Mainstream media has the American public aghast at a recent report from the World Bank claiming China is poised to take over the United States as the world’s largest economy. Of course, this is not exactly true. Measuring economic performance goes beyond simple measures of GDP, PPP, and per capita income—something that is obviously missing from the World Bank report. China still has a ways to go to give the United States serious contention as the world’s greatest economic power.
There are considerable issues with trying to use Purchasing Power Parity (PPP) to compare the sizes of world economies. The concept of PPP is useful for domestic policymakers to evaluate the relative prices of non-tradable goods and services within their country. But, it’s not exactly a true barometer of economic prosperity. For example, as the Wall Street Journal points out, China cannot buy missiles, ships, iPhones, German cars, or any other imported goods, at PPP exchange rates. When standard GDP exchange rates are used rather than PPP, China’s economy is only half of the size of the U.S. economy. When population is taken into account and factoring PPP measures of GDP, China’s economy is only ranked 99th in the world. Most of the Chinese population is still relatively poor.
Beyond these technical problems, the future of the Chinese economy is less bright when China’s major long-term economic weaknesses are taken into account. There are many essential factors China lacks that will prevent the country from experiencing the sustained, broadly-based economic growth that developed countries such as the U.S. experience. It is well-established among economists that institutions are the fundamental determinants of long-term economic growth.
The United States and other advanced economies have well-developed, transparent, and accountable political institutions that have implemented laws and policies which favor trade, innovation, and competitiveness. For that reason, developed economies are the most connected to the global economy. While Chinese policy leaders have attempted to foster innovation to spur domestic sources of economic growth, they lack these institutions, which allow Chinese citizens to become entrepreneurs. It is this top-down approach that will ultimately limit the innovativeness of the Chinese economy, and why the U.S. economy continues to be driven by bottom-up sources of innovation