China Is Not More Economically Powerful Than the U.S., and It Is Far From Certain If and When It Will Be

06/22/2015 09:26 am ET | Updated Jun 22, 2016
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China's creation of an Asian Infrastructure Investment Bank and its plans to invest in "Silk Road and Belt" infrastructure projects in neighboring countries has raised alarm about its growing economic power. Moreover, last year, International Monetary Fund economists estimated that the Chinese economy was larger than the American. That statement made front-page headlines but was somewhat misleading because it used purchasing power parity, a measure of welfare that is somewhat dubious as an index of power. After all, a country imports oil or engines at the exchange rate, not purchasing power parity. However, even when the Chinese and American economies are equal in size as measured by exchange rates, they will not be equal in economic power. Per capita income provides a better measure of the sophistication of an economy, and China's per capita income is only a quarter of the American level. It will take many decades to catch up.

Of course, total size matters. Having a large attractive market and being the largest trading partner for a large number of countries is an important source of Chinese power but that is not the same as equality. For example, although China surpassed Germany and the U.S. as the world's largest trading nation in 2013, Chinese trade in services is lackluster, many exports have low added value and China lacks many global brands.

Sophistication in an economy also applies to technology. China has important technological achievements but its growth model has relied heavily on legal and illegal copying of foreign technologies more than domestic innovation. China now leads in number of patents issued, but most Chinese patents relate to the less important parts of the entire industrial chain. While this is beginning to change, some Chinese complain that they are better at producing iPhone jobs than Steve Jobs.

"China's per capita income is only a quarter of the American level. It will take many decades to catch up."

In monetary affairs, China has tried to increase its financial power by encouraging the international use of the yuan but as The Economist notes, "size and sophistication do not always go together. In the 2020s, China will probably be the world's biggest economy, but not its most advanced. America's sophistication is reflected in the depth of its financial markets." And although China holds the world's largest foreign currency reserves, they do not give China much power over the U.S.

In an interdependent relationship, power depends on asymmetries in the interdependence, and China depends heavily on access to the American market. Dumping dollars would be self-destructive. In 2009, some Peoples Liberation Army officials suggested that China use its dollar reserves to punish the United States for its arms sales to Taiwan, but economic officials quickly pointed out that this would impose intolerable damage on their own economy.

China's impressive 10 percent economic growth rate has slowed. Chinese officials now say 7 percent is the "new normal," but based on a statistical analysis of previous high growing countries (such as Japan, which also once had 10 percent growth), Lawrence Summers and Lant Pritchett estimate that Chinese growth may drop to around 4 percent. This, of course, would postpone the date that China is projected to have a larger economy than that of the United States. Some economists now project a crossover around 2030; but Charles Wolf of RAND thinks it will not occur until the 2050s. All such estimates are somewhat arbitrary and depend on assumptions about future growth rates.

Some Chinese fear that unless they change the growth model that has brought them success in the past, they may fall into a "middle income trap." This is not an iron law but a regularity that many countries encounter if they fail to change after they have picked the low hanging fruit of the early stages of industrialization. China faces serious problems of transition from inefficient state-owned enterprises, growing inequality, environmental degradation, corruption and an inadequate rule of law. In addition, China will begin to face demographic problems from the delayed effects of the one child policy. China's labor force has already peaked and its population is likely to shrink after 2030. Chinese express concern that their country is "getting old before getting rich."

"China has not yet found a way to solve the problem of political participation (if not democracy)."

However, the biggest uncertainty is political. Generally, when countries approach $10,000 per capita income (as China has), they experience increasing demands for political participation. Unlike India, which inherited a democratic constitution at independence, China has not yet found a way to solve the problem of political participation (if not democracy). The legitimacy of the ruling Communist Party rests on economic growth and ethnic Han nationalism. President Xi Jinping's anti-corruption campaign aims to bolster legitimacy, but it has also contributed to a climate of fear and uncertainty.

Cyber politics adds another dimension. While China has highly developed systems of filters, censorship and punishment of dissenting views, more Chinese have access to more information than in earlier eras. Whether China can develop a formula that can manage an expanding urban middle class, regional inequality and resentment among ethnic minorities remains to be seen. No one, including Chinese leaders, knows how China's political future will evolve and how that will affect its economic growth.

What does this tell us about when China will pass the United States in economic power? Straight-line extrapolations of current trends are bound to be misleading. All we can say is that China is not more economically powerful than the U.S. today, and it is far from certain if and when it will be.

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