From economic miracle to mirage – will China’s GDP ever overtake the US?

Analysis: issues of governance, rising debt, Covid and property market turmoil will delay Beijing’s quest to become the global economy’s No 1

First published on Tue 28 Dec 2021 09.13 EST

“The east is rising, the west is declining”, according to the narrative propagated by the Chinese Communist party (CCP). Many outside China take its “inevitable rise” as read. On the way to becoming a “modern socialist country” by 2035, and rich, powerful, and dominant by 2049, the centenary of the People’s Republic, China wants to claim bragging rights as its GDP surpasses the United States, and project its power based on its expanding economic heft.

There is, however, a critical flaw in this narrative. China’s economy may fail to overtake the US as it succumbs to the proverbial middle-income trap. This is where the relative development progress of countries in relation to richer nations stalls, and is normally characterised by difficult economic adjustment and often by unpredictable political consequences.

Historically, China’s growth miracle has been remarkable. In the 30 years to 1990. The money GDP (the market value of goods and services produced in an economy) for China and the US in American dollar terms grew more or less in tandem at just over 6% and 8% per annum, respectively. . But in the next three decades, China’s GDP growth doubled to over 13%, while America’s halved to 4.5%. That pushed China’s GDP up from 5% of American GDP to 66%.

Yet, China’s growth spurt is now over, and the huge disparity in GDP growth has been eliminated. In the last few quarters, China’s GDP has been growing at half the rate of the US. Although that discrepancy is probably unsustainable, America’s $9tn GDP margin over China means that comparable rates of GDP growth in the future will sustain and even widen the margin. A Japanese thinktank has recently extended the date when it expects China to overtake the US, from 2029 to 2033. Deferrals like this are now a feature, and there will be more.

What is gross domestic product (GDP)?

Gross domestic product (GDP) measures the total value of activity in the economy over a given period of time. 

Put simply, if GDP is up on the previous three months, the economy is growing; if it is down, it is contracting. Two or more consecutive quarters of contraction are considered to be a recession. 

GDP is the sum of all goods and services produced in the economy, including the service sector, manufacturing, construction, energy, agriculture and government. Several key activities are not counted, such as unpaid work in the home. 

The ONS uses three measures that should, in theory, add up to the same number.

• The value of all goods and services produced – known as the output or production measure.
• The value of the income generated from company profits and wages – known as the income measure.
• The value of goods and services purchased by households, government, business (in terms of investment in machinery and buildings) and from overseas – known as the expenditure measure.

Economists are concerned with the real rate of change of GDP, which accounts for how the economy is performing after inflation.

Britain’s government statistics body, the Office for National Statistics, produces GDP figures on a monthly basis about six weeks after the end of the month. It compares the change in GDP month on month, as well as over a three-month period. 

The ONS warns that changes on the month can prove volatile, preferring to assess economic performance over a three-month period as the wider period can smooth over irregularities. 

The most closely watched GDP figures are for the four quarters of the year; for the three months to March, June, September and December.

The figures are usually revised in subsequent months as more data from businesses and the government becomes available.  

The ONS also calculates the size of the UK economy relative to the number of people living here. GDP per capita shows whether we are actually getting richer or poorer, by stripping out the impact of population changes. Richard Partington

The issue though is less about the maths and more about why China is at a turning point.
Remember we have been here before. In the 1930s, Germany was going to dominate Europe, if not the world. In the 1960s and the 1980s, the Soviet Union – which had already stolen a march on the US in space technology – and later Japan, which was the rising economic force on the planet, would within 10 to 20 years overtake America to become the dominant economic and technological power.

History was not kind to the consensus. There is a serial tendency going back to the 1920s to underestimate the self-rectifying capacity of American institutions and enterprise. Equally, the Soviet Union and Japan both pursued similar development models, based around distortions that emphasised unsustainably and excessively high savings, high investment, and eventually high debt. Their development models cracked with spectacular consequences attributable to chronic failures of institutions and governance.

China is our 21st-century version of this phenomenon. Its investment rate is a good 10 percentage points of GDP higher than it was at the peak in the USSR and Japan, and strongly associated with misallocation and inefficiency of capital, and widespread debt servicing problems.

Its zero-Covid policy could keep barriers in place between China and the world economy until 2023 or even beyond, but this aside, a protracted slowing in trend growth, exacerbated by over-indebtedness and the tipping point now in real estate, as illustrated by the crumbling development giant Evergrande, is already under way. China’s $60tn real estate sector is four times GDP and accounts for a quarter to a third of annual growth. It faces years of awkward adjustment, not least as developers cut debt, the first-time buyer age cohort contracts, and probably as real estate prices decline.

China’s economic structure, moreover, is unbalanced. It has income per head that is the equivalent of Mexico, but consumption per head that is no higher than Peru. Consumer spending accounts for about 37% of GDP, little higher than it was in 2010, and much lower than in 2000. Productivity growth, closely associated with liberalising reform, has stalled.

China’s development model urgently needs a makeover to avoid the middle-income trap. The longer it is delayed, the bigger the costs. China’s leaders recognise that change is necessary, and Xi Jinping recently revived the slogan of “common prosperity” to mobilise the Communist party and citizens around a strategy to reduce income and regional inequality, and improve living standards.

Yet these political goals require precisely the kind of liberalising, progressive and redistributive reforms to the economy to which Xi Jinping is opposed. He has pursued an increasingly ideological and totalitarian governance style in which the already dominant position of the party and state in the economy, has been strengthened further.

Perversely, he has created a contradiction in which even the CCP’s expertise in dialectical argument may be of little help. The recent blizzard of new laws and regulations aimed at private firms and entrepreneurs, for example, is designed to nail down the part’s control and bring the private sector to political heel. This is hardly compatible with the productivity growth and innovation on which China’s lofty economic ambition depends.

Overtaking the United States is going to need a lot more than narrative. It requires policies to which Xi’s China is opposed, and might just remain a mirage. The consequences for China and the rest of the world have not been properly thought about.

George Magnus is a research associate at Oxford University’s China Centre and at Soas. He is the author of Red Flags: Why Xi’s China is in Jeopardy.

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