Is China Already Number One? New GDP Estimates

When the presidents of China and the United States meet next week in Washington, neither will likely be aware that, measured in terms of purchasing power, it is Hu Jintao not Barack Obama who represents the world’s largest economy. Some time in 2010, the Chinese economy overtook that of the United States. 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 $14.6 trillion while that of China was $5.7 trillion.

But it has long been recognized 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—which 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 1970.1 My calculations (explained in greater detail below) 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 IMF has produced its own PPP-based estimates for 2010 (published in the World Economic Outlook in October 2010). But these are problematic in two important respects for China: The GDP number for 2005, which is the starting point for all the PPP-based calculations, is understated, and the price increases between 2005 and 2010 are overstated, which further reduces the GDP number for 2010. Consider each.

When the World Bank published its PPP-adjusted estimates for GDP per capita based on disaggregated data collected by the International Comparison of Prices (ICP) project exercise in 2005, a number of commentators expressed doubts about them, especially because the estimates for China ($4,091 per capita) and India ($2,126) were revised downward by 40 percent relative to the pre-ICP estimates. The IMF uses this lower number for 2005.

Surjit Bhalla (2008) argued that the number for China was unrealistic. Suppose, he said, the revised number was extrapolated backward, using China’s growth rate between 1952 and 2004 of 5.52 percent. It would imply a level of GDP per capita in 1952 of $153 (in 1985 prices) that was well below the threshold value of $250 that Pritchett (1997) has argued is the minimum required for subsistence. In Bhalla’s evocative description, the revisions meant that there were few living Chinese in 1952.

The validity of doing this backward extrapolation is questionable because, as I pointed out in a paper with Simon Johnson and colleagues (2009), PPP growth rates and market exchange rate-based growth rates are not identical and cannot be used interchangeably.

Nevertheless, Bhalla’s point is correct, albeit for slightly different reasons as argued by Deaton and Heston (2010). They suggest that China’s PPP-GDP was underestimated (by the ICP project and by the World Bank) because of the urban bias of the price sampling in ICP 2005. Data on prices were collected for 11 cities and their surroundings but no rural prices—which are typically substantially below urban prices—were collected (or rather allowed to be collected by the Chinese authorities).

The latest version of the Penn World Tables (version 7 to be released in early February 2011) have corrected these biases, which result in an upward revision for China’s PPP-based GDP by about 27 percent and for India by about 13 percent 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.

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