Measuring China’s Economy (Or Sizing Up Economies as a Numbers Game)

According to the International Monetary Fund (IMF), China’s gross domestic product (GDP) is projected to increase to $17.6 trillion this year, whereas the United States’ is expected to grow to $17.4 trillion. In reality, China has not yet overtaken the US as the world’s largest economy.

Size of the Chinese economy

To compare the economies of different countries, you need data. That data, in turn, is reported by each country in its own currency, which must be converted into a common currency (usually in US dollars). There are two main methods for this conversion.

One method relies on market exchange rates — that is, the rates in the foreign exchange market. As every international tourist knows, foreign destinations exchange money only on the basis of hard cash.

The other method relies on the purchasing power parity (PPP) exchange rate — that is, the rate at which the currency of a country would have to be converted for a purchase in another country. After all, non-traded goods and services tend to be cheaper in low-income countries than in high-income ones. For example, a haircut is cheaper in Shanghai than in New York.

In advanced economies, the difference between market rate and exchange rate measurements is significant, but not huge. In emerging economies, it is typically both significant and huge.

Measured by the market-exchange rate, the US economy was $16.2 trillion in 2013. If the PPP is used, it was close to $17.6 trillion. Based on the market exchange rate, the Chinese economy was less than $8.4 trillion, but if the PPP is used, it was nearly $16.2 trillion — almost twice as large.

Based on market rates, the Chinese economy remains 55-60 percent relative to the US GDP. So China will overtake the US in these terms, but by the 2020s — not yet.

Country rankings as a numbers racket

If the PPP concept were applied to compare entire economies, then India would already be the world’s third-richest nation having overtaken Germany in 2003 and Japan in 2008. The Indonesian economy would be larger than that of the United Kingdom and the Philippines economy would be bigger than Switzerland’s.

If, however, you rely on GDP comparisons that are based on market exchange rates, India is the tenth-largest economy and will need years to overtake the US. By the same token, the Indonesian economy is about one-third of the UK economy, whereas the Swiss economy is 2.5 times bigger than that of the Philippines.

Huge gaps remain between the living standards in the advanced and emerging economies. Measured by per capita GDP (PPP), living standards in the UK are nearly four times higher relative to Indonesia, while living standards in Switzerland are more than eight times higher than those in the Philippines.

For all practical purposes, per capita GDP, adjusted for PPP, is a better measure of individual well-being. It makes more sense when we compare living standards of people in different countries.

Before China launched reforms and opening-up, the living standards in the country were only 2 percent of those in the US. Today, the comparable figure is 20-25 percent. Despite China’s unprecedented economic catch-up, living standards in the US remain four to five times higher than in China.

Rationale for flawed comparisons

So why are PPP figures used to compare economies, even when not warranted? Often, reasons are political rather than economic. Misguided comparisons shift attention away from absolute and relative poverty in emerging economies. The World Bank measures international poverty by $1.25 (7.66 yuan) a day, which is not enough for a single day’s meal in China, not to speak of housing and other expenditures.

Yet the current poverty rate for a family of three persons with one child in the US is about $19,800 — or 2.8 times the average (nominal) per capita GDP in China (and more than 13 times the comparable figure in India).

The practice may also be in self-interest. Climate change is typically defined in aggregate terms in the West. In this way, China and other emerging economies are often portrayed as the greatest polluters. And yet, on a per capita basis, people in advanced economies cause 4-5 times more pollution than their Chinese counterparts, not to speak of poorer emerging nations.

China is not yet the world’s largest economy, but it will become one by the 2020s. With a population of more than 1.3 billion, that’s only to be expected.

Two nations, one dream

However, higher living standards will require higher productivity. In China, that means the completion of industrialization and the shift to a post-industrial economy. The same goes for the urbanization rate, which in China is close to 55 percent, whereas in advanced economies it is 80-90 percent.

China has begun the transition from cost-efficiencies to innovation but the catch-up will take time.

Ultimately, it’s higher productivity that makes possible the living standards that really matter to people. That’s what the “American dream” is all about. And the Chinese dream is no different.

The original version was published by China Daily on October 14, 2014