May 31, 2020 — The World Bank on May 19, as it does every six years, released the results of the most recent International Comparison Program (ICP), which measures price levels and GDPs across 176 countries. The new results are striking. It is surprising that they have received almost no attention so far, perhaps overshadowed by all things coronavirus.
For the first time, the ICP shows China’s total real income as slightly larger than the US. It reports that China’s GDP was $19,617 billion in 2017, in Purchasing Power Parity (PPP) terms, while the United States’ GDP stood at $19,519 billion.
Income per capita
On the other hand, when China’s income is divided by its population, it is revealed to be still far from a wealthy country: its income per capita has pulled ahead of Albania and Egypt, but remains behind Brazil, Thailand, Mexico, and Botswana. China’s standard of living is still below the global mean, $10,858.
The two concepts — the total size of the economy and the level of income per capita — each have major possible implications. One must be careful to keep them apart, however, and to use the right measure for the right purpose.
China wants to be considered a developing country. For example, although the country had to give up many of the concessions traditionally accorded developing countries when it acceded to the WTO, it has not given up all of them. The ICP statistic for income per capita indicates that China is indeed still a developing country.
Total GDP
But it is the total size of the economy that matters for topical questions of great power rivalry and China’s appropriate weight in international institutions. Here the right answer is less clear. The contribution of the ICP enterprise is to compare countries’ incomes on a PPP basis. This is the right way to do it when computing income per capita. But I would argue that for questions of geopolitical power, it is better to compare national GDPs at actual exchange rates, not PPP exchange rates. At actual exchange rates, the US economy remains far ahead of China.
The ICP statistics released this month pertain to 2017. (The three-year lag in processing the numbers is typical.) China’s growth since then, though well down from the glory years of 1980-2010, has exceeded US growth. Thus, it would remain true in 2020 that the Chinese economy is bigger than the American economy, when compared on a PPP basis. But China is still far behind when compared by actual exchange rates.
What does it mean to use PPP for the comparison?
The question whether to compare national incomes by means of PPP or by means of actual exchange rates is familiar to international economists. This annoying but unavoidable technical problem arises because China’s output is measured in its currency, the renminbi (RMB), while US income is measured in dollars. How should one translate the numbers so that they are comparable? The obvious solution is to use the contemporaneous exchange rate: Multiply China’s RMB-measured GDP by the dollar-per-RMB exchange rate, so that it is expressed in dollars. By this calculation, the American economy remains more than half again as big as China’s, according to the latest figures. In 2017, US GDP was $19,519 billion, while China’s GDP translated to $12,144 billion.
Where does the PPP version come in? If one wants to measure the standard of living of Chinese citizens, one has to take into account that many goods and services are cheaper on that side of the Pacific. One yuan goes further if it is spent in China than if it is spent abroad. True, some internationally traded goods have similar prices in both countries. But haircuts and housing, services that cannot readily be traded internationally, are cheaper in China than in the US. For this reason, if one wants to compare income per capita across countries, one needs to measure local purchasing power, as the ICP does.
What is the right way to measure economic size?
The PPP measure is useful for many purposes. It is right for computing income per capita, so as to know which governments have been successful at raising their citizens’ standard of living and whether they should be classified as developing. But not for questions of geopolitical power in particular. There is a fascination with the question how China’s economic size or power compares to America’s, and especially whether the challenger has now displaced the reigning champ as #1. PPP rates are not the best ones for making this comparison.
Why do we consider the United States the incumbent number 1 power in the first place? Partly because it is rich; but not just that. If income per capita were the criterion, then Luxembourg, Qatar, Norway, and Brunei would all rank ahead of the US. If you are choosing what country to be a citizen of, you might want to consider one of these richest countries. But we don’t consider Brunei and Luxembourg to be among the world’s leading economic powers, because they are so small. What makes the US the #1 economic power is the combination of having one of the highest populations together with having one of the higher levels of income per capita.
When we talk about size or power, we are talking about such questions as the following. From the viewpoint of the International Monetary Fund and other multilateral agencies, how much money can China contribute, and how much voting power should it get in return? From the viewpoint of countries with rival claims in the South China Sea, how many ships can its military buy? For these questions and most others where the issue is total economic heft, it is better to use GDP evaluated at current exchange rates. It is how much the RMB can buy on world markets that is of interest, not how many haircuts or other local goods it can buy back home. True, the Chinese government can pay more soldiers or sailors with one million RMB than the US government can pay with the equivalent sum of US dollars. But the productivity of the US military personnel is higher.
The preceding ICP report
Some readers might recall reports six years ago that China’s economy was already surpassing the US. The story was based on the April 29, 2014, World Bank release of the preceding report from the ICP. That one immediately received substantial media coverage. (“China poised to pass US as world’s leading economic power this year” ran the headline in the Financial Times.) Those ICP numbers, which pertained to 2011, showed China’s GDP still behind the US, but gaining rapidly on it.
Subsequently (toward the end of 2014), it was reported that the cross-over had indeed taken place, based on the use of national growth statistics to interpolate in between the six-year ICP benchmarks. But that announcement was premature. The ICP statistics have not shown China’s GDP bigger than the US until now.
Among those accepting as gospel that China has surpassed the US is Graham Allison, in his influential 2017 book Destined for War: Can America and China Escape Thucydides’s Trap? He argues that when a rising power catches up with a status quo power, there is a danger of war. Thucydides, historian of ancient Greece, wrote: “It was the rise of Athens, and the fear that this inspired in Sparta, that made war inevitable.” Out of a set of 16 historical cases in the last 500 years where a newcomer power caught up with an established power, the book says, 12 ended in war. It stops short of predicting war between China and the US. (For one thing, the book makes no attempt at a statistical test, which would use a control group of pairs of comparably sized powers.) Allison suggests that conflict can be averted, if both countries behave wisely.
What does the IMF say?
Commentators such as Allison assert that the IMF says that the PPP basis is the right way to make the comparison and that it reports on this basis that China is larger than the US. It is true that the database for the IMF’s World Economic Outlook includes statistics that measure the weights of countries’ GDPs in PPP terms. It does this by extrapolating between the six-yearly-ICP measurement of GDP, based on separately measured real growth rates in each country. For arbitrary reasons of tradition, the IMF’s WEO has emphasized the PPP method when computing the weights to aggregate nations’ growth rates together, while the World Bank emphasizes the use of actual exchange rates in its own aggregation (which is ironic, in that the ICP numbers come from the World Bank).
But the IMF, in fact, has no official position on which economy is bigger or what is the right way to make the comparison. The closest it comes to an official position is the formula that guides the assignment of quota shares to member countries. The formula puts a weight of 50% on economic size, i.e., a GDP measure, and the rest on other indicators such as trade openness). The formula’s index of GDP itself assigns a weight of 60% to GDP measured at market exchange rates and only 40% to GDP at PPP rates.
The IMF takes the quota sizes seriously. For one thing, if China were to attain a higher quota than the US, the Articles of Agreement say that the Fund would have to move its headquarters from Washington DC to Beijing, as then-Managing Director Christine Lagarde noted in 2017.
For now, the weight of China’s influence at the IMF remains far behind the US. But under its current president, the US is rapidly giving up influence in multilateral organizations such as the WTO, NATO, and – even in the midst of the global COVID-19 pandemic — the World Health Organization. One can expect that China will fill the vacuum.
International relations are not a zero-sum game, especially in the coronavirus age. For 75 years the US has had the best of both worlds: a stable multilateral rules-based system and hegemonic perks such as the special role of the dollar. The US does not lack the economic or financial power to sustain its leadership of the international order. But under President Trump, it lacks an understanding of why it is important.
| Alternative Comparisons of GDPs | ||||||
| $ billion | 2020 (extrapolated)* | 2017 | 2011 (revised) | |||
| China | US | China | US | China | US | |
| PPP | 21,761 | 20,679 | 19,617 | 19,519 | 13,883 | 15,543 |
| Market FX rate | 13,471 | 20,679 | 12,144 | 19,519 | 7,573 | 15,543 |
| * Q1 2020, annualized. | ||||||
| Sources: ICP, BEA, NBS, Chinamoney,and author’s calculations. The extrapolation uses real growth rates. | ||||||
[A shorter version appeared at Project Syndicate and the Guardian. Comments can be posted there, or at Econbrowser.]