Michael A. Levi

Why the Chinese economy still lags behind the US

A worker at a Chinese car factory in Hefei, Anhui province. The attractiveness of Chinese and American markets to foreign firms depends on the profits to be made in international terms, not as measured by the workers' domestic purchasing power.
A worker at a Chinese car factory in Hefei, Anhui province. The attractiveness of Chinese and American markets to foreign firms depends on the profits to be made in international terms, not as measured by the workers' domestic purchasing power.PHOTO: REUTERS

A REPORT last month that China's economy will soon become the world's largest has sparked worries.

Normally calm observers are taking the news as a sign that China is overtaking the United States as an economic power.

But much as counting warships or troops often provides a misleading measure of military might, tallying up gross domestic product (GDP) - the figure behind the latest headlines - yields a warped picture of China's economic rise.

By most meaningful yardsticks, China is still less economically powerful than the US.

The problem with the new numbers starts with how they compare economies' sizes.

The World Bank tables that show China passing the US compare the two countries using purchasing power parity, which measures national incomes in terms of what they can buy at home.

Because domestic spending is dominated by items such as food and housing that aren't traded internationally, and because most goods and services are cheaper in China than in the US, this comparison boosts China's apparent economic strength.

Yet compared using market exchange rates, which measure incomes in terms of what they can buy on international markets (where every country pays the same price), the US economy remains nearly twice as big as China's.

Indeed it is this latter measure that matters most when comparing economic power.

After all, one would never compare two countries' military strengths on the basis of how well each could suppress a domestic rebellion rather than fight a foreign war, and one should not compare countries' economic power on the basis of what a worker in each country can buy at home.

When American and Chinese companies bid against each other to acquire resources or companies abroad, what matters is their wealth as measured by the global market. Oil suppliers, for example, don't care if the US$100 (S$125) they get for a barrel sold to China can buy more rice in a Beijing market than at a shop in New York - they care about what their revenues are worth in the world market.

Similarly, the attractiveness of the Chinese and American markets to foreign firms depends on the profits to be made in international terms, not as measured by purchasing power.

The alarm about China surpassing the US also ignores the critical role of political and institutional strength and flexibility. One wouldn't compare countries' arsenals while ignoring their different states of disrepair - yet Chinese GDP numbers ignore severe pollution problems that are driving successful Chinese abroad.

Nor would one compare numbers of aircraft or troops without asking about the training, doctrine and organisation necessary to mobilise them effectively in combat.

China faces real challenges translating its economic resources into international influence.

The need to maintain political stability and the Communist Party's grip on power constrains what the Chinese government can do to capitalise on the country's economic heft.

The difficulty of getting recalcitrant provincial and local governments to enforce Beijing's edicts can make it tough for China to take full advantage of its economic power.

The Chinese government, for example, has tried to forge packages of infrastructure and resource investment in strategically attractive developing countries, only to have the Chinese companies that would need to implement the schemes refuse to participate.

Certainly, China has its advantages. There are some things that matter for international power - notably military personnel - that can be paid for domestically, making lower Chinese prices (and wages) a meaningful advantage.

The US market may be larger than China's, but China's is growing more rapidly, often creating more new opportunities for international firms. And Washington faces political and institutional constraints just like Beijing does.

America's economy can't compete with a state-dominated behemoth when it comes to rewarding favoured partners with economic opportunities.

And the US is less able to direct its outward commerce toward political ends than China is.

Beijing is more capable, for example, of persuading Chinese oil and gas giant Sinopec to pursue geopolitically attractive investments than Washington is of mobilising ExxonMobil.

Twenty-first century rivalry between the US and China will be as much about economic might as military power. Judging the economic balance correctly will be as essential a foundation for effective international strategy as proper assessment of the military balance was during the Cold War.

Avoiding overreaction in the face of the latest headlines about China's economic triumph would be a great place to start.

The writer, a senior fellow at the Council on Foreign Relations, is co-author of By All Means Necessary: How China's Resource Quest is Changing the World.

NEW YORK TIMES