So, is China’s GDP about to grow larger than that of the US, and what are the implications for investors? I don’t know and from an economic perspective, we shouldn’t really care.
National accounting, when done well, is a worthwhile exercise, and GDP is probably the best measure we have of overall production within a country. However, it is a very difficult task to measure an economy. Moreover, comparing GDP across nations is often meaningless, especially between advanced and developing countries. It’s not just economic activity that’s developing, so is statisticians’ knowledge of household and firm activity. In April Nigeria revised its method of calculating GDP by changing its base year for calculations from 1990 to 2010. The result was a whopping 89% overnight increase in GDP, which saw it overtake South Africa as Africa’s ‘largest’ economy.
Comparing GDP across countries means that you have to use the same measuring rod. The simple way is to adjust for the exchange rate; a more sophisticated analysis takes into account the fact that price levels, as measured in a common currency, may vary between two countries. With the latter method, China’s annual GDP will overtake that of the US in 2019 according to the IMF. According to the World Bank it will happen this year.
Yet, it might already have happened. Much more value might be added in Mandarin and Cantonese speaking firms than is recognised by the Chinese National Bureau of Statistics.
From an economic point of view we should not care too much about comparative GDPs. “Head to head” thinking in economics often leads to unsound politics. An example of this was the “voluntary” export quota in Japan in the 1980’s when some influential American economists warned of a flood of cheap Japanese cars. It led to increased prices for both Japanese and American automobiles and US consumers suffered as a result.
China has grown furiously over the last generation because politicians in large part gave up controlling their citizens’ economic activity. With some important exemptions, Chinese men and women are now free to pursue prosperity as they see fit. Hence, Chinese economic activity has become interwoven with global economic activity.
The etymology for “economy” is Greek for a “household”. In fact there are very few countries remaining, perhaps only North Korea, that run their economy as parents run a household. China has prospered because it gave up having an economy in the etymological sense of the word. The toil, saving and investment of the Chinese population is now mostly part and parcel of the global spontaneous order of individual economic activities – what Friedrich Hayek labelled the ‘catallaxy’ – and the more the Chinese are contributing to building that order, the better it will be for everyone.
Do not let clumsy cross-country GDP comparisons cloud your vision of the roots of global prosperity or influence your portfolio construction decisions; it is much more meaningful to judge countries and their economic prospects based on their individual strengths and in the context of their wider role in the global economy.