On China Becoming the Largest Economy in the World: What Does That Really Mean?

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Macroeconomics

It was only 18 months ago that I can recall a discussion with some of my MetalMiner colleagues about the rise of China. The question was posed: when would China take over from the US as Number One?

Of course, the question is ill-defined. Do we mean economically, politically, militarily? As we batted this around, it became clear the answer was, if it were all these things, then maybe never. But in essence, the question centered on GDP and the size of the economy. Even though that was just months ago, our view has been forced by events to change; then we were talking in terms of decades — “maybe by 2030” said the most adventurous; “no way, not before 2050,” said others.

Well, the IMF issued a report covered by Gideon Rachman in an FT article that suggested, with adjustments for purchasing power parity, that the Chinese economy will be larger than that of the US by 2016. Dodgy PPP adjustments aside, Rachman cites an Economist report in December that suggested a change of position by 2019. Some may point out such projections may be based on the double-digit growth rates China has achieved up to early 2011, and that current single-digit rates will slow the process, possibly pushing the date back into the next decade if the current slowdown is extended.

Standards of Living Not So Standard

These are, after all, only projections. But the probability remains that at some point, a population of 1.3 billion people aspiring to similar living standards to the West will drive the economy to overtake the US and Europe. The last ten years have been transformational; there is little to suggest the next ten will not be even more so.

Of course, the largest economy does not mean the most influential politically, or militarily, or culturally. We have become accustomed to believing economic progress goes hand in hand with democracy and freedom, but China may change the rules. So far they have achieved phenomenal growth with a one-party state that may crumble from within given time, but in the meantime is a model many emerging markets may seek to copy, feeling democracy is not the obvious path it was once assumed.

The Middle East reaction against authoritarian rule is not linked to a push for economic growth as much as it is a reaction against oppression. Russia, for example, is achieving impressive growth and finally some degree of middle-class expansion, while at the same time drifting towards more authoritarian rule, not to mention a continued disdain for the rules of corporate law. But economic mass brings political influence, as Rachman reports; Brazil considers China more important to them than the US and points to Dilma Rousseff, the new Brazilian president, recently making her first overseas trip to Beijing, where once it would have been Washington.

Nor will China match the US militarily for much longer than it will take them to overtake economically. The level of affluence and technological superiority in the US will allow them to remain the world’s dominant superpower for the foreseeable future. But the balance will gradually shift, as China builds aircraft carriers and stealth bombers. They may not be a match in terms of sophistication, but China can project its influence on countries far beyond its borders.

Dollar v. Yuan and Inflation

Rachman doesn’t touch on the role of the dollar as the world’s reserve currency, yet there has been a lot of coverage both in the press and by (mostly emerging market) politicians in recent years. The fact is today there is nothing to take the dollar’s place (once the Euro was mooted as a possible replacement), but Europe has soundly shot itself in the foot with its debt woes. Nor is the yuan a likely successor; it is not a world currency, being tightly controlled and manipulated by the Chinese authorities, nor do the Chinese have a sufficiently sophisticated financial system to accommodate a free-floating tradable currency, so the best it’s likely to achieve this decade is a gradual adoption of trade and bond issuance.

China clearly has its own problems. Continued high levels of growth are not guaranteed, headline inflation appears for the time being to be coming under control, but wage inflation is so strong, many coastal zones are in danger of pricing themselves out of lower value manufacturing. In the medium term, their biggest challenge will be balancing the desires of a growing middle class aspiring to political freedoms and regional disadvantaged groups demanding a greater voice with the traditional one-party state. China will likely manage to control inflation, re-balance the economy more towards internal consumer demand, and tackle its huge environmental challenges, but quite how or if it will manage its political institutions remains to be seen. In many ways, what has been China’s greatest strength up to now could be its greatest weakness in the years to come.

–Stuart Burns

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