The World Bank recently said that China’s economy would surpass that of the US this year, measured according to purchasing power parity (PPP). However, this is far from a holistic depiction of China’s global economic standing.
Though PPP can serve some purpose in comparing welfare across nations, it is affected significantly by population size. India, the world’s 10th-largest economy measured by the market exchange rate of the US dollar and the Indian rupee, is the third-largest in PPP terms. Moreover, power resources, such as the cost of imported oil or an advanced fighter aircraft engine, are better judged according to the exchange rates of the currencies that must be used to pay for them.
To be sure, total size is an important aspect of economic power. China has an attractive market and is many nations’ largest trading partner — important sources of leverage that China’s leaders are not afraid to wield.
However, even if China’s overall GDP surpasses that of the US — by any measure— the two economies will maintain very different structures and levels of sophistication. China’s per capita income — a more accurate measure of economic sophistication — amounts to just 20 percent of the US’, and will take decades at least to catch up, if it ever does.
Moreover, as Chinese officials and researchers have acknowledged, though China surpassed Germany in 2009 as the world’s largest exporter by volume, it has yet to develop into a truly “strong” trading country, owing to lackluster trade in services and low value-added production. China also lacks the kind of strong international brands that trade powerhouses like the US and Germany boast; indeed, 17 of the top 25 global brands are from the US.
China’s lagging economic sophistication is also reflected in its financial markets, which are only one-eighth the size of the US’, with foreigners permitted to own just a tiny portion of Chinese debt. Though China has tried to increase its financial clout by encouraging the international use of its currency, yuan-denominated trade still represents just 9 percent of the global total, compared with the US dollar’s 81 percent share.
Not even China’s massive foreign-currency reserves — the world’s largest, at nearly US$4 trillion — will be adequate to boost its financial leverage, unless the authorities create a deep and open bond market with liberalized interest rates and an easily convertible currency. These reserves do not give China much direct bargaining power over the US, either, given that interdependent relationships depend on asymmetries.
China holds US dollars that it receives from its exports to the US, while the US, by keeping its market open to Chinese products, helps to generate growth, employment and stability in China. Yes, China could bring the US economy to its knees by dumping its dollars, but not without taking a serious hit itself.
The differences between China and the US in terms of economic sophistication extend to technology as well. Despite some important achievements, China relies on copying foreign inventions more than domestic innovation for its technological progress. Though China is issuing more patents than ever, few represent groundbreaking inventions. Chinese often complain that they produce iPhone jobs, but not Steve Jobs.
In the coming decades, China’s GDP growth will slow, as occurs in all economies once they reach a certain level of development — usually the per capita income level, in PPP terms, that China is approaching. After all, China cannot rely on imported technologies and cheap labor to support growth forever. Harvard economists Lant Pritchett and Lawrence Summers have concluded that regression to the mean would place Chinese growth at 3.9 percent for the next two decades.
However, this straightforward statistical estimate does not account for the serious problems that China must address in the coming years, such as rising inequality between rural and urban areas, and between coastal and inland regions. Other major challenges include a bloated and inefficient state sector, environmental degradation, massive internal migration, an inadequate social safety net, corruption and weak rule of law.
Moreover, China will face increasingly adverse demographic conditions. After enforcing a one-child policy for more than three decades, China’s labor force is set to peak in 2016, with elderly dependents outnumbering children by 2030. This has raised concerns that the population will grow old before it grows rich.
China’s authoritarian political system has demonstrated an impressive ability to meet specific targets, from the construction of high-speed railways to the creation of entire new cities. What China’s government is not yet prepared to do is respond effectively to increasingly loud demands for political participation — if not democracy — that tend to accompany rising per capita GDP. Will political change occur when per capita nominal GDP, now at about US$7,000, approaches US$10,000, as occurred in Taiwan and South Korea?
It remains to be seen whether China can develop a formula to manage an expanding urban middle class, regional inequality, and — in many places — restive ethnic minorities. Its lagging economic sophistication might further complicate matters. In any case, it means that aggregate GDP is inadequate to determine when — and whether — China will overtake the US in economic power.
Joseph Nye is a professor at Harvard University and chairman of the World Economic Forum’s Global Agenda Council on the Future of Government.
Copyright: Project Syndicate
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