2016, 2019, 2021, 2026. What do these dates have in common? They’re among the various predictions of investment banks and other pundits of when the Chinese economy will overtake that of the US to become the world’s largest. The most optimistic forecast (from a Chinese point of view) was that of Peterson Institute of International Economics author Arvind Subramanian in his September 2011 book Eclipse: Living in the Shadow of China’s Economic Dominance. He argued that Chinese economic output already matched that of the US in 2010 (at purchasing power parity – more of that below). And, more dramatically, that the renminbi could overtake the dollar far more quickly than generally expected. As a comparison he cited the fifteen years it took for the US to go from creating the Federal Reserve, it’s central bank, to having a larger share of world trade in dollars than in pounds sterling, the previous global reserve currency. The US was already by then a much larger economy than the UK but the transition to international financial dominance was delayed by the absence of a US central bank. Once that was in place, the UK was rapidly displaced. Only the great depression delayed the full impact of dollarisation, until from 1944 the dollar emerged utterly dominant, as it has remained, more or less, till now.
Purchasing power parity (PPP) is a way of comparing national economic magnitudes in different currencies. If you compare US and Chinese national output (Gross Domestic Product) using current market exchange rates, US GDP is still larger. PPP is used to adjust for the different cost of living between countries. One theory of exchange rates says that in the long run – the very long run – then exchanges rates should move to offset these differences in costs but commonly there is a marked difference between PPP rates and market rates. If it costs less to buy something in China at PPP rates than at market rates, then valuing output at market exchange rates will understate the real volume of output. The IMF, World Bank and international economists routinely use PPP as a more accurate measure of true economic values. But since PPP is not an exact science and opinions can reasonably differ, it’s often less controversial to use market rates.
Subramanian’s estimate of Chinese GDP was 46% higher than that of the IMF, because of various adjustments he argued the IMF should have made, drawing on other respected economic authors. Last week he cited a new report which suggests his estimate of Chinese GDP at PPP was still too low, perhaps by 20%. This report is by two economists responsible for updating the widely respected Penn Global Table, run out of the University of Pennsylvania. If the new report is even roughly accurate, China’s real economic output overtook that of the US several years ago. Even if it’s still somewhat inaccurate, the timing of when China is number one is now imminent, not some next-decade event.