The U.S.-China Race

If we had extrapolated Japan's average economic growth between 1960 and 1970, one would have expected the Japanese economy to become larger than the U.S. economy before 1980 (see the chart below).

Until 1990, Japan still was converging towards the U.S. GDP. But since 1991, the U.S. economy has grown much faster than Japan's. From 1960 to 1991, Japan's GDP rose from 37% to 78% of the U.S. GDP — before falling back to a level of 63% by 2000.

The chart below displays, on a ratio scale (where a straight line represents a constant percentage growth rate), the total economic output of the United States and Japan — the two largest economies today.

It also displays the two most populous countries, China and India. Trend growth since 1980 is extrapolated for each of these (for Japan, since 1990).

Source: All figures use data from the World Bank, World Development Indicators 2002

The chart projects China's economy growing at nearly 10% per year — and shows that it will become larger than the Japanese economy in less than two decades. On the same basis, it will become larger than the U.S. economy in about three decades. India’s economy will catch neither the United States nor Japan in this period.

Of course, even by 2033, when the United States and China have the same GDP based on current growth trends, the United States still will be about five times as rich on a per capita basis.

Indeed, China's slow start and huge population make continued rapid growth more likely perhaps than in an economy that already has caught up with — or soon will join — the high-income world.

One possible constraint of continued rapid growth in China is the ability of the rest of the world to adjust to the trade and capital flows that such growth will entail.

Some analysts assume that China's growth is not only heavily export-dependent — but that it also has been accompanied by a rapidly growing export surplus.

While the graph below shows that this first assertion about China's growth is consistent, the latter proposition is not true. Yet, in the 1990s, exports expanded from 18% to 26% of China's GDP. But net exports showed no such trend relative to GDP. In fact, in 2000, they were near the decade-long average of below 3% of GDP.

Source: World Bank

While Chinese competition has set off alarm bells for manufacturers worldwide, increasing Chinese imports of capital goods, raw material and other goods have received less attention.

In fact, most new Chinese production has not been destined for consumers overseas. It has satisfied new demand in China. Nowhere in the world are bicycles "made in China" as widely used and popular as in China itself.

China's domestic demand has also grown with its income. From 1970 to 2000, China's GDP (in constant 1995 prices) increased by $942 billion. But domestic consumption and investment also increased by $914 billion.

The gap of $28 billion between GDP and domestic consumption figures shows that China is exporting more than it is producing. But the gap is significantly smaller than domestic consumption. This fact again suggests that China's economy is focused on satisfying both domestic and foreign demand.

The rest of the world must indeed adjust to the changing composition of China's exports and imports, and to the composition of Chinese financial assets and liabilities. But at $28 billion per year, the net increase in the flow of capital is modest.

Long-term forecasts can make fools of those who rush in to make them. It would be foolish indeed to treat the trajectory of Chinese development as an Iron Law.

But it would be more foolish still to assume that the current constellation of economic and political power will not change.

For a business or political leader, the next annual report or the next election may define the limit of any useful forecast. But experience has shown that the status quo of the global economy can change substantially over just a few decades.

For example, the distribution of economic and political power today is radically different than it was in 1973. Back then, the United States had just lost the war in Vietnam — and OPEC was flexing its muscles.

The year 2033 will most certainly not resemble today. For my money, China remains the country to watch.