30 March 2019

US-China Who Is Bigger and When

When will China pass the US in economic size? The near-universal belief that the People's Republic of China (PRC) has already passed or is soon to pass the US in size' has multiple distinct flaws. These range from the gross—Chinese government statis­tics are unreliable—to the subtle—none of the ways economic size is measured are especially reliable. 

Obviously, the policies of the two countries matter, especially whether China ever returns to the pro-market reform path.2 While evaluating the competing development models is contentious and complex, growth arithmetic is simple. Putting policy aside, "the year 2030" turns out not to be a bad call for when China will pass the US in economic size, but so is "never." 

Purchasing Power Parity (Briefly) 

Gross domestic product (GDP) is the standard measurement of national economic size, but it is illuminating to start with a variation, GDP adjusted for purchasing power parity (PPP). PPP-adjusted GDP is arguably the core US-China comparison because 

it appears to show China has already passed the US in size. And the idea behind PPP itself is appealing; the equivalent of a dollar may buy more or less around the world depending on local prices, so economic com­parisons should adjust for local purchasing power. But applying PPP to Chinese GDP (the US is the base­line, so American GDP is unchanged) is so fraught with problems that it should be viewed as nearly worthless. It is not generally viewed that way, but it should be. 

PPP rests on assumptions, chiefly that the law of one price must hold for part of the purchases being compared.3 The law of one price, in turn, rests on arbitrage—making money by buying, moving, and selling in markets with different prices. Arbitrage pushes these discrete prices together over time, to a single integrated price. 

The main reason to set this aside in Sino-American economic comparison is simple: PPP does not actu­ally hold for China or in important ways for the US. Within China, it fails between the coastal and inte­rior regions.4 China does not see arbitrage pushing prices close together even within the country, much 


less internationally. A study of the US and Mexico after NAFTA went into effect still shows multiple important qualifiers to PPP between those two coun­tries and an indeterminate result. PPP does not seem to hold for US-Canada exchange rates.5 Even in economies as linked as Chinese provinces and as similar to the US as Canada, PPP fares poorly.

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