For as long as we can remember, economists have tried to project a time when China would overtake the U.S. to be the world’s largest economy.
Now, Chris Giles at the Financial Times writes that China is likely to overtake the U.S. this year!
Giles draws on a new report from the International Comparison Program (ICP), that looks at the size of economies not based on market exchange rates, but through the purchasing power of parity (PPP).
The report found that “the United States remained the world’s largest economy, but it was closely followed by China when measured using PPPs.” This report is looking at figures from 2011.
What does methodology have to do with it?
But we before launch into the report’s findings, here’s a look at the methodology, since that’s crucial.
Since countries typically estimate their GDP in their national price levels and currencies, GDPs are not easily comparable. “To be compared, they must be valued at a common price level and expressed in a common currency. The ICP uses purchasing power parities (PPPs) to effect this double conversion,” according to the ICP.
PPP is way to compare incomes levels of different countries. It shows the ratio of prices in a national currency, for the same good or service, in different countries. “When converting national economic measures (e.g. GDP), into a common currency, PPPs are a more direct measure of what money can buy than exchange rates,” according to the report.
The ICP gives a very basic example of how it works:
“If the price of a hamburger in France is €4.80 and in the United States it is $US4.00, the PPP for hamburgers between the two economies is $US0.83 to the euro from the French perspective (4.00/4.80) and €1.20 to the dollar from the U.S. perspective (4.80/4.00). In other words, for every euro spent on hamburgers in France, $US0.83 would have to be spent in the United States to obtain the same quantity and quality — that is, the same volume — of hamburgers. Conversely, for every dollar spent on hamburgers in the United States, €1.20 would have to be spent in France to obtain the same volume of hamburgers.”
The PPP-based world GDP totaled $US90.64 trillion in 2011, compared with $US70.29 trillion when measured by exchange rates.
How China came out of nowhere
The report found that in 2011, the PPP-based China GDP amounted to $US13.49 trillion. Chinese GDP simply based on the currency exchange rate was $US7.32 trillion at the time. This is crucial.
PPP-based U.S. GDP amounted to $US15.53 trillion at the time.
Giles extrapolates from this to show how the change in methodology gives China the upper hand:
“In 2005, the ICP thought China’s economy was less than half the size of the US, accounting for only 43 per cent of America’s total. Because of the new methodology — and the fact that China’s economy has grown much more quickly — the research placed China’s GDP at 87 per cent of the US in 2011.
“…With the IMF expecting China’s economy to have grown 24 per cent between 2011 and 2014 while the US is expected to expand only 7.6 per cent, China is likely to overtake the US this year.”
All that being said, it’s important to remember that “PPPs are statistical estimates” and it’s hard to gauge the margin of error.
But turns out, despite its economic slowdown, the China could be well on its way to overtaking the U.S. this year.
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