Dreaming of Number One

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A Hugh Grant response to the news of China becoming the largest economy in the world

‘Next time someone tells you China is the number 1 economy, a bumbling Hugh Grant response is probably apt: “well, yes um, maybe, but, for how long, and, why does it matter?”’

Over the past few weeks there have been a host of stories about China overtaking the US as the largest economy in the world. This stems from analysis undertaken by the World Bank’s International Comparison Programme (ICP) which has revised its methodology for calculating comparative GDP. These updated figures suggest that economic output in China – in terms of purchasing power parity – was higher in 2011 than previously thought and that rather than overtaking US GDP towards the end of this decade, the moment of truth could come later this year.

But is China really the soon-to-be crowned number 1?

Economic output is a function of two things – the amount of labour and the productivity of that labour. China has a clear advantage with regard to the former because of its massive population of over 1.3 billion people. But in terms of the productivity of its workforce, it still ranks amongst middle income countries – on par with the likes of Indonesia and Brazil. As a result, while China comes a clear second in terms of overall output (these are 2011 figures), it is significantly below the advanced economies of North America, Asia and Europe in terms of output per person (see chart 1). And this is important – GDP per person is a better measure of overall prosperity within a country because it takes account of population size.

Scatterplot showing overall GDP against GDP per person

And on an output per person basis, Chinese catch-up is likely to remain a long way off the US over the coming years (see chart 2).

ben 2

A demographic timebomb?

Just as China looks set to overtake the US economy in terms of overall output, demographic trends are looming large. The Chinese working age population is set to fall by nearly 40% over the course of this century by comparison to a 25% rise in the United States (see chart 3). As a result of these diverging demographics, it will particularly important that the productivity of the Chinese workforce continues to grow at breakneck speed to offset a falling working age population.

ben 3

How much is enough?

According to our very rough calculations, assuming population change consistent with the UN’s predictions, Chinese productivity per person in the labour market will need to grow by 3% a year more than in the US in order to maintain and grow its position as the largest economy. If, for example, US productivity grows faster than expected at around 5% per annum, and Chinese productivity slumps to around 7% per annum, then China will not catch-up until 2025 and will only move slowly ahead over subsequent years (see chart 4 for the various scenarios).

ben 4

…there are lies, damn lies and statistics

As ever, when looking at measures of GDP – and particularly comparing GDP across countries – it is important to take these figures with a pinch of salt. As well as deciding on what goods and services should be included in a measure of GDP, analysts must decide on an appropriate method of measuring this output, adjust for price rises within an economy to account for inflation, and ensure whatever measure is used is comparable across countries – in this case they use the US dollar to create a standardised measure. Each stage is far from trivial and fraught with its own challenges. Any comparative measure is therefore a rough proxy at best.

And – a final but vital point – GDP is only one measure of a country’s wellbeing. Life expectancy, infant mortality and absolute poverty are arguably just as important for gaining a full picture about the standard of living within a country. Now of course, higher GDP is often positively associated with many of these other indicators, but not always, and it can mask significant inequalities.

So next time someone tells you China is the number 1 economy, a bumbling Hugh Grant response is probably apt: “well, yes, um, maybe, but, for how long, and, why does it matter?”

Ben Franklin

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