FP Explainer

How Do We Know That China’s Economy Is Really Bigger Than Japan’s?

Because they said so.

China Photos/Getty Images
China Photos/Getty Images

The world economy reached a major milestone Monday when China officially became the world’s second-largest economy, displacing Japan, which has held the title for more than four decades. The recognition of China’s new status came after the Japanese government reported that, after a quarter of slow economic growth, the country’s annual gross domestic product (GDP) was estimated to be around $1.28 trillion, slightly below China’s $1.33 trillion. Do all countries use the same method for estimating GDP?

They’re supposed to. The System of National Accounts (SNA), a set of guidelines developed jointly by the United Nations, the European Commission, the International Monetary Fund (IMF), the Organization for Economic Co-operation and Development, and the World Bank, specifies the methods by which countries measure the size of their economies.

There are two main methods for estimating GDP. One involves looking at production. This includes the value of the goods produced by all the firms in the country, the added value of government work projects, and — particularly in developing countries — the value of goods produced for personal consumption, like the crops grown by subsistence farmers. Not all wealth counts toward GDP. For instance, if you build a new house, that’s considered value added to the economy.  If a pre-existing house increases in value, the owner may be better off, but the country’s GDP is unaffected. Of course, companies often have a vested interest in exaggerating their profits, so reliable figures can sometimes be tough to calculate.

The other method of calculating GDP involves measuring total consumption of products by a country’s population. Since it relies mostly on household surveys, this method also has flaws. People tend to underreport the amount they spend on alcohol and cigarettes, for instance. But hopefully, the two measures should come up with close to the same number and when the results from the two approaches are compiled, they should give you a pretty good idea of the size of a country’s economy.

(Some dispute whether GDP is a useful indicator at all, given that currency fluctuations can make comparisons between countries unreliable. According to purchasing power parity numbers, which compare economies based on the absolute price of a basket of goods, China actually overtook Japan a decade ago.)

Most countries have a dedicated statistical service in charge of monitoring economic growth and calculating GDP (in the United States, it is the Bureau of Economic Analysis at the Department of Commerce). For many developing countries, however, the task of collecting all that data can be a daunting one, involving large amounts of unreported income, so groups like the IMF are often called in to assist.

The GDP numbers of European countries are subjected to outside scrutiny by the European Union’s statistics branch, Eurostat, since GDP determines how much a country is expected to pay into the EU budget. Greece and Ireland were caught underestimating their debt-to-GDP ratios in a bid to minimize the severity of their debt crises earlier this year.

But for most countries, there’s no international legal authority to ensure that statistical offices are following the SNA guidelines, and international economists largely have to rely on self-reported numbers. While no one’s disputing China’s new status, the country has often been suspected of cooking its books. Although China is not a member of the OECD, it does cooperate with the organization in producing statistics according to the SNA guidelines.

Those guidelines are updated every few years. The most recent edition, which was made in 2008 and has so far only been implemented by Australia, was revised so that a firm’s investments in research and development are considered added value. This means that as the new standard is implemented worldwide over the next four years or so, many countries will see their GDP numbers increase by as much as 1 percent. That’s one way to stimulate growth.

Thanks to Nadim Ahmad at the statistics directorate of the Organization for Economic Cooperation and Development.

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