Using purchasing power parity estimates narrows the differences between the two economies, says Arvind Subramanian
The world’s two economic superpowers, the United States of America and the People’s Republic of China, will meet soon for the third installment of their Strategic and Economic Dialogue. Beyond the specifics, the real issue for the US and the world is really about China’s looming economic dominance. President Barack Obama’s State of the Union address after President Hu Jintao’s visit to the US in January 2011 showed the level of anxiety that policy makers feel about China as a potential rival and perhaps a threat, with growing economic, military and political power, including its bankrolling of American debt. But judging from the reaction to the president’s speech, that threat is not viewed as imminent. The same was said, some pointed out, of the rise of Russia and Japan, 20 and 40 years ago, respectively, and those threats turned out to be false alarms.
But what if the threat is actually greater than policy makers suppose?
According to the International Monetary Fund, for example, total US gross domestic product in 2010 was $14.7 trillion, more than twice China’s $5.8 trillion, making the average American about 11 times more affluent as the average Chinese. Goldman Sachs does not forecast the Chinese economy overtaking that of the US until 2025 at the earliest. Americans also draw satisfaction from their unmatched strengths of an open society, an entrepreneurial culture, and world-class universities and research institutions.
But these beliefs may be overly sanguine. The underlying numbers that contribute to them are a little misleading because they are based on converting the value of goods and services around the world into dollars at market exchange rates.
It has long been recognised that using the market exchange rate to value goods and services misleads about the real costs of living in different countries. Several goods and services that are not traded across borders (medical care, retail services, construction and so on) are cheaper in poorer countries because labour is abundant. Using the market exchange rate to compare living standards across countries understates the benefits that citizens in poor countries enjoy from having access to these goods and services. Estimates of purchasing power parity take account of these differing costs and are an alternative, and for some purposes a better, way of computing and comparing standards of living and economic output across countries.
My calculations (explained in greater detail on the Peterson Institute website) show that the Chinese economy in 2010, adjusted for purchasing power, was worth about $14.8 trillion, surpassing that of the US. And, on this basis, the average American is “only” four times as wealthy as the average Chinese, not 11 times as rich, as the conventional numbers suggest.
The different approaches to valuing economic output and resources are not just of theoretical interest. They have real-world significance, especially in the balance of power and economic dominance. The conventional numbers would suggest that the US has three times the capability of China to mobilise real military resources in the event of a conflict. The numbers based on purchasing power parity suggest that conventional estimates considerably exaggerate US capability. To the extent that the service of soldiers and other domestically produced goods and services constitute real military resources, the purchasing power parity numbers must also be taken into account.
The economic advantage China is gaining will only widen in the future because China’s gross domestic product growth rate will be substantially and consistently greater than that of the US in the near future. By 2030, I expect the Chinese economy to be twice as large as that of the US (in purchasing power parity dollars).
Moreover, China’s lead will not be confined to gross domestic product. China is already the world’s largest exporter of goods. By 2030, China’s trade volume will be twice that of the US. And, of course, China is also a net creditor to the US.
The combination of economic size, trade and creditor status will confer on China a kind of economic dominance that the US enjoyed for about five to six decades after World War II and that Britain enjoyed at the peak of the empire in the late nineteenth century.
This will matter in two important ways. America’s ability to influence China will be seriously diminished, which is already evident in China’s unwillingness to change its exchange rate policy despite US urging. And the open trading and financial system that the US fashioned after World War II will be increasingly China’s to sustain or undermine.
The new numbers, the underlying realities they represent and the future they portend must serve as a wake-up call for America to get its fiscal house in order and quickly find new sources of economic dynamism if it is not to cede its pre-eminence to a rising, perhaps already risen, China.
The author is a senior fellow at the Peterson Institute and Centre for Global Development, Washington DC.
He is the author of a forthcoming book on China’s economic dominance