06.07.2021 – 12:29
When will China overtake the US to become the world’s largest economy?
Few questions are more important, whether for executives wondering where long-term profits will come from, investors weighing dollar status as a global reserve currency, or generals strategizing on geopolitical hotspots.
In Beijing, where they have just celebrated the 100th anniversary of the Chinese Communist Party, leaders are doing their best to present the change of stick as imminent and inevitable. “Chinese nation,” said President Xi Jinping last week, “It is marching towards a great renewal at an unstoppable pace.”
At the beginning of the Covid-19 crisis, when China managed to control infections and maintain growth even when the US suffered hundreds of thousands of deaths and a severe recession, many were inclined to agree. Recently, a sudden U.S. rapid recovery has illustrated how much uncertainty remains about the time of transition and even if it will not happen at all.
If Xi delivers economic growth reforms and US counterpart President Joe Biden fails to push back on proposals to upgrade infrastructure and expand the workforce, forecasts from Bloomberg Economics suggest China could take first place, held from the US for much more than a century, as soon as 2031.
But this result is not guaranteed. China’s reform agenda is already faltering, tariffs and other trade borders are hampering access to global markets and advanced technologies, and covid stimulus has pushed debt to record levels.
The nightmare scenario for Xi is that China could follow the same trajectory as Japan, also declared a potential U.S. challenger before it collapsed three decades ago. A combination of reform failure, international isolation and the financial crisis could stop China before it reaches the top.
Another possibility, tempting for skeptics, if China’s official GDP data is exaggerated, the gap between the world’s largest and second largest economies may be larger than it looks and closing with a slower pace.
Throughout this report, we refer to the nominal level of the GDP dollar, widely seen as the best measure of economic strength. In the alternative measure of purchasing power parity, which takes into account changes in the cost of living and is often used to measure quality of life, China has already taken first place.
Over a long period, three factors determine the growth rate of an economy. The first is the size of the workforce. The second is the stock of capital, everything from factories to transport infrastructure to communications networks. Finally there is productivity, or how effectively the first two can be combined.
In each of these areas, China faces an uncertain future.
Start with the workforce. The math is straightforward, more workers means more growth, and fewer workers means less. Herein lies China’s first challenge. Low fertility, the legacy of a child policy, means that China’s working-age population has already peaked. If fertility remains low, it is projected to shrink by more than 260 million over the next three decades, a decline of 28%.
Aware of the dangers, China has changed course. Fertility controls have calmed down. In 2016, the limit was increased for two children. This year, the government announced that three were allowed. Meanwhile, plans to raise the retirement age can keep older workers in their jobs for longer.
Even if the reforms succeed, it will be difficult for China to offset the impact of demographic attraction. And they may not succeed. Rules are not the only thing preventing families from having more children: there is also the high cost of things like housing and education. “The reason I did not buy three Rolls Royces is not because the government did not allow me.”, wrote a young man in response to the news with three children.
The outlook for capital spending is not so bleak, no one expects the number of railways, factory robots or 5G towers to be reduced. But after years of staggering investment growth, there are many signs that it is now bringing back returns. Overcapacity in industry, ghost towns of empty buildings, and six-lane highways cascading into sparsely populated farmland all illustrate the problem.
With the projected labor force shrinking, and capital expenditures already exorbitant, it is productivity that holds the key to China’s future growth. Its rise, most Western economists think, requires action such as removing the jumping hukou system (which connects workers to their homeland), leveling the playing field between state-owned giants and agile entrepreneurs, and reducing barriers. for foreign participation in the economy and financial system.
Beijing industrial planners have their own project, and China has a long history of successful growth reforms. With China only about 50% as efficient as the US in how it combines labor and capital, there is still much room for improvement.
By 2050, according to Bloomberg Economics projects, China’s output will have captured up to 70% of the US level, placing it in the typical interval for countries at a comparable level of development.
Will China be able to deliver on its promise, boosting growth not with more workers and endless investment, but with smarter workers and more advanced technology? Unfortunately for Beijing and in contrast to the choreographed celebrations in detail for the 100th anniversary of the Communist Party, not all determinants of future growth are under their control.
Global connections have begun to break down. A recent Pew study found that 76% of Americans had an unfavorable opinion of China, a record high. They are not alone. The blame game over the origin of covid, the growing human rights concern in Xinjiang, and Hong Kong’s draconian National Security Act have all helped obscure China’s global outlook on growth.
If ties with the US and its allies continue to break down, the cross-border flow of ideas and innovations it has done so much to accelerate China’s rise will begin to dry up. Europe is pulling out of a major investment deal and India closing the door on Chinese technology.
A detailed exercise by economists at the International Monetary Fund found that in an extreme scenario, with China and the United States dividing the world into separate spheres of influence, China’s 2030 GDP could take a 8% hit, compared to with a base case where the links stay stable.
A combination of stalled domestic reforms and international isolation could bring another extreme scenario to the fore: the financial crisis.
Since 2008, China’s ratio to GDP has grown from 140% to 290%, with covid stimulus contributing to recent growth. In other countries, such rapid growth in borrowing has warned of problems ahead.
Relying on Carmen Reinhart and Kenneth Rogoff’s study of financial crises, Bloomberg Economics estimates that a Lehman-style downturn could push China into a deep recession followed by a lost decade of near-zero growth.
There are also widespread doubts about the reliability of China’s official growth figures. The country’s leaders have acknowledged the problem. GDP data are “Man-made”, said current Premier Li Keqiang when he was the head of Liaoning province. For a more reliable reading, he preferred to look at the numbers for things like electricity generation, rail transport and bank loans.
A study by economists at the Chinese University of Hong Kong and the University of Chicago suggested that between 2010 and 2016, the increase in “True” China’s GDP was about 1.8 percentage points lower than official data suggested. If China is actually already on a slower growth path, overcoming the US becomes more difficult.
Not in Biden’s time
“It will not happen in my time.” said Biden when asked about China ‘s ambitions to take first global place. “Because the United States will continue to grow.”
For the US, as for China, the path to faster growth lies in expanding the workforce, updating the capital stock, and innovating in technology. Biden’s infrastructure and family plans represent trillions of dollars in prepayments to do just that. By elevating U.S. growth on a faster path, they could delay China’s ascent.
Pulling all these threads together, Bloomberg Economics has built scenarios for the outcome of the US-China economic race.
If all goes well for China, from domestic reforms to international relations, then it could start the next decade head-on with the US and then accelerate at a distance.
Who wins? hang
It is in Xi’s interest that the world see it as the inevitable path. If political leaders, business executives and investment managers are convinced that China is ready for supremacy, they have a strong incentive to join the gang, turning Beijing’s prophecy of success into a self-fulfilling prophecy.
And Xi has the development logic on his side. China’s population of 1.4 billion is four times that of US GDP per capita is currently less than 20% of the level in the US. It will only need to converge a little more for China to claim first place. The success of China’s past development, as well as that of its Asian neighbors Japan and South Korea, suggest it should not be a very long order.
But as China’s quadratic history shows, development is not predetermined. On the 100th anniversary, the focus, of course, is on the successes of the last forty years. In the early decades, the Party data on growth delivery were, to say the least, much less impressive. As Xi lifts his term limits and prepares for a third term as President, some fear a return to leadership dysfunctions that damaged the early period of Communist rule.
If doubts begin to linger, another path is possible. Stalled reforms, the breakdown of global ties, shrinking labor and the financial crisis could keep China in second place indefinitely.
Translated and adapted for Konica.al by Bloomberg
