Foreign and Defense Policy, China, Economics, International economy

China passing the US: Nonsense

Image Credit: Shutterstock

Image Credit: Shutterstock

Headlines say today that the Chinese economy will be larger than the American economy very soon. The headlines are quite wrong.

Their basis is a report by an arm of the World Bank. It says China’s gross domestic product (GDP) adjusted by purchasing power parity (PPP) was 87% that of the US in 2011. Projecting forward, China could pass the US on this measure this year or next.

The mistake: the comparison makes no sense. It does not make any sense to compare one country’s PPP-adjusted GDP to another and say its economy is larger. Not for any country at any time.

PPP was developed as a way to better understand incomes in poorer economies. Average income might be reported as less than $500 per year in parts of Bangladesh but that $500, while still horrifying low, at least buys more (of what’s available) than $500 spent on the same things in New Zealand.

So the first issue with PPP is how to make the adjustment – how to compare buying power across all of Bangladesh and New Zealand. And then adjust for what can be hugely different goods and services available in the two countries. It’s a hard task.

It’s a much harder task for very large countries like China and the US. The average price between New York city and Monroe, Louisiana means something? We can compare it to the average between Shanghai and Lhasa, Tibet? The PPP idea is good but its usefulness is strained in practice.

That isn’t the big problem. The big problem is PPP is supposed to be about purchasing power, as the term indicates, not economic size. Most comparable goods and services are cheaper on average in Bangladesh than in New Zealand. How do we jump from that to saying Bangladesh’s economy is really (much) bigger than it seems?

It’s true that purchasing power and economic size are related, but they aren’t closely related. The claim that China will soon be larger than the US is based on GDP, which adds up personal and government consumption, investment, and trade transactions.

The already strained PPP adjustment was created for personal consumption. To apply it to all of GDP is not what it was made for and stretches the idea of PPP beyond the breaking point. PPP-adjusted GDP comparisons just don’t make sense.

Of course, it is still clear that the Chinese economy has been growing quickly and is a larger fraction of the American economy than 30 years ago, or even 10. What is less clear is how close the two are. There’s the $2 trillion gap in PPP-adjusted GDP in 2011, which is causing all the fuss. There’s the $7 trillion gap in standard GDP in 2013. There’s also a $35 trillion gap.

That isn’t a typo. There should be a debate about PPP, there should also be a debate about GDP. GDP measures what happened in an economy in a year, not how big the economy is. A new year comes and GDP resets to zero.

But the economy doesn’t reset to zero on January 1. All the stuff is still there. And it’s still there even if we don’t do anything with it and it never gets counted in GDP. That’s why the right measure of economic size is national wealth – the value of what we have, not what transactions occurred during a calendar year. National wealth provides a far more accurate view of economic size than GDP, whether standard or PPP-adjusted.

Credit Suisse has a measurement of private wealth in most countries. It puts Chinese private wealth at about $22 trillion in mid-2013, well ahead of their $9 trillion or so standard GDP last year. Credit Suisse puts American private wealth at the same time at $72 trillion.

Let’s stop for a second. Private wealth isn’t everything, but that gap is $50 trillion. You can pass a country for economic leadership when your private wealth is $50 trillion less?

As a check on Credit Suisse, the Federal Reserve has a measurement of US net private wealth of about $80 trillion at the end of last year. Our huge public debt cuts our national wealth to about $65-70 trillion (the government also owns a lot of valuable property).

China’s government owns a great deal through its huge state-owned enterprises but those firms also owe a great deal. The net value of what the Chinese state owns on top of what its people own is highly uncertain but let’s be generous (and imprecise) and bump them up $10 trillion.

This puts China in the $30-35 trillion range, about $35 trillion behind us. The gap has closed in the past 10 years but not in the past 4, as the US came out of the financial crisis and China intensified its own borrowing. It’s not at all obvious when China will catch up, except that it won’t be soon. At the moment, it’s not even obvious that China will catch up at all. This is the true relationship.

I haven’t mentioned problems with Chinese government data which are used as a base by the World Bank in its study. That’s because I don’t want to alienate my ally in the argument against China passing the US. My ally is the Chinese government, which today rejected the idea of China passing the US. It has good reason.

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