China as number two — or even three

As China prepares for a momentous change of leadership at the top, a question increasingly being posed is how the new leaders will guide a country that will soon be the world’s largest economy. That the Chinese economy will reach the top rung sometime between now (some economists believe it already is the biggest economy) and the early 2020s is assumed as part of the conventional wisdom, having been confidently predicted by such influential voices as the International Monetary Fund, the Economist magazine, and virtually all of the leading pundits both in the West and in Asia.

So it was fascinating last week for me to meet with one of Beijing’s top economists who says "it’s never going to happen." Because this analyst requested anonymity, I cannot reveal who it is which I believe is itself a commentary on some of the reasons why it may not happen. Nevertheless, the substance and logic of the analysts argument is compelling and important.

The first point is that the Chinese economy today is not, as is commonly stated, half that of the U.S. economy. Rather it is only about a third the size of the U.S. GDP. This is because a lot of the growth of the past was accomplished by building stuff that will never be used sufficiently to justify its cost and should thus represent negative growth if it were correctly counted.

This should show up as non performing loans whose liquidation should have been subtracted from GDP. But since they were not officially recognized they were not subtracted and will thus eventually show up as negative growth in the future as resources are used to service them.

This does not include environmental degradation which one Chinese economist estimates should have reduced China’s reported GDP by 10-20 percent but was not reported to have done so. However, it will show up in the future as rivers and farmland produce less and as health care costs and sick workers eat up more and more of the nation’s wealth

Most orthodox observers think that China has four times the U.S. population and about half its GDP. China’s productivity is about an eighth that of the United States. So if China doubles its productivity, it would equal the U.S. GDP while still having only half the productivity of the United States. That appears to be a mathematical certainty for China, and thus the conventional analysts hold to the conventional prediction of China soon becoming the world’s top economy.

However, there is a weakness in this analysis. It focuses on the wrong demographics. It’s not population size that counts with regard to GDP. Rather it’s the size of the working population. China now has five times as many workers as the United States, but that will drop to only three times by 2050. That means that Chinese workers must increase their productivity from one tenth of U.S. productivity to one third. In other words, instead of doubling productivity they would have to triple it. Indeed, if you believe that the size of the Chinese GDP is over-stated, then current productivity is also overstated. So, maybe Chinese workers would have to quadruple their productivity in order for the Chinese GDP to equal the U.S. GDP.

That is a much higher hurdle that my economist friend in China doesn’t think the Chinese workers will ever be able to clear.