Economy's size matters but only to a point

Economy's size matters but only to a point

That China will one day topple the United States from its perch as the world's No.1 economy, for the first time since the 1800s, has been as close to a foregone conclusion as it gets in economic circles.

Last year, China already overtook the US as the largest trader in goods, four years after it became the biggest goods exporter.

Projections of when China's economy will leapfrog that of the US have ranged from 2016, according to the Organisation for Economic Co-operation and Development, to 2028, going by London-based economic consultancy Centre for Economics and Business Research.

But a new set of figures, released by the World Bank's International Comparison Programme (ICP) yesterday, now suggests that the seismic shift could happen as early as this year - at least by one measure.

This is not because China has grown more quickly than expected, or that the US economy has stagnated, although both of those are true to some extent.

Rather, the change in pecking order boils down to statistical quirks. To measure the size of an economy relative to others, economists sometimes adjust for the value of the different currencies and how they affect living standards. This is done by converting the currencies not simply at market exchange rates, but at a more painstaking level of how many comparable goods and services each unit of currency can buy in their own countries.

The ICP has just completed its latest and most comprehensive study of 199 of the world's economies based on this measure of purchasing-power parity (PPP), which has led it to conclude that countries such as China and India have much bigger economies than it earlier estimated.

China's economy was 86.9 per cent the size of the US' as of 2011, double the 43.1 per cent it made up in the ICP's last study in 2005. Going by its growth rates since 2011, China should just pip the US by the end of this year.

But while this marks a milestone in China's economic influence, it is not the only - perhaps not even the most important - barometer of economic success.

China is still only about 60 per cent the size of the US economy based on market exchange rates, which remain more relevant "for most business and financial market purposes", notes RBS economist Louis Kuijs.

Market exchange rates are also more commonly used for ranking economies by size and economic clout, as these are the rates each country must pay in international markets for imported goods and services. On this measure, Mr Kuijs expects China to overtake the US only in 2022-2023.

More importantly, the US looks set to remain richer than China for much longer. Even on a PPP basis, China's gross domestic product (GDP) per capita is merely a fifth of America's.

The US also consumes double what China does, a reflection of its higher living standards. The ICP considers per capita consumption "a better measure of material well-being" than per capita GDP, which includes collective goods - such as defence - that are not what households purchase for their own use.

"The absolute size of the economy is not the be-all and end-all... the methodology counts, as PPP estimations are never a walk in the park," noted OCBC economist Selena Ling. "While China may give itself a pat on the back, the socio-economic challenges for the developing nation remain significant, to say the least."

Driving home the extent to which the ICP's study is mainly an academic one is the fact that, based on its PPP measurement, India's economy has overtaken Japan's in size - despite India ranking only 10th on the basis of market exchange rates.

In any case, the size fight is not yet decisively over. China's economy, grappling with a rebalancing of demand, is likely to see slower growth in the next few years while the US enjoys a shale gas-fuelled resurgence.

Still, it is just a matter of time before China, with its 1.4 billion population to the US' 318 million, claims the title of the world's No.1 economy permanently.

"China will also likely surpass the US as the world's largest foreign direct investor by 2025, and as the world's largest economy in nominal US dollar terms before 2030, by our estimates," said Bank of America Merrill Lynch economist Chua Hak Bin.

Given this, the world economic order ought to start rearranging itself to reflect the inevitable. China, and India, will no doubt ask for - and should receive - greater representation in international organisations such as the International Monetary Fund.

China's economic leadership will also likely benefit Asia, notes Dr Chua.

"Asia has already felt China's prowess as a trading powerhouse, and will increasingly feel the full force of China's weight as a consumer and investor in the coming years," he said. "The world, including Asia, is only starting to grapple with this dramatic shift in the balance of power."

This article was published on May 1 in The Straits Times.

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