The World’s Second Largest Economy

News reports over the weekend noted that China has overtaken Japan as the second-largest economy in the world.

The reports stemmed from a remark made on Friday by Yi Gang, deputy governor of the People’s Bank of China, who said that the Chinese economy outpaced Japan’s in the first half of this year. “China, in fact, is now already the world’s second-largest economy,” he said in an interview with China Reform magazine posted on the website of his agency, the State Administration of Foreign Exchange.

“China’s GDP as of late last year totaled US$4.99 trillion, slightly lower than Japan’s $5.07 trillion, but with China’s 11.1 percent growth in the first six months of this year its GDP is already at $5.54 trillion,” said Wang Songqi, deputy director of the Finance Research Center at the Chinese Academy of Social Sciences. If Japan achieves its growth target of 2.6 percent this year, its GDP will amount to $5.20 trillion for the January to June period. Even at 5 percent growth Japan’s GDP would reach only $5.32 trillion, still behind China.

Media coverage of this new watershed event tended to focus on three areas:

1. Will the United States be next?

Various commentators and reporters quoted studies by authorities such as the World Bank and Goldman Sachs that concluded that China would surpass the United States as the largest economy in the world by 2025. In response, naysayers rejected the inevitability of China becoming the world’s largest economy by citing equally aggressive comments made about Japan in the 1980s as the Japanese economy seemed unstoppable.

Whether China surpasses the United States in 2025, or another time, is not the point. The fact is that China has already become a major force in the global economy and will become even more so in the years ahead.

Comparisons with Japan are overdone in my opinion. Japan is a country with a population one-tenth the size of China’s and its economy has a completely different set of drivers. There will surely be many economic bumps in the road ahead for China, but I doubt that there is a “lost decade” in China’s future as there was for Japan in the 1990s.

2. Comparisons with the United States are not viable because China’s per capita GDP is much lower.

This is certainly true — as far as it goes. China’s GDP per capita of $3,800 is less than one-tenth that of the United States. However, this does not mean that China’s domestic market is not already considerable. Unlike developed economies where income distribution tends to be more uniform, China has a very large disparity of income where as many as 900 million people have average per capita incomes of less than $1,000, and the balance of the population have per capita incomes that are ten times that. A market consisting of 400 million people making an average of $10,000 annually is very formidable, and by itself, ranks as one of the largest and most prosperous in the world. If China’s currency is undervalued by as much as 40 percent as some experts believe, then per capita incomes and the spending power of the more affluent portion of China’s population are even greater.

3. Can China lead the world out of the global recession?

With the economy in the United States sputtering and European governments moving to policies of fiscal constraint, this is a particularly pertinent question. Unfortunately, there are limits to what China can do. Even at approximately $5 trillion, China’s economy is less than one-third that of the $15 trillion U.S economy, and only 8 percent of the global economy of just over $60 trillion. Continued fast growth in China will certainly help, but China’s economy is simply not large enough at this point to completely offset the economic issues facing the global economy.

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