When Mismeasurement Matters: China is Bigger Than You Think

By Mark Weisbrot

This article was published in the following news outlets:

Salt Lake Tribune - April 21, 2006
Arkansas Democrat-Gazette - April 23, 2006
Augusta Chronicle - April 24, 2006
Journal Star (Peorial, IL) - April 30, 2006

Chinese President Hu Jintao's visit to the United States comes at a time of increased tensions between the two countries over a number of economic and foreign policy issues. The United States’ trade deficit with China, now about $200 billion annually, is the big one. There are also differences over how to deal with Iran’s nuclear program, where Washington is seeking UN sanctions against Iran while Beijing is opposed. And a recent Pentagon report cited China as the country with “the greatest potential to compete militarily” with the United States.

Will China continue to be a huge and growing trading partner and recipient of U.S. foreign investment, or will relations deteriorate, possibly toward a new Cold War? One thing that would be helpful in assessing U.S.-China relations is a reasonable measure of the size of China's economy. Most Americans, including policy-makers, do not realize that China already has the second-largest economy in the world. At current growth rates, it will pass the United States in less than a decade.

For the first time in more than a century, the United States will no longer have the biggest economy in the world. This has profound implications for our foreign policy, and is not very far away.  Washington will most likely be forced to shift more towards the diplomacy that most Europeans favor, and rely less on military or even economic muscle to achieve its international goals. The main reason why this historic change has not been foreseen is that China's GDP is usually reported on an exchange-rate basis. In other words, the value of China's annual output of goods and services is converted to dollars on the basis of the exchange rate between the dollar and the Chinese currency (renminbi) – currently about 8 renminbi per dollar.

So China is reported as having the sixth largest economy in the world, and one that will not catch up to the U.S. until 2041. But for most comparisons, this is the wrong measure. Anyone who has been to China and the U.S. will testify that 8 renminbi (the value of a dollar in Chinese currency) will buy more of most things in China than a dollar will buy in the United States. Because of these price differences, economists use what is called Purchasing Power Parity (PPP) GDP to make these kinds of international comparisons. This measure tries to adjust for the price differences between countries.

By this measure, according to IMF data, China's economy is more than eight trillion, or about two-thirds the size of the U.S. economy. This is vastly different from the $2 trillion, or 15 percent of U.S. GDP that is often reported. The PPP measure of GDP is what matters for such things as military power, too – it costs much less in China than in the U.S. to build a plane or put a soldier in the army.

Unlike the Cold War with the USSR – during which we were able to enact Medicare, Medicaid, and significantly increase spending on Social Security – a Cold War with China as it grows larger than the United States could force enormous reductions in our living standards. Although it may still happen, we are currently a long way from any such breakdown in relations. The most powerful business interests in the United States have too much at stake, especially since China has agreed – in joining the World Trade Organization – to a radical opening of its telecommunications, financial services, and insurance industries. These multi-billion dollar opportunities could go to Europe and other competitors who – again unlike in the Cold War era – would be loathe to cooperate against China if it meant abandoning the world's fastest growing market for their exports. It is also probably noticed in some policy-making circles that China today could trigger a sharp spike in U.S. long-term interest rates, simply by dumping a fraction of its huge accumulation of U.S. Treasury bonds. This would drive up mortgage rates and burst the housing bubble here, very likely triggering a recession.

So the current tensions with China over trade or foreign policy issues are likely to be papered over, at least for the present. From a U.S. business point of view, especially, China is just too big for U.S.-China relations to fail.

Mark Weisbrot is co-director of the Center for Economic and Policy Research, in Washington, DC.