Last Wednesday, the World Bank declared China would overtake the U.S. as the world’s biggest economy on a PPP basis by the end of this year. The practice of utilizing PPP in comparing economic output across countries has become less useful as global trade and cross-border asset flows continues to grow as a percentage of the global economy. Yes, your US$ still gets you further in China than in the U.S. on average; and the median Chinese urban household still earns less than 20% of the median U.S. (both urban & non-urban) household. But this ignores the fact China is the world’s biggest importer of commodities such as copper, iron ore and precious metals–all of which are settled at world market prices which PPP has no bearing upon. Chinese economic output measured at PPP also ignores the fact that real estate prices in Tier-1 cities such as Beijing and Shanghai are now on par with those in New York and Los Angeles. Seen in this light, a Yuan actually goes further in a major U.S. city such as Houston or Dallas than in Shanghai or Beijing. Since Americans are generally much more mobile than the Chinese (which in theory allows a U.S. family to resettle to lower cost-of-living areas), a comparison between U.S. and Chinese economic output using PPP is highly misleading.
That is not to say it isn’t a worthwhile exercise. At the very least, the World Bank study has again put the Chinese economy, leadership, and corporations in the spotlight as the “Central Kingdom” re-asserts herself, first in the global economy, and second, in global geopolitics. Work done by the late British economist Angus Maddison suggests China’s share of global GDP was over 30% as recent as 1820. At their respective peaks, total economic output of China and India together made up approximately half of global GDP during most of the last two thousand years, with the exception of the last 200 years.
As students of Asian history, the above chart comports with our understanding of the history of the Chinese dynastic system, and its subsequent decline (note that pre-1368 A.D. data–i.e. pre-Ming Dynasty–is almost non-existent, e.g. the invasion of the Mongols and its impact on China during the early 1200s does not register in the above chart). The relative decline of China’s influence as the Ming Dynasty retreated from global trade–along with a costly war with Hideyoshi-led Japan–could be seen in the above chart. The decline in Chinese relative influence accelerated in the early 1600s as the Ming Dynasty weakened, with the dynasty eventually falling due to corruption, inept management, bad harvests, and the Manchu invasion during the early to mid-1600s.
Under the Manchu-led Qing Dynasty, however, the Middle Kingdom regained her former glory. The Qianlong Emperor (who ruled for 60 years and interestingly, would die in 1799–the same year that President George Washington died) ruled an empire unprecedented in size–encompassing both Mongolia and Tibet. By 1790, the population of the Qing Empire soared to over 300 million, or just under the U.S. population today. Chinese relative economic output would peak soon afterwards at nearly 35% of global GDP.
According to Professor Maddison and Professor Dwight Perkins of the Harvard Kennedy School, what was most impressive about China during most of her history was not its sheer population growth; nor the size of her empire. What was most impressive about the Chinese economy was her successful response to population growth–i.e. her ability to sustain per capita consumption over time even as population grew. The Chinese drove productivity growth in agriculture through increased use of fertilizers, irrigation, development of crop varieties, as well as published and distributed agricultural handbooks to spread “best practices” in farming. New crops from the Americas–which could be grown on inferior lands–were also introduced.
In other words, China has a rich history of innovation, adaptation, and engaging herself with the rest of the world. By the early 19th century, however, China’s 2,000 year-old dynastic system was no longer a suitable governing system for a fast-changing, industrializing world. As innovation and change swept the world, the Chinese ruling class hung on to outdated concepts and actively discouraged reforms–including the emphasis of science/math over the “classics” in the Imperial Examination. The rigidity of China’s ruling class and system during the 19th century made her vulnerable to foreign influence and invasion. The subsequent experimentation with Communist ideology in the early 20th century would prove disastrous. All in all, it took over 150 years for China to recover and to be recognized as a global economic power once again.
The latest World Bank study is thus timely, as both China and the rest of the world need to begin addressing the consequences of China rising to become the world’s #1 economy. Consensus suggests China will surpass the U.S. in nominal GDP by 2019 (as recent as 2003, Goldman Sachs believed China won’t surpass the U.S. until 2041). e.g. Chinese battery maker BYD experienced significant growing pains due to the company’s inexperience when it opened its North American HQ in Los Angeles. As Chinese influence continues to grow around the world, there will be inevitable clashes over business practices, cultural misunderstandings, and increased competition (including those for real estate and college applications). As an investment bank who actively engage in U.S.-Chinese cross-border transactions, CB Capital has had first-hand experience in working with Chinese companies and cultures. We are also engaging with other U.S.-Chinese cross-border groups to cultivate closer relationships between local U.S. and Chinese/Hong Kong companies.
Sure, China is experiencing growth challenges, but this is to be expected. In particular, we are watching three issues very closely. As we have discussed, the Chinese “demographic dividend” is over. We expect Chinese real GDP growth to be in the range of 5%-8% over the next several years. China’s population growth has sunk to just 0.47%, ranking 159th in the world. By 2020, the Chinese demographic pyramid will be more inverted than that of the U.S. Another challenge is China’s unprecedented credit growth over the last five years, which was fueled by the country’s well-intended but poorly-executed US$586 billion fiscal stimulus package in 2008-09. A final challenge–which comes with the territory of being potentially the world’s #1 economy–is China’s dependence on foreign energy imports. China as we speak is making slow but steady progress on shale gas, but the country’s oil consumption growth remains unabated. In fact, the Energy Information Administration (EIA) expects Chinese oil imports to surpass those of the U.S. sometime this year. Energy security will thus become an increasing concern for China over the next several years.
Chart 2: China to Become World’s #1 Crude Oil Importer in 2014