Will China surpass the United States? The dangers of the game of extrapolation.

To read the press, one might think that China's economy would soon surpass in size and prosperity the world's remaining superpower. There is some basis for this speculation, though it is wildly premature at best, and very unlikely for several decades, if ever, at worst. The correct factual basis is that China is a very large place with an even larger population. The other correct ingredient in such a story is that for the past twenty-eight years or so China has exhibited extremely rapid growth. If its massive population had an average level of productivity for what the International Monetary Fund calls a "middle-income country," or productivity equal to that of some of its wealthier neighbors, China would already have the largest GDP in the world. That is not likely to happen for another thirty years or so at the earliest. More importantly, even under the best of trends sustained for far longer than is likely, China will not reach the U.S. standard of living--not to mention surpass it--until mid-century. More likely China will, even under very optimistic assumptions, not reach the U.S. standard of living until late in this century. Nonetheless, due to the size of its economy and markets, it will have a relatively large share of production and consumption of most goods and services in a few decades.

The key facts that determine these possibilities are that China is a country that is almost identically the same size in land area as the United States and has over four times as many people (1.3 billion versus 300 million people). Its output or income has been growing at nearly 10 percent per year since reforms began in the late 1970s, but due to its political turmoil and exploitation of its people by a political party and class backed by an economically and politically powerful army, the country's economy regressed for several decades. Economic reform has allowed the country to climb out of a very deep hole, but there remains far to go before reclaiming its earlier relative ranking in the world economy. Fortunately, the notion of convergence means that the further behind a country gets, the more likely it is, if allowed, to grow faster in order to catch up.

To take a long view, consider that in 1820 China produced about 28.7 percent of the world's GDP with about 35.7 percent of its population, which implies that it had a productivity level close to 80 percent of the world average. By 2005, despite incredible growth of near 10 percent per year over the past twenty-eight years, China produced 5 percent of the world's GDP despite having a smaller, but still world-beating 20.2 percent of the world's population. By the same standard, China's productivity had fallen to about 25 percent of the world average. In contrast, the United States rose from 1.8 percent of the world's output with about 0.9 percent of the world's population (already about twice the world average GDP per person) to claim almost the same share of output as China had in 1820, 28.1 percent, with only 4.6 percent of the world population, or about six times the world average GDP per person. Had China kept its relative level of productivity, just keeping pace with the world average, its GDP and standard of living would have been over three times higher than today and it would already have a GDP level in excess of Japan's, or been the second largest in the world, and a standard of living approaching that of Chile instead of Morocco.

The basic facts about China's income and growth are summarized in the table. China is classified as a lower-middle income country by the IMF, but it has grown rapidly for the past twenty-eight years since the transformation from a command to a market economy began, averaging about 9.6 percent per year from 1980 to 2005. The data in the table are for the period 1990-2005 and form the "best case" baseline scenario, where growth rates continue to repeat the past. The past period chosen is somewhat arbitrary. Chinese growth is a little slower than a shorter period at the end of the interval, but faster than the whole period of reform, which would include some initial years with slower growth and also some years of slow growth that followed a couple of highly inflationary periods. U.S. growth is also faster than in the most recent five years at the end of the period, and a slightly slower than for the past twenty-five years.

BEST CASE SCENARIO

In the best case scenario, China and the United States would continue to grow at the same pace as over the fifteen years from 1990 to 2005. For China, this is considered the best case because no economy has grown so fast for such a prolonged period over the past fifty years, if ever. Also, population growth is expected to continue to slow in both countries, more so in China. Finally the United States is expected to have slowing productivity growth according to the projections of the Social Security trustees and most experts, and this is even more likely in China as it converges toward U.S. productivity levels.

Extrapolating the Chinese and U.S. growth rates shown in the table implies that China will catch up with the size of the U.S. GDP in twenty-six years, or in 2031. The power of compound interest is illustrated by the fact that it would take eighteen years to catch up to the size of U.S. GDP, but within another eight years China would expand its output enough to match more than a quarter-century of U.S. growth.

Because of China's population size advantage, its GDP can grow to the same size as the U.S. economy with little productivity growth. Just as low productivity holds down output, however, the expected convergence of productivity, output per worker, means that China's productivity will grow faster than that in the United States, at least until it catches up. Since productivity determines the standard of living, this means that China's standard of living would continue to rise faster than that in the United States well beyond the period when its GDP catches up to that in the United States.

In the best case scenario, China's standard of living, measured by its GDP per person, would continue to improve relative to that in the United States well beyond 2031. In 2031, for example, based on the continuation of conditions described in the table, China's GDP per capita would be about one-fourth that in the United States, but it would have joined the group of high-income countries, at least based on today's definition. China would converge to the same GDP per capita as the United States in 2053, under the "best case" assumptions. The per capita GDP in both countries would be about $105,000 per person, measured in 2005 prices, or about 2.5 times the current U.S. level.

OPTIMISTIC CASE SCENARIO

China and the United States are not expected to be able to continue the trends of the past fifteen years, however. The United Nations projects that China's population will peak in about 2030 and then decline slightly, averaging about a 0.1 percent rate from 2005-50. Similarly, U.S. population growth is expected to slow, though not as much, averaging about a 0.6 percent rate from 2005-50. If these trends are included, both countries' GDP will grow more slowly. For example, the U.S. Social Security trustees expect U.S. real GDP to expand at a 2.1 percent rate from 2005-50, with much of the slowing coming around 2012 and beyond. A slowing in GDP growth in China due to slower growth of the population and labor force, and because of slowing productivity growth as convergence occurs, easily could bring GDP growth to about 8 percent, in a still very optimistic case. Since the United States is slowing too, however, this does not have much effect on the convergence results. China would still, under these optimistic assumptions, reach the same GDP size as the United States by 2035 and match its GDP per capita by 2057, both only four years later than in the "best case."

PLAUSIBLE CASE SCENARIO

Convergence is typically expected to occur primarily because higher rates of return to investment are expected in China than in the United States until convergence occurs, and this in turn is expected to lead to more rapid growth of the capital stock per worker in China. In addition, it occurs because China can take advantage of existing and more productive technologies until the country has exploited all the highest technology available in the world and it can do so relatively cheaply. Following convergence, however, the possibilities become limited as China's ability to develop new technology through importing it would be virtually eliminated and the country would have to rely on its ability to develop its own globally competitive technology. In fact, both processes will slow growth in productivity and GDP well before convergence actually occurs, actually pushing convergence further into the future. Thus, the optimistic case above is just that.

More importantly, China faces four major trends that require close management to avoid major economic and political turmoil. The first is urbanization. Only about 43 percent of the population currently lives in cities and is part of the modern labor force. Most of the population lives in rural areas where economic opportunities are much more limited. There is strong pressure to move to cities because of huge differences in income possibilities. Second, nearly half of all enterprises are state-owned and the transition from highly inefficient state-owned firms to profitable ones, or more likely to private firms, results in major disruption and unemployment. Both of these trends put strong pressure on the central government to slow these processes and to find other ways to ameliorate the political pressures arising from relative income disparities.

The third trend is the slowing in population growth which, as noted above, is expected to bring population expansion to a halt in about 2030 and then to reduce it. At about that time, China is expected to have a median age for its population that is about the same as in the United States and subsequently its population will continue to age more rapidly. This will create pressures on the social safety net and especially on the retirement system. Fortunately, there will still be ample opportunity to develop the work opportunities of the still largely rural population and the productivity of the state-industrial sector to continue to boost income growth.

The fourth trend is that such rapid growth in income per person, at least eight times its 1980 level today, creates strong demands for political rights as a large middle class begins to emerge. Managing the widening gap between greater economic rights and prosperity and a static political system with few rights and little self-determination will become increasingly difficult over time. There will be growing pressures for political liberalization and openness, but meeting those demands either too rapidly or too slowly risks political and economic instability. All of these risks potentially adversely affect GDP growth in China.

Faced with burgeoning risks and blessed by earlier rapid convergence, it is not likely that China will be able to continue the rapid economic growth assumed in the optimistic case. More likely, China will begin to slow, like its richer neighbors already have, so that its average growth rate will slow further. A slowing to 6 percent real GDP growth over the post-2005 period, mainly achieved by slowing after the next couple of decades, would result in China matching the size of the U.S. economy by mid-century and converging to a similar standard of living by 2080 or so. Only slightly slower growth could push the latter achievement off to the next century. No country in the world has ever achieved a growth rate as rapid as 6 percent per year over such a long period, however, in this case for over seventy-five years. However, though understandable in geopolitical terms, China's growth for the past twenty-eight years defies history by a much greater margin.

REFERENCES

Barro, Robert J. and Xavier Sala-i-Martin, "Convergence," Journal of Political Economy, vol. 100, No. 2 (April 1992), pp. 223-51.

Fishman, Ted C., China, Inc.: How the Rise of the Next Superpower Challenges America and the World, Simon & Schuster, 2005.

Hall, Robert and Charles I. Jones, "Why Do Some Countries Produce So Much More Output per Worker than Others?" Quarterly Journal of Economics, (February 1999), pp. 83-116.

Kynge, James, China Shakes the World: A Titan's Rise and Troubled Future--and the Challenge for America, Weidenfeld and Nicolson, 2006.

Maddison, Angus, The World Economy: A Millennial Perspective, OECD Development Centre Studies, Organization for Economic Cooperation and Development, 2001.

Spence, Michael, "Why China Grows So Fast," Wall Street Journal, January 23, 2007.

Tatom, John A., "Getting to Know China," Networks Financial Institute NFI Report, 2007-NFI-01, January 2007.

Trustees of the Social Security and Medicare Trust Funds, 2006 Annual Report of the Trustees of the Social Security and Medicare Trust Funds, Government Printing Office, 2006.

John A. Tatom is Director of Research for Networks Financial Institute.

Basic facts of China and U.S. income and growth

                          2005 Levels        1990-2005 growth rate

                                  United                 United
                        China     States        China    States

GOP ($ billions)       $2,278    $12,455        9.92%    2.98%

Population              1.304     0.298         1.08      1.02
(billions)

GDP per person ($)      1749      41,765        8.97      1.93

PPP-based GOP           7,198     41,399         NA        NA
per person

Sources: GDP: Economic Insight

Population: Asian Development Bank and United Nations
PPP-based GDP per capita: International Monetary Fund