GDP misleads on China and the US
- By Derek Scissors
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E-mail China.org.cn, October 29, 2014
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Success at any price? [By Jiao Haiyang/China.org.cn] |
In April and again last month, the World Bank and International Monetary Fund made headlines by projecting the Chinese economy to surpass the American economy this year. The international institutions see China as attaining a larger gross domestic product calculated under the assumption of purchasing power parity (GDP PPP). However, this method and this view are fundamentally flawed. In fact, the U.S. economy will remain larger than China’s for decades.
PPP problems
It is of course true that the average American is far better off than the average Chinese. But size does matter in economics – for people, companies, and countries – so the comparison between a long-predominant U.S. and an expanding China merits attention. The problem is the Bank and Fund use a measure of economic size that badly distorts the China-U.S. comparison.
Start with PPP. Its application stems from observing that $100 generally buys less in Austria than Zambia. Just comparing incomes in the two countries is misleading, so an adjustment is needed. From there, though, problems with PPP mount:
1) Just compiling price levels for China and the U.S. is a huge task, given their size and internal variations. Comparing them is that much harder. And price comparisons can change rapidly, undermining the “latest” PPP adjustment. The most dramatic expression of this occurred in 2007, when the World Bank abruptly cut China’s 2005 GDP PPP by 40 percent.
2) PPP relies on something called “the law of one price,” that is, prices should be the same in all competitive markets, since buyers will find the cheaper good and push its price up. But China controls prices in energy, grain, and capital, including the exchange rate. It distorts market competition in construction materials and labor. Applying full price parity to China is dubious.
3) PPP was meant to apply only to consumer buying power. But GDP includes activities other than consumption – in China most GDP is not consumption. The law of one price in competitive markets plainly cannot hold for purchases made by the Chinese government. Yet the World Bank and IMF apply PPP to those purchases.
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