World Bank Shocker — China’s GDP to Top the U. S. in 2014 — Means Little

World Bank Shocker — China’s GDP to Top the U. S. in 2014 — Means Little

May 1, 2014

The World Bank shook up a lot of people this week with its declaration that by a new accounting, China’s GDP will top America’s this year. But the meaning and significance of that accounting remain at best elusive. Last year, the World Bank reported that using prevailing exchange rates, China’s GDP in 2012 was barely half that of America ($8. 2 trillion versus $16. 2 trillion). The new report draws on a statistical adjustment called “purchasing power parity,” or PPP, often used to compare GDP in two or more countries when exchange rates fluctuate widely. In analytic shorthand, PPP calculates GDP by looking at what it costs households in one country to feed, house, educate and otherwise take care of itself — including the costs of doing business and maintaining government — compared to households in another country.  

Setting aside the fact that U. S. -China exchange rates have been pretty stable, here’s how PPP works. You start with a basket of personal and business goods and services in each country, taking account of habits, tastes and preferences. So, the Chinese basket will be different from its American counterpart because, for example, Americans eat potatoes and subscribe to premium cable stations while Chinese eat rice and go to outdoor cinemas. Since a serving of potatoes in America costs more than a serving of rice in China, China’s GDP is adjusted (upward) to take that into account. These comparisons also require adjustments for quality. Americans pay much more for health care and housing than Chinese — but the quality and quantity per-household of these services and goods as Americans consume them is much higher and larger than Chinese enjoy. So, World Bank statisticians have to not only observe prices and levels of consumption, but also come up with adjustment factors for differences in quality for each country. The truth is, nobody knows how to do that for countless goods and services, including the Bank’s PPP experts.

The United States is the baseline for PPP calculations. So if China’s basket of goods and services takes half as much income to buy there as the American basket does in the United States, after accounting for quality differences, China’s GDP is adjusted up by that increment. I should also mention that PPP analysis can produce a range of results based not only on all of the adjustments, but also on which of four distinct and accepted ways of calculating PPP the analyst uses. This week’s announcement of PPP-based GDP came after the World Bank applied a new weighting regimen to one of the four methods. What it means, then, depends on all of those assumptions and calculations, which makes any conclusions based on that accounting problematic, at best. As the Bank itself noted, “Because of the complexity of the process used to collect the data and calculate the PPPs, it is not possible to directly estimate their margins of error.

By any accounting, China’s GDP has been growing very rapidly for several decades. The reasons are pretty basic. They start with the world’s largest workforce producing Chinese goods and services. And, thanks to the foreign direct investments of advanced technologies and business methods, much of it from America, Western multinationals have given China the means to make all those workers more productive. Yet, the lives led by China’s people remain a world away from the lives of Americans. Even using the World Bank’s PPP calculations, per-capita GDP in China is just $9,844, compared to $53,101 in the United States.

One more caveat: China’s PPP-adjusted GDP may be said to statistically rival America’s — whatever that means — only because U. S.  growth has been unusually slow for more than a decade. If the American economy had continued to expand since 2001 at the rate it grew in the 1990s, our GDP would still be more than 20 percent bigger than China’s even using the World Bank’s new adjustments and accounting. For that, we have no one to blame but our policymakers and ourselves.