China Is Now the World's Largest Economy. We Shouldn't Be Shocked.
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October 15, 2020  Topic: Economics  Region: Asia  Tags: ChinaAsiaGraham
AllisonHarvardEconomicsIMFCIAPPP
China has now displaced the U.S. to become the largest economy in the world.
Measured by the more refined yardstick that both the IMF and CIA now judge
to be the single best metric for comparing national economies, the IMF
Report shows that China’s economy is one-sixth larger than America’s ($24.
2 trillion versus the U.S.’s $20.8 trillion). Why can't we admit reality?
What does this mean?
by Graham Allison Follow @GrahamTAllison on TwitterL
This week, the IMF presented its 2020 World Economic Outlook providing an
overview of the global economy and the challenges ahead. The most
inconvenient fact in the Report is one Americans don’t want to hear—and
even when they read it, refuse to accept: China has now displaced the U.S.
to become the largest economy in the world. Measured by the more refined
yardstick that both the IMF and CIA now judge to be the single best metric
for comparing national economies, the IMF Report shows that China’s economy
is one-sixth larger than America’s ($24.2 trillion versus the U.S.’s $20.
8 trillion).
Despite this unambiguous statement from the two most authoritative sources,
most of the mainstream press—with the exception of The Economist—continue
reporting that the U.S. economy is No. 1. So, what’s going on?
Obviously, measuring the size of a nation’s economy is more complicated
than it might appear. In addition to collecting data, it requires selecting
a proper yardstick. Traditionally, economists have used a metric called MER
(market exchange rates) to calculate GDP. The U.S. economy is taken as the
baseline—reflecting the fact that when this method was developed in the
years after World War II, the U.S. accounted for almost half of global GDP.
For other nations’ economies, this method adds up all goods and services
produced by their economy in their own currency and then converts that total
into U.S. dollars at the current “market exchange rate.” For 2020, the
value of all goods and services produced in China is projected to be 102
trillion yuan. Converted to U.S. dollars at a market rate of 7 yuan to 1
dollar, China will have an MER GDP of $14.6 trillion versus the U.S. GDP of
$20.8 trillion.
But this comparison assumes that 7 yuan buy the same amount of goods in
China as $1 does in the U.S. And obviously, that’s not the case. To make
this point easier to understand, The Economist Magazine created the “Big
Mac Index” from which the graph at the top of this piece is derived. As
this index shows, for 21 yuan, a Chinese consumer can buy an entire Big Mac
in Beijing. If he converted those yuan at the current exchange rate, he
would have $3, which will only buy half a Big Mac in the U.S. In other words
, when buying most products from burgers and smartphones, to missiles and
naval bases, the Chinese get almost twice as much bang for each buck.
Recognizing this reality, over the past decade, the CIA and the IMF have
developed a more appropriate yardstick for comparing national economies,
which is called PPP (purchasing power parity). As the IMF Report explains,
PPP “eliminates differences in price levels between economies” and thus
compares national economies in terms of how much each nation can buy with
its own currency at the prices items sell for there. While MER answers how
much Chinese would get at American prices, PPP answers how much Chinese do
get at Chinese prices.
If the Chinese converted their yuan to dollars, bought Big Macs in the U.S.,
and took them home on the plane to China to consume them, comparing the
Chinese and U.S. economies using the MER yardstick would be appropriate. But
instead, they buy them at one of the 3300 McDonald’s locations in their
home country where they cost half what Americans pay.
Explaining its decision to switch from MER to PPP in its annual assessment
of national economies—which is available online in the CIA Factbook—the
CIA noted that “GDP at the official exchange rate [MER GDP] substantially
understates the actual level of China's output vis-a-vis the rest of the
world.” Thus, in its view, PPP “provides the best available starting point
for comparisons of economic strength and wellbeing between economies.” The
IMF adds further that “market rates are more volatile and using them can
produce quite large swings in aggregate measures of growth even when growth
rates in individual countries are stable.”
In sum, while the yardstick most Americans are accustomed to still shows
that the Chinese economy is one-third smaller than the U.S., when one
recognizes the fact that $1 buys nearly twice as much in China than in the U
.S., the Chinese economy today is one-sixth larger than the U.S. economy.
So what? If this were simply a contest for bragging rights, picking a
measuring rod that allows Americans to feel better about ourselves has a
certain logic. But in the real world, a nation’s GDP is the substructure of
its global power. Over the past generation, as China has created the
largest economy in the world, it has displaced the U.S. as the largest
trading partner of nearly every major nation (just last year adding Germany
to that list). It has become the manufacturing workshop of the world,
including for face masks and other protective equipment as we are now seeing
in the coronavirus crisis. Thanks to double-digit growth in its defense
budget, its military forces have steadily shifted the seesaw of power in
potential regional conflicts, in particular over Taiwan. And this year,
China will surpass the U.S. in R&D spending, leading the U.S. to a “tipping
point in R&D” and future competitiveness.
For the U.S. to meet the China challenge, Americans must wake up to the ugly
fact: China has already passed us in the race to be the No. 1 economy in
the world. Moreover, in 2020, China will be the only major economy that
records positive growth: the only economy that will be bigger at the end of
the year than it was when the year began. The consequences for American
security are not difficult to predict. Diverging economic growth will
embolden an ever more assertive geopolitical player on the world stage.