Guest Post: China’s Economy: #1 or #126?

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Submitted by Kurt Brouwer of Fundmastery

China’s economy: #1 or #126?

There have been plenty of reports that China’s economy is overtaking
the U.S. economy and that it may soon outstrip the U.S..  As an example,
in a recent piece, my MarketWatch.com colleague Brett Arends, reported
on a study by the International Monetary Fund on the size of China’s
economy.  The IMF study suggested that by one economic measure China’s
economy would look almost as big as the U.S. economy in a few years.  Of
course, that set off my innate skepticism so I did a little digging.  
In this post, my goal is to cover two questions:

  • How big is China’s economy compared to ours?
  • And, is it really going to surpass our economy in size any time soon

To get started, check out the opening from the Marketwatch report:

The International Monetary Fund has just dropped a bombshell, and nobody noticed.

For the first time, the international organization has set a date for
the moment when the “Age of America” will end and the U.S. economy will
be overtaken by that of China.

And it’s a lot closer than you may think.

According to the latest IMF official forecasts, China’s economy will
surpass that of America in real terms in 2016 — just five years from
now.

Yikes.  Sounds pretty scary doesn’t it? Some folks might find a
report like this disconcerting because they want the U.S. to be the #1
economic power.  I don’t really care one way or the other about our
economy being #1 or #2 in the world.  Size has both advantages and
disadvantages.

But, if that concerns you, don’t worry. Despite the gloomy reports, the U.S. is likely to  remain the world’s largest national
economic power for many years to come.  And, if we would stop wearing
wearing cement shoes while running against competitors in lightweight
Nikes, it wouldn’t even be close, but that’s a story for a different
day.

A trillion here; a trillion there

To do my own research, I went to one of my favorite sources, the CIA
World Factbook.  I’ve used it many times before and I have more
confidence in the FActbook’s data than most sources.  According to the
Factbook, in terms of comparing Gross Domestic Product (GDP) straight
up, we’re #2 at $14.62 trillion and China is a distant #3 at $5.75
trillion.  Japan is close to China at $5.39 trillion. We would be #1,
but when the European Union is viewed as a single entity, it is at
$15.95 trillion. Viewing the European Union as a single, unified entity
is a bit of a stretch, but let’s not quibble.

We’re #2 and China is a distant #3

So, if we are north of $14 trillion and China is a bit over $5
trillion, how the heck can the IMF legitimately claim that China is
catching up and may even be on its way to #1 in a few years?  Well,
without massaging the numbers a lot, they cannot.

A straight up comparison shows China is far behind us.  However, the
IMF report used an alternative way to measure economic output called
purchasing power parity (PPP).

Purchasing power parity: what the heck is that?

Purchasing power parity (PPP) attempts to compare economies that have
very different price levels for basic goods and services. The most
famous example of using PPP is the Big Mac Index which is described by the Economist this way:

…[the Big Mac Index] is based on one of the oldest
concepts in international economics, purchasing power parity (PPP), the
notion that a dollar, say, should buy the same amount in all
countries. In the long run, argue ppp fans, currencies should move
towards the exchange rate, which equalises the prices of an identical
basket of goods and services in each country. In this case, the basket
is a McDonalds’ Big Mac, which is produced in more than 100
countries. The Big Mac PPP is the exchange rate that would leave
hamburgers costing the same in the United States as elsewhere…

This chart from the CIA World Factbook shows the world’s economic
powerhouses in terms of GDP, as adjusted for purchasing power parity. 
According to this, the EU is #1, the U.S. is a close #2 and China is
still #3.  This data is from 2010.

Source: CIA World Factbook

PPP tries to look at economic output across countries by leveling
the playing field. In China personal incomes are lower, but the cost
of rent or food is also lower, so by using PPP, you can perform a useful
comparison of economic output between the two countries.  Another
aspect of PPP is that it helps compare economies adjusting for currency
disparities.  Even the CIA World Factbook suggests that currency
differences need to be accounted for to compare our two economies.  I
agree.

In GDP per person, China ranks…

A further way to look at economic output is to divide GDP by the
number of people in a country.  This is GDP per capita.  It takes the
same data used in the chart above, which is GDP adjusted for purchasing
power parity, but divides that number by population. So, for China we
have to divide by more than 1.3 billion people.  For the U.S., we have
to divide by a bit over 300 million.

Here are the top 10 countries for GDP per person:

Source: CIA World Factbook

As you can see, the top 10 countries for GDP per capita are very
small nations that are either oil producers or financial centers.  The
only large country is the U.S., with a GDP per person of $47,400.  What
about China?  Well, it’s nowhere to be seen on this top 10 list.  Would
you like to guess at where China stacks up by this comparison, I gave
you a hint in the title of this post.

China is #126 is in GDP per capita:

For GDP per capita, China ranks between two economic powerhouses —
Turkmenistan and Albania.  And, remember, for this ranking, we are using
the PPP adjusted GDP so this is favorable to China compared to the
U.S.  In other words, China has a big economy overall, but it has a very
low ranking when you adjust for population:

Source: CIA World Factbook

Does this mean China’s economy is bad?  No, of course not.   China
has come a long way since its leaders adopted limited free market
reforms back in the late 1970s.  Nonetheless, it is also clear that much
of China’s large economic impact in the world is a function of the size
of its population.

China is not #1 on any economic ranking

Even with a generous methodology such as PPP, the highest China gets
is #3.  And, adjusted for economic output per person, it is #126 and
that’s not exactly something you crow about.  At a per capita GDP of
$7,400 China is a long, long way from the $47,400 we have in the U.S. 
In fact, I’ll make a prediction. China will not come close to our per
capita GDP.  Not next year or even 10 years from now.

In terms of overall economic output, China would have to grow at a
very high rate for many years to catch up to the EU or to the U.S.  I
hope it does keep growing because that is good.  And, China has vastly
improved its economy over the past few decades, particularly in terms of
export industries.  I’m not trying to knock those accomplishments at
all.  However, the idea that it is an economic power comparable to the
U.S. is clearly not accurate.