China’s GDP growth made news this week because, on the official figures, China overtook Japan to become the second largest economy in the world in 2010. But actually, on a different way of calculating the data, this was very old news. Using purchasing power parity, China not only overtook Japan way back in 2001, but it is also quite close to overtaking the US as the biggest economy in the world – if, indeed, it has not done so already.
GDP statistics measure the amount of value added or income in the economy, measured in domestic currencies, over a given period of time. But it is more difficult to compare the GDP in one economy (China) with that in another economy (Japan), because we need to use an exchange rate which translates yuan into yen or vice versa. This is not as straightforward as it may seem.
The simplest method is just to take the market exchange rate over the period in question. This is the basis used in the comparisons which this week showed the level of GDP in China exceeding that in Japan for the first time in 2010.
The first graph shows the share of the three largest countries in global GDP, all measured in US dollars at market exchange rates. On this basis, the US has been by far the largest economy throughout the last three decades. Although Japan showed some signs of catching the US in the 1980s, it never got very close, and the gap widened again after the mid 1990s. Meanwhile, China has been on a steady climb for about 15 years, and it finally overtook Japan last year. But its share of world GDP on this basis is still less than half that of the US.
The shortcoming of these familiar calculations is that market exchange rates are known systematically to undervalue the quantum of GDP produced in the service sectors of developing economies. This is because there is no international trade in items like personal services (eg haircuts), medical services, retailing and many other internal activities. Therefore, unlike in the case of internationally traded manufactured goods, there is no tendency for trade to equalise the prices of these services in different economies. Yet a haircut in Beijing is essentially the same (well, similar anyway) to a haircut in Tokyo or New York. It is just a whole lot cheaper, if we choose to measure each of them in dollars. This problem probably results in a large undervaluation of GDP in China compared to more developed economies.
The alternative method of comparing GDP between economies is to abandon the use of market exchange rates, and to use (hypothetical) PPP exchange rates instead. In principle, these exchange rates can be calculated so that the value of all goods and services are equalised between economies, provided that they are of the same quality. A visit to the doctor in the US is valued the same as a visit to an equivalently trained doctor in China. Or that is the theory, anyway.
The IMF publishes regular comparisons of GDP based on painstaking surveys of international prices so that PPP can be estimated. This is what they look like:
On this basis, China’s GDP has been bigger than Japan’s for exactly a decade, and it is closing in fast on the level of GDP in the US. Using the IMF’s calculations, and extrapolating at recent growth rates for the two economies, China will overtake the US in about 5 years time.
Which of these two methods is more valid? That probably depends on what the figures are being used for. The former is a better guage of the international purchasing power of the citizens of each of the economies, and it is also based on actual market prices. But because most citizens spend most of the money domestically, the second set of data is probably a better guage of how well off people are in their everyday lives. After all, citizens of Beijing do not need to feel worse off just because they would have to pay a much higher price for a haircut in New York, since most of them never have to pay for a haircut in the US in the first place.
There is no dispute that, on any way of measuring GDP, the average American is still several times better off than the average Chinese citizen. On the official data used by the IMF, GDP per capita in the US in 2010 was $47,131. In China, GDP per capita was $4,282 at market exchange rates, and $7,517 at PPP rates. The latter figure is still only about one sixth of that in the US, but since the population of China is about four and a half times larger than that of the US, total GDP on this measure is not so very different between the two countries, and the gap will be closed within a few years.
One last point. Arvind Subramanian of the Petersen Institute for International Economics argues here that the IMF figures for GDP per capita in China are significantly understated, even at PPP, because they rely on price data taken almost exclusively from China’s cities, instead of its rural areas. Many prices are much lower in the rural areas than they are in the cities, which means that GDP per head in rural areas, measured at the true PPP rates, is probably higher than shown in the IMF data.
Adjusting for this and other (perhaps more dubious) factors, Subramanian says that GDP per capita in China in 2010 may have been as high as $11,047, rather than the $7,517 published by the IMF. This enhanced estimate of GDP per capita would imply that total Chinese GDP in 2010 was not only vastly higher than that in Japan, but was also very slightly higher than that in the US itself.
Subramanian’s calculations are not the official view. They are based on controversial estimates which will no doubt be hotly disputed by other economists. But they are intriguing nonetheless.
