China as the World’s “Largest Economy”

China as the World’s “Largest Economy”

January 29, 2015
China as the World’s “Largest Economy”
Various media have recently reported that China has
How does the PPP Exchange Rate
overtaken the United States to become the world’s largest
Calculation Affect the Estimated Size of
economy (a position the United States had held at least
China’s Economy?
since 1913), based on estimates of purchasing power parity
The IMF’s PPP data are based on price surveys conducted
(PPP) measurements and projections made by the
globally by the World Bank, the most current of which was
International Monetary Fund (IMF). What do these data
done for 2011. The sharp differential in prices between
mean? How should they be interpreted? And what
China and the United States resulted in an estimate of
implications, if any, do they have for the United States?
China’s 2011 PPP exchange rate with the dollar that was
84.3% greater than the nominal exchange rate, which in
What Are PPPs and Why Are They
turn, raised the estimated value of China’s GDP in PPP
Used?
terms by the same level. The IMF’s PPP data raise China’s
The IMF’s World Economic Outlook (WEO) provides
2013 GDP to $16.1 trillion (95.3% of the U.S. level) and
comparative economic data and makes economic
the projected 2014 level to $17.6 trillion, which exceeds
projections for numerous countries several times a year.
that of the projected 2014 U.S. level by 1.1%. The IMF
These include country measurements of gross domestic
further projected that China’s 2019 GDP on a PPP basis
product (GDP) converted into U.S. dollars using nominal
would be 21.7% greater than the U.S. level.
exchange rates. The October 2014 WEO database estimated
U.S. and Chinese nominal GDP for 2013 at $16.8 billion
Figure 1. Estimates of U.S. and Chinese GDP on a
and $9.5 billion, making them the number one and number
PPP Basis: 1980-2013 and Projections through 2019
two largest economies, respectively. The IMF further
($ in billions)
projected that 2014 nominal GDP for each at $17.4 trillion
and $10.4 trillion, respectively. These data would indicate
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that U.S. GDP is much larger than China’s (76.8% higher in
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2013). However, many economists contend that using
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nominal exchange rates to convert foreign currency into
U.S. dollars for comparing GDP can be misleading. First,
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China pegs its currency (the renminbi or RMB) largely to
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the U.S. dollar and has intervened in currency markets to
limit its appreciation, leading some observers to charge that
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the RMB is undervalued against the dollar, which in turn
would affect estimates of China’s GDP. Second, n
0
ominal
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exchange rates simply reflect the prices of foreign
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currencies vis-à-vis the U.S. dollar and such measurements
U.S.
China
do not take into account differences in the prices for goods

and services across countries. To illustrate, one U.S. dollar
Source: International Monetary Fund.
exchanged for RMB in China would buy more goods and
Factoring in Per Capita GDP
services there than it would in the United States. This is
because prices for goods and services in China are
China’s emergence as the world’s largest economy in PPP
generally much lower than they are in the United States.
terms should be put into perspective, especially given that
China’s population is nearly 4.3 times greater than that of
To factor in these differences, many economists attempt to
the United States. China’s GDP on a per capita on a PPP
calculate a PPP exchange rate, based on price surveys that
basis, a common measurement for comparing international
are conducted across countries, to reflect the actual
living standards, is considerably smaller than the U.S. level.
The IMF estimates China’s 2014 per c
purchasing power of each currency relative to the dollar in
apita GDP on a PPP
real terms. Thus, for example, if China produced one ton of
basis at $12,893, equivalent to 24% of the U.S. level
steel, the PPP exchange rate would attempt to reflect the
($54,678). Even with a rapidly growing GDP, Chinese
value of that steel in the United States. Although the PPP
living standards are not likely to approach U.S. levels for
data have numerous shortcomings and do not reflect quality
several decades. The Economist Intelligence Unit projects
that by 2030, China’s per capita GDP on a PPP basis will
of life measures (such as clean air, political freedom, health
and safety, leisure time, etc.), they are considered by many
amount to only 39% of U.S. levels.
economists to be a more accurate method to make
China’s Economy from a Historical
international comparisons of certain GDP data than the use
Perspective
of nominal exchange rates.
This would not be the first time that China has been the
world’s largest economy. According to one study by
https://crsreports.congress.gov

China as the World’s “Largest Economy”
economist Agnus Maddison, China was the world’s largest
Figure 3. Estimates of Chinese and U.S.GDP on a PPP
economy from at least 1500 to 1870. In 1820, China
Basis as a percent of Global Total: 1980-2012 and
accounted for an estimated 33% of global GDP on a PPP
Projections through 2019
basis. However, foreign and civil wars, internal strife, weak
(in %)
and ineffective governments, distortive and sometimes
disruptive economic policies, and rapid economic growth
25
and productivity in other countries caused China’s share of
20
global GDP on a PPP basis to decline significantly over the
next subsequent century, falling to 5% by 1978. Once
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China undertook comprehensive economic reforms,
beginning in 1979, its economy began to expand rapidly
10
(annual real GDP growth averaged nearly 10% through
2014), helping to restore it as a major economic power.
5
China’s share of global GDP on a PPP basis was estimated
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by the IMF at 16.5% in 2014 (up from 2.3% in 1980) and is
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projected to reach 19.3% by 2019. China’s real GDP
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growth has slowed in recent years, but it still averaged
China
United States
about 7.6% from 2012 to 2014. Many economists contend

that China’s ability to maintain relatively healthy economic
Source: International Monetary Fund.
growth in the long run will depend on its ability to deepen
Implications of China Becoming the
economic reforms.
World’s “Largest Economy”
Figure 2. Estimates of U.S. and Chinese Per Capita
While China’s economic rise does not necessarily imply
GDP on a PPP Basis: 1980-2013 and Projections
that the United States is in economic decline, or is in a zero-
through 2019
sum game, it may imply that the United States is no longer
(in $)
the dominant economic power it once was. China’s
continued economic rise may lead it to seek a larger role in
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setting global trade rules and economic policies, which may
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not always coincide with U.S. goals. Some view China’s
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economic ascendency as a major source of its rising “soft
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power,” the ability to influence other nations, because they
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admire and/or seek to emulate China’s economic system.
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China’s rapidly growing economy and large consumer
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market have made it an increasingly attractive market for
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foreign exporters and investors, including those from the
United States. China could also become an increasingly
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important source of FDI flows to the United States.
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U.S.
China
While the PPP data purport to show that China is the
world’s largest economy, such data are not an indicator of
Source: International Monetary Fund.
the quality of that development relative to the United States.
China’s economic rise is also reflected in a number of other
For example, while the role of the RMB in global finance
categories where China ranks first in the world, including in
and trade is increasing, it is not likely to replace the dollar
total merchandise trade (estimated at $3.2 trillion in 2014),
anytime soon as the world’s main reserve currency. In
gross value-added manufacturing (at $2.6 trillion in 2012),
October 2014, the dollar accounted for 43.5% of global
payments, compared with 1.6% for the RMB. China’s rapid
and holdings of foreign exchange reserves ($4.0 trillion as
of June 2014). China is seeking to use its growing
economic growth has been partly fueled by FDI inflows and
economic power to boost its influence globally, including
resulting productivity gains. However, while China has
by promoting and funding new multilateral banks, such as
become a major center of manufacturing, especially for
the New Development Bank (along with Brazil, Russia,
foreign firms that use China as the final point of assembly
India, and South Africa) to assist developing countries, and
in their global supply chain networks, it has not become a
the Asian Infrastructure Investment Bank (with an initial 21
global center for innovation. The World Economic Forum’s
members from Asia) to fund regional infrastructure
2014-2015 Global Competitive Index, which assesses the
projects. China has also rapidly become one of the world’s
competitiveness of 144 countries, based on a set of polices
largest sources of global foreign direct investment (FDI)
institutions, and factors that determine productivity growth.
outflows, which were $101 billion in 2013—the third
ranked China 28th compared with 3rd for the United States.
Also, see CRS Report RL33534, China’s Economic Rise:
largest after the United States and Japan.
History, Trends, Challenges, and Implications for the
United States, by Wayne M. Morrison.
Wayne M. Morrison, Specialist in Asian Trade and
Finance
IF10110
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China as the World’s “Largest Economy”

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