Thursday, October 29, 2009

How Hot Is The Dragon?

Soon after Mao Zedong died in 1976, bringing to an end his 27-year attempt to starve China's people to death (which was only partially successful, but give him credit for trying), that country began to allow market forces to work once more. Now, more than three decades later, commentators are asking whether China is about to overtake the U.S. as the world's major economic power.

Cool your jets, says the Economist in its October 24 issue. While they note that:

China owns $800 billion of American government debt—enough to give it power of life and death over the American economy

they go on to describe continued American dominance:

China’s economy is still less than a third the size of America’s at market exchange-rates. Its GDP per head is one-fourteenth that of America. The innovation gap between the two countries remains huge. America’s defence budget is still six times China’s. As for the Treasury bills, dumping them is not an option for China: a tumbling dollar would hurt its own economy.

As is the case with many accounting concepts, comparing the size of countries' economies is not as simple as one might think.

There are two ways of calculating GDP. One of those methods takes into account the fact that cost of living tends to be lower in poorer countries. Those countries' GDP amounts are inflated to reflect the additional buying power of any given monetary amount. Some international economist who likes alliteration labeled this the "purchasing power parity" (PPP) method of calculating GDP.

Fareed Zakaria, in his book The Post-American World, explains the PPP concept and discusses when the unadjusted GDP (GDP at market exchange rates) is a more suitable measure. (See his footnote on p. 17.) He writes:

... when it comes to the stuff of raw national power, measuring GDP at market exchange rates makes more sense. You can't buy an aircraft carrier, fund a UN peacekeeping mission, announce corporate earnings, or give foreign aid with dollars measured in PPP.

I agree with that, and that is the basis on which the Economist came up with its comparison, with the American economy still being three times as large as China's.

Here are data from the World Bank, showing that, on a PPP basis, the U.S. GDP is less than twice that of China.

Where I think the PPP adjustment makes more sense, is to apply it to per capita GDP, and thereby come up with a comparison of standard of living between countries.

On that basis, China falls even further behind, due to its huge population. Those numbers are: US $39,319, and China $5,453. That is the number that China's leaders focus on, in their attempt to distract their people from questioning their political impotence. And it is also the figure that marketers will look at, to gauge how quickly China's consumption will continue to grow.

Will China eventually surpass the U.S. in all of these measurements? If so, that's too far into the future to predict with any accuracy.

China's percentage rate of growth (from a very small base) has exceeded that of the U.S. over the past 30 years. It is easy to extrapolate from that, and show that, if those rates continue into the indefinite future, China will eventually surpass America.

But, if China's GDP continues to grow at double-digit rates over the next few years, it will become increasingly difficult to maintain those percentage rates. It was relatively easy for them to quickly grow from the desperate poverty of the Mao era. But, as the GDP base gets larger, those percentages will probably flatten out. And who knows? Maybe, many years from now, a neo-Mao will bring China back into economic chaos.

Certainly, we can't rule out China eventually taking over the #1 spot. But it doesn't seem to me that there's any basis for a prediction that that will happen and, if so, when.

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