Is China already the No 1 economy?

PUBLISHED : Tuesday, 01 March, 2011, 12:00am
UPDATED : Tuesday, 01 March, 2011, 12:00am

There was a prolonged popping of champagne corks recently when the official statistics showed that China had surpassed Japan as the second biggest economy in the world. The celebrations were bogus because almost everyone knew that China's graduation really occurred last year, and the Japanese figures confirmed it some weeks before Beijing did.

The next round of speculation is when will China take over from the US as the world's top economic dog: could it be as early as 2020 or as late as 2030? But now an eminent US-based economist has concluded that in real terms China's economy is already bigger than America's.

Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, claims that in terms of purchasing power parity properly adjusted China has surpassed the US. He estimates China's gross domestic product (GDP) at US$14.8 trillion, slightly higher than the US with US$14.6 trillion. At market exchange rates, China reached US$5.88 trillion last year, according to China's own figures, announced in mid-February. (The US is US$14.6 trillion at market rates, of course.)

The limitations of market exchange rates to assess economic strength across international borders have long been recognised. You only have to look at the controversy over whether the yuan is manipulated, messaged or otherwise undervalued to appreciate this. The US Central Intelligence Agency Factbook says: 'Because China's exchange rate is determined by fiat, rather than by market forces, the official exchange rate measure of GDP is not an accurate measure of China's output.'

The price of a quality home is not the same in the US, China and India, although in cities like Shanghai and Mumbai a home costs more than most places in developed countries. Prices of goods and services generally are typically far cheaper in developing countries where labour and other costs are less. This is especially so for the wide range of things that are not traded across borders.

Purchasing power parity (PPP) calculations are an alternative way of measuring and comparing economic reality across borders, using output according to volume rather than price. The CIA Factbook prefers PPP, as do other international organisations such as the International Monetary Fund and the Organisation for Economic Co-operation and Development. The CIA in its update of mid-February gives China's GDP as US$9.872 trillion. The IMF in October 2010 estimated China's GDP at PPP rates at US$10.084 trillion.

Subramanian takes issue with the IMF figures. He criticises a major 2005 revision based on a project by the International Comparison of Prices (ICP). As a result of this, GDP figures for both China and India were revised downwards by 40 per cent. The 2005 revisions have formed the basis for subsequent IMF estimates of purchasing power parity figures.

Many economists have cast doubt on the ICP work. One flawed criticism said that extrapolating the revisions backward would mean that there were few Chinese living in 1952. Such backward extrapolation is itself questionable because it relies on interchanging of PPP growth rates and market exchange rate based growth rates. However, more legitimate criticism is that the ICP had an urban bias in its price sampling in China: it used data from 11 cities and suburbs but no rural prices, partly because of the refusal of the Chinese authorities to allow collection of rural data.

Subramanian uses corrections for these biases published in the latest version 7 of the Penn World Tables from the University of Pennsylvania, probably the most respected international set of comparisons of production, income and prices. Version 7 was due last month but has not yet appeared on the Penn website. China's PPP-based GDP has been revised upwards by 27 per cent for 2005 (and India's by 13 per cent) as a result of the corrections.

In addition, Subramanian makes further adjustments to take account of what has happened since 2005, and this takes him into the controversial area of exchange rates. He argues that IMF data at face value led to an implausible increase in the real cost of living in China relative to the US (equivalent to a real appreciation of the yuan) of 35 per cent. Most of the real exchange rate indices for China point to currency appreciation of 10 to 15 per cent.

Having made adjustments of 27 per cent for the revisions to the 2005 estimate and of 20 per cent for lower cost of living rises, Subramanian lifts the true PPP measure of China's GDP by 47 per cent, giving China US$14.8 trillion against the US$14.6 trillion of the US. He concedes that the difference is so small as to be within the margin of error.

Subramanian's claims are only slightly ahead of other forecasts. The Conference Board, the US economic research association, said in November that China would overtake the US by next year. It predicts that by 2020 China's output will be almost half as big as that of the US, and China will account for 24.1 per cent of world output, against 14.8 per cent by the US.

What does it matter - or is it all a case of lies, damned lies and statistics (being the worst of all lies)? It does mean that at a stroke China achieves a real symbolic victory. It also means that the per capita income of Chinese vaults to US$11,047 (from US$7,518 under the old PPP method and US$4,283 at market exchange rates).

Of course, China remains a relatively poor developing country because of its large and sprawling population, but these revisions give it a significant lift up the global table. If other countries stay the same, the revision lifts China by 20 places to 72nd, just below Brazil and above Iran in the per capita league.

If China is the biggest economy it can also argue for a bigger role, for example in international institutions: why should the US hold 16 per cent of the voting rights and effective veto in the IMF if China is bigger? But being the world's biggest economy also implies responsibilities and a spotlight that the rulers in Beijing may wish to avoid. If per capita income is more than US$11,000 in real terms, what is the gap between rich and poor, and is Beijing doing enough to lift the millions of rural have-nots?

Professor T. N. Srinivasen of Yale University says China tends to exaggerate its growth rate to demonstrate its strength, but understates its GDP to present itself as a poor country that should be exempted from bigger contributions to global public goods.

Premier Wen Jiabao and the mainland's security forces have belatedly realised that it is not only the quantity of growth that counts but its quality and where it is spread.