Friday, January 21, 2011

Debunking Subramanian: No, China Isn't Bigger

Tom Gjelten of NPR in a piece asking "Is China's Economy Already No. 1?" tells us that "By traditional measures of gross domestic product — the value, in U.S. dollars, of total goods and services produced — the size of the U.S. economy is $14.6 trillion. China's GDP is only $5.7 trillion. But if China's economy is assessed according to its "purchasing power," it may be a different story." He further relates how Arvind Subramanian tells us that by purchasing power, their economy is already larger.

But this isn't just in conflict with tradition. Purchasing power parity (PPP) is mainly useful for assessing living standards because it adjusts for the costs of selected goods within a currency's market area. PPP gives a better sense of how many bowls of rice the average Chinese citizen can buy with their Renminbi vs how many bowls the average American can buy with our Dollar. The strength of PPP comes as a per capita measure on internal purchases. For 2010 the IMF rated per capita PPP of China at 7,518 International Dollars whereas the per capita PPP of the US is 47,123 International Dollars. So we can see that the average American can buy a lot more bowls of rice (or most anything else) in America than the average Chinese citizen can buy in China. By contrast, when they're both touring Germany, if you want some idea what the Chinese citizen can buy there vs what the American can buy there, PPP won't help you as much as GDP because their PPP figures aren't tuned for Germany's market. For international buying, you need to use the actual exchange rates, which means you want the GDP because it is listed using those very same exchange rates that would take effect for international purchases. Anyone (like Subramanian) who'd use PPP as an assessment of "the bigger economy" internationally should generally be considered dubious at best. There are good reasons why it is traditional to use GDP to compare the size of national economies. When you're looking at the ability to purchase outside of your own market, it just doesn't make sense to use a figure tuned to purchasing strictly within your own market.

If that weren't enough, by all accounts other than Subramanian, his assessment of Chinese PPP is bizarrely high. While the IMF, World Bank, and CIA World Factbook all come up with slightly different calculation results from each other, they're only slightly different from each other and way, way below what Subramanian claims. They all list China below the US in PPP by a fairly wide margin.

Then, for icing on the cake, there are the very big problems in China, such as the housing bubble mentioned in Gjelten's article. Their growth is currently on a trajectory to overtake us. But past results do not guarantee future performance. China is likely to generally grow over the coming decades, but they may face some serious stumbles and possible huge crashes as well. And while we're not doing it now, if we were to start revamping our infrastructure and investing more in our own growth, we could actually use our head start to keep our advantage. Not that we necessarily will. But it is a bit premature to say that China's economy will necessarily eclipse our economy at any point in the future. It may. It seems plausible that it will. It isn't guaranteed.

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