Does size matter? China poised to overtake US as world’s largest economy in 2014

Containers sit stacked on a cargo ship berthed at Qingdao Port in Lianyungang, China

According to the latest estimates from the International Comparison Program, hosted by the World Bank, China is poised to overtake the US as the world’s largest economy later this year, toppling it from a perch it has held since 1872.

That is several years ahead of all previous estimates and reflects just how much more important the Chinese economy is now to the rest of the world.

Since the financial crisis, China has contributed around one quarter of global growth and even as it slows that contribution is still likely to increase given how big its economy has become.

The news is likely to be greeted with delight by President Xi Jinping, who will place the “world’s biggest economy” title front and centre in the trophy cabinet dedicated to his campaign for the “great rejuvenation of the Chinese nation”.

But while China as a country will soon be able to claim the top spot, the living standards of the average Chinese citizen are still far lower than those in many developing countries, let alone in the West.

Before the latest estimates, China’s economy ranked 93 in per capita purchasing power parity terms, according to the International Monetary Fund. That was just ahead of Turkmenistan and Albania but well behind Libya, Azerbaijan and Suriname.

That means that on average China’s 1.36bn people are unlikely to catch up with Western living standards for many decades to come.

The latest estimates from the ICP are based on purchasing power parity, which attempts to adjust the size of an economy based on the assumption that prices of non-tradable goods and services like haircuts are a lot lower in poorer countries.

The results can vary wildly depending on how those prices are adjusted and the ICP’s conclusions will almost certainly be controversial among economists.

The first problem is how you value the good or service beyond the price that is paid for it.

A person can get a haircut in Beijing for a pittance but is unlikely to derive the same satisfaction or perceived value from their two-minute crew-cut as someone who paid $100 in New York or even in an expensive hair salon in Beijing. Likewise, a consumer can buy a cheap toaster or DVD player in Beijing but if they want one they know will last longer than a couple of months they will pay a lot more than their counterparts in the West, where consumer protection laws are far more robust.

Another major problem in the case of China is the quality of underlying data.

In such a vast country controlled by a secretive authoritarian government that sometimes manipulates data for political purposes, measuring the true size of the economy is very hard.

By some estimates, China’s economy could be at least 20 per cent larger than official figures show, thanks to a huge amount of illegal and uncounted “grey income”, such as proceeds from corruption.

Add on to that a huge and thriving sex industry, numerous illegal street vendors and other services sectors that are not counted in official statistics and the Chinese economy may have overtaken the US several years ago.

On the flip side, local government officials often overstate growth figures in order to improve their chances of promotion, thereby distorting the data in the other direction.

The question of exactly when China will overtake the US as the world’s largest economy in PPP terms is less controversial when you recognise this will almost certainly happen even in real exchange rate terms within the next five or 10 years.

The bigger question is probably the quality of growth and the actual impact it has on ordinary people’s lives.

Before the financial crisis China’s growth was already extraordinarily reliant on investment but in the last five years investment as a share of GDP jumped nearly 10 percentage points and now makes up around half of total GDP.

The majority of that investment is paid for with credit and goes into infrastructure, particularly real estate-related infrastructure, which now directly accounts for around 16 per cent of GDP on its own.

Apart from being unsustainable, growth of this sort also has limited value if it does not translate into higher consumption and better living standards at some point in the future.

In the last three decades, average living standards in China have clearly increased for most people but the benefits of growth have also been distributed very unevenly.

Today, inequality in this nominally socialist country is now much worse than the US, the epitome of a capitalist country. The level and availability of social services such as health, pensions and unemployment benefits are also much lower proportionally than in the US and even many other developing countries.

A popular joke among Chinese economists describes two economics students who make a bet compelling each other to eat dog faeces in exchange for Rmb1m.

After carrying out the bet and handing Rmb1m to each other both realise neither is better off than before but both now have a foul taste in their mouths so they go to their professor to ask his opinion on their wager.

The professor responds gleefully: “This is fantastic news,” he says. “You may both be worse off than before but the two of you have just added Rmb2m to China’s GDP.”

One of the most striking outcomes of rapid economic growth in China over the last three decades has been the deterioration of quality of life thanks to shocking levels of air, water and soil pollution.

In China’s crowded megacities, ordinary citizens ask what use higher GDP figures are if they can’t breathe the air or drink the water and if going to the doctor or buying an apartment can bankrupt their entire family.

Many Chinese people, including President Xi himself, still choose to send their children to study in the West and if they have the option they still prefer to be an ordinary citizen in a wealthy country than a wealthy one in a big poor country like China.