’t adjust for PPP.

Switzerland’s nominal GDP per capita is $81,323, and Germany is $44,999. Here are three more:

Greece $21,857

Taiwan, $20,930

Portugal, $20,727

Now let’s go to PPP. We find Switzerland at $46,430, and Germany at $40,007. Doesn’t that gap seem more plausible? In PPP terms Taiwan has a bit under $40,000, whereas Greece is just over $24,000 and Portugal a bit over $23,000. Again, far more plausible.

Still not convinced? China produced more cement in 2011-12 than the US did in the entire 20th century.

Still not convinced? Think about the fact that China has 1.36 billion people while you read this:

CHINA Northern Locomotive and Rolling Stock Corporation (CNR) has been awarded a contract to supply a fleet of 60 driverless trains for the first metro line in Beijing to be equipped for Unattended Train Operation (UTO).

I’m telling you, this country isn’t messing around.

For Lars to be right, China’s nominal GDP per person would have to get stuck at Brazilian levels.

Ladies and gentlemen of the jury, I rest my case.

PS. Under PPP Denmark drops from over $59,000 to under $38,000. Maybe that’s why Lars likes the unadjusted figures. 🙂

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This entry was posted on August 28th, 2014 and is filed under China. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



