Category Archives: GDP

12th
Oct 2014

Power shift: China is now the world’s largest economy

It is official: China has toppled the United States (US) to become the biggest economy in the world. Measuring gross domestic product (GDP) using purchasing power parity (PPP), the latest figures released by the International Monetary Fund (IMF) on 8 October 2014 estimate China’s GDP to be at $17.6 trillion, compared to the US’s $17.4 trillion (see graph below).

GDPchinavsus

Image source: Daily Mail

Using PPP is an attempt to account for varying price levels between countries, particularly in goods and services which are not open to international competition. If measured in current dollars, unadjusted for cost of living, the US economy still dwarfs China’s, at $17.4 trillion to $10.4 trillion. Yet, according to the IMF, the PPP measure gives a better picture of the real size of an economy, since prices and salaries are not the same in each country. For instance, a typical worker in China earns a lot less than the typical worker in the US. However, simply converting a Chinese salary into dollars underestimates how much purchasing power that individual, and therefore that country, might have. The IMF views the PPP as more stable and a better measure of how much a country’s economy is worth in terms of what its currency can buy.

Notwithstanding any measurement problems and/or criteria adopted, China’s rise has been remarkable in recent years, having firmly replaced the US as the main engine of the global economy. According to analysts at Morgan Stanley, China’s contribution to global growth has more than tripled to 34% this decade from 10% in the 1990s. The US contribution has decreased to 17% from 32% in the 1990s, and the part of Europe has fallen to 8% from 23%. By the end of 2014, Europe’s contribution will be more or less where China was in the early 1990s. As a result, the West – i.e. US and Europe combined – contributes today a quarter to global growth, while China’s part is more than one-third.

Over the long-run, the historical perspective sees China’s ascendancy as a return to it’s former grandeur. According to Angus Maddison, a British economic historian, China was the world’s leading trading nation up to the 18th century, until European powers took control of its ports and trade. It was Great Britain – which led the world in the industrial revolution – that became the world’s largest economy. This position was held by London until 1872, when the US took the lead.

The US has been the world’s largest economy for 142 years, until October 2014, when the IMF certified that the lead had returned to China. There are two main implications of this shift: firstly, there will be a Western scramble for the Chinese market – and for Chinese money. The global downturn which begun in the US in 2008 has not only weakened the American economy, but it has also had a tremendous influence on other countries, in particular those of the Eurozone. The peripheral countries of the euro-area have witnessed the most remarkable surge of Chinese outbound investments. Secondly, the next crisis is likely to originate from China.

Today, every one-point slowdown in China’s growth takes about half a point off global growth, according to analysts at J.P. Morgan. It is, therefore, crucial for Western governments and businesses to prepare now so that when China sneezes in the future, catching the cold would not be the only option.