My calculations of GDP for 2010 — which of course are subject to the uncertainty associated with all such exercises — are based on new estimates of GDP that will soon be published by the Penn World Tables (PWT) under the guidance of Professor Alan Heston at the University of Pennsylvania.
Cross-country comparisons of economic size and standards of living of the average citizen rely on two approaches. The first uses market exchange rates to convert the economic value of goods and services produced around the world into a common currency, usually the dollar. According to the IMF’s latest estimates for 2010, the value of total US GDP was $US 14.6 trillion while that of China was $US 5.7 trillion.
But it has long been recognised by many economists that using the market exchange rate to value goods and services is misleading about the real costs of living in two countries. Such goods and services as medical services, retail and constructions services, and haircuts—that are not traded across borders are cheaper in poorer countries because labor is abundant. Using the market exchange rate to compare living standards across countries understates the benefits that citizens in poor countries enjoy from having access to these goods and services.
Purchasing power parity (PPP) estimates — which take account of these differing costs — are an alternative and, in some respects, more revealing way of computing and comparing standards of living and economic size across countries. These estimates have been published periodically in the Penn World Tables since 1970. My calculations are based on the most recent version, which is due in early February, show that the size of the Chinese economy in 2010 was about $14.8 trillion dollars — surpassing that of the United States.
How do I obtain this number?
The latest version of the Penn World Tables show an upward revision for China’s PPP-based GDP by about 27 per cent and for India by about 13 per cent for the year 2005. I use the new PWT corrections as the starting point for computing new estimates for PPP-based GDP and GDP per capita.
For this period between between 2005 and 2010, if the IMF data are taken at face value, they suggest an increase in the real cost of living in China relative to that in the United States (which is equivalent to a real appreciation of the Chinese currency) of about 35 per cent. This seems implausible because three alternative ways of assessing currency changes point to a much smaller appreciation.
First, most real exchange rate indices computed for China (for example those of JPMorgan and the Bank for International Settlements) point to an appreciation during this period of between 12 and 20 per cent. Analysis of productivity differentials between China and its trading partners, and between tradable and non-tradable sectors within China, by the IMF in its 2010 Article IV consultation (p. 19) would also imply an appreciation of the yuan of no more than 10 to 15 per cent, recalling the basic theory, which says that exchange rates between two countries should move in line with productivity differentials between them or between tradable and nontradable sectors within a country. Third, one could ask what currency appreciation would be implied for China if it behaved like the average country: For this country, estimates suggest that currency appreciation responds to the difference between its own growth rate of per capita GDP and that of the United States (in the jargon, this is called the dynamic Balassa-Samuelson effect). This procedure also yields estimates of about 10-15 per cent for Chinese currency appreciation.
If a currency appreciates, the movement is akin to an increase in the average cost of living. So taking 15 per cent as the best estimate of the currency appreciation, rather than the 35 per cent estimated by the IMF, requires adjusting China’s 2010 GDP upward by 20 per cent (because the increase in the cost of living has been overstated by 20 per cent). To be conservative, I have not adjusted GDP up by the entire 20 per cent.
These two adjustments increase China’s GDP from the current estimate of $10.1 trillion to $14.8 trillion (an increase of 47 per cent, of which 27 per cent is due to the revision in the 2005 estimate, and the rest due to smaller-than-assumed increases in the cost of living between 2005 and 2010). This $14.8 trillion figure exceeds US GDP of $14.6 trillion. It must be emphasised, of course, that the difference is small enough to be within the margin of error, although in 2011, with China’s growth likely to substantially exceed that of the United States, the difference in their levels of GDP will likely move beyond error margins.
Applying the same adjustments to GDP per capita increases the estimate for China from $7,518 (the current estimate in the IMF’s World Economic Outlook) to $11,047. The GDP per capita (the average standard of living) is now about 4.3 times greater in the US than in China compared with a multiple of 6.3 without my corrections (and compared with a multiple of 11 if GDP is computed using market exchange rates).
One interesting question is why China did not allow more representative prices to be collected as part of the ICP project in 2005. Professor T. N. Srinivasan of Yale University has long argued that China likes to exaggerate its growth rate (to showcase its strength and dynamism) and simultaneously understate its level of GDP (being seen to be poorer may have advantages internationally, such as not being expected to contribute financially to global institutions or global public goods). Overstating prices has the effect of understating GDP, and thus helps achieve this objective.
Perhaps a more important explanation of China’s behavior has to do with exchange rate politics. Had all prices been collected, China’s average price level (cost of living) would have been substantially lower. And this would have resulted in estimates of undervaluation of the Chinese currency of close to 40 per cent against the dollar. China’s trading partners would have had additional technical ammunition to deploy against its highly sensitive but demonstrably beggar-thy-neighbour exchange rate policy.
Arvind Subramanian is a Senior Fellow at the Peterson Institute for International Economics and a Senior Fellow at the Center for Global Development, in Washington DC.
This is an updated version of an earlier post, published here on the Peterson Institute’s RealTime Economic Issues Watch.
Why don’t you come to China and experience the cost of living as it really is. You can calculate back and forth as you like but the truth is that in housing prices are ten times higher compared to 10 years ago. Prices for meat and vegetables have also more than doubled compared to a few years ago. However, the salary level has not changed much over the last years, so if you go and ask the average Chinese about their purchasing power they will laugh at you. Particularly the young generation is under enormous pressure. It is now the Chinese New Year and many migrant workers in large cities decide not to go back home because the costs for transportation, gifts etc are too expensive
The size of the Chinese economy may be catching up with that of the America’s in PPP terms, but it is probably not quite close to that point yet.
It is unclear whether your calculation is correct, given that some and possibly a large portion of the Chinese growth from 2005 to 2010 is from tradable sector – it implies that its PPP growth should be lower than its headline GDP growth.
If my reasoning is correct, then the part you didn’t say but probably used in your calculation may have overstated China’s PPP level.
China’s Innovative Way of Skinning the United States!
Insanity: doing the same thing over and over again and expecting different results. – Albert Einstein
As long as the United States continues to allow China to manipulate the U.S. Dollar and therefore manipulate our trade with ALL our trading partners, our balance of trade with ALL our trading partners will be worse than it would otherwise be.
Mark Twain is credited with an early use of the cliché “more than one way to skin a cat” in A Connecticut Yankee in King Arthur’s Court, as follows: “she was wise, subtle, and knew more than one way to skin a cat, that is, more than one way to get what she wanted”. Thefreedictionary.com defines beggar-thy-neighbor as: an international trade policy of competitive devaluations and increased protective barriers that one country institutes to gain at the expense of its trading partners. Under the guise of fostering ‘indigenous innovation’, the Chinese government has creatively used a non-conventional, subtle version of beggar-thy-neighbor. Its version doesn’t entail the competitive devaluation of its own currency, which would enhance China’s exports and inhibits its trading partners’ exports to China. China’s version perpetrates an over-valuation of the currencies of one or more of its trading partners. This negatively affects all the trade of the pegged trading partner(s), not just trade with China. During the recent period China pegged its currency to the U.S. Dollar, its version of beggar-thy-neighbor was 8 times as damaging to the U.S. economy as what the media refers to as “China keeping it currency undervalued”.
In November 2003, Warren Buffett in his Fortune, Squanderville versus Thriftville article recommended that America adopt a balanced trade model. The fact that advice advocating balance and sustainability, from a sage the caliber of Warren Buffett, could be virtually ignored for over seven years is unfathomable. Until action is taken on Buffett’s or a similar balanced trade model, America will continue to squander time, treasure and talent in pursuit of an illusionary recovery.
Hugh Campbell’s short commentary appears to have some internal inconsistency.
It started with “manipulate the U.S. Dollar and therefore manipulate our trade with ALL our trading partners, our balance of trade with ALL our trading partners will be worse than it would otherwise be.”
In the middle it acknowledged the following “Its version doesn’t entail the competitive devaluation of its own currency, which would enhance China’s exports and inhibits its trading partners’ exports to China.”
It left others wondering whether China has engaged competitive devaluation or not, and hence manipulated its currency or not.
Furthermore, the US has run trade deficits with a number of countries. What does that mean? Were they all due to the others manipulate their currencies?
For considerable periods of time, the US had a strong dollar policy. So who was manipulating its currency?
I love the talk about how China is to blame for manipulating its currency coming from the US, as if the US hasn’t been economically hosing the planet since World War II. The bottom line is there’s a new kid on the block and now the US look like a bunch of whiners. They should shut up and compete and adapt. The US problems’ now are it’s own doing. You can’t blame China for trying to come up.