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The sun rises in the East and set in the West. The rise of China and the decline of the US?

Jean-Pierre Dumas

Tuesday, November 3, 2020

We show that 1) the rise of China has been accompanied by the relative decline of the US. The US is no more number one in terms of GDP at purchasing power parity. 2) Trump remaining in power may maintain America second position.

Prominent Chinese foreign-policy scholars … have argued that the “greatest change” in the “great changes unseen in a century” is the shifting balance of power between China and the United States.

Rush Doshi, “Beijing Believes Trump Is Accelerating American Decline” FP, Oct. 12, 2020

China’s ambition to become the first super power is not hidden. President Xi delivered a series of speeches that suggested it was time to “leave behind” the era of “hiding capabilities and biding time” and to now move toward the “world’s center stage.”

Rush Doshi, 2020

1 Since 2017, China has surpassed the US in terms of GDP on a PPP.

To compare GDP between countries you need a common currency; the currency used as the numéraire is the dollar. There are two big methods to do that conversion, and each can give a different answer. One uses the official exchange rate (OER) prevailing in the foreign exchange market (to convert a flow, we will use the average exchange rate over a year). The other use the purchasing power parity (PPP) exchange rate.

· The official exchange rate method

Let’s estimate the Chinese GDP in US dollars. We can divide the Chinese GDP expressed in national currency (the yuan) in dollars using the official exchange rate (OER). In 2019, the Chinese GDP was Y99 493, the average OER this year was 6.908Y/$ thus the Chinese GDP was $14 403.

This method does not provide a stable result since the exchange rate varies over time and depends on a lot of factors. In addition, market exchange rates are relevant only for traded goods. If one desires to compare GDP between countries, these GDP include a lot of non-traded goods. Non-traded goods and services are cheaper in low-income countries (LICs) than in high-income countries (wages are lower in LICs), therefore the purchasing power of LICs is underestimated when one uses the OER as a conversion factor. A haircut is cheaper in Ouagadougou than in Paris, same for a taxi ride.

Therefore, to estimate the value of the GDP in dollars of a country using the OER method fails to take into account the difference in the prices of nontraded goods across countries and will underestimate the purchasing power of consumers in developing countries. PPP methodology, to compare GDP across countries, provides a better measure of the economic welfare of the country.

· The PPP exchange rate methodology

An alternative consists to estimate the purchasing power parity (PPP) between a currency of a country vis à vis the dollar. This PPP ratio is the ratio of the prices of a basket of goods & services in China against the prices of the same basket in the US.

The PPP exchange rate gives the amount of national currency to buy a comparable basket of goods & services valued in dollars. The PPP exchange rate is equivalent to the exchange rate that indicates equal purchasing power between local currency and the US dollar.

This is the method used by TE with its famous “big mac index”. Instead of comparing the prices of a basket of goods and service, TE collapses all goods in one homogenous good, the big mac. It is a heroic hypothesis, but one that is pragmatic and works.

It compares the price of a big mac in China (Y21 in 2019) to the price of the same big mac in the US ($5.75). The parity exchange rate is Y21/$5.75 = 3.65Y/$. Of course, this PPP is different from the OER (Y6.88/$). Therefore it can be inferred that the US dollar OER is overvalued in relation to its PPP valuation.

The International Comparison Program (ICP) estimates the PPP between all countries in the world with the US taken as the numéraire. It compares the prices of a wide range of products but every six years. The IMF estimates in between data using differential rates of inflation.

Let’s consider two countries China and the US. The ICP compares the prices of a lot of goods and services in these two countries each expressed in their own currency. The Purchasing Power Parity (PPP) of China with respect to the US will be the price ratio of Chinese goods (expressed in national currency) divided by the prices of similar goods in the US expressed in dollars.

In 2019, the PPP conversion factor between China and the US was estimated by the ICP at 4.25, this is the ratio of the price levels in China (in yuan) and the US (expressed in dollars) of identical products. We remember that we used the big mac index to have a short cut to find this PPP ratio, it is very similar to the calculation elaborated by the TE see: burgernomics. The PPP ratio is 4.25 for the ICP and 3.65 for the quick method proposed by TE.

The purchasing power parity consists to assess the GDP of a country with the quantity produced in this country multiplied by the level of prices of a reference country which is the US.

To have the Chinese GDP in terms of PPP we divide the GDP in yuan by the PPP conversion factor. Y99 493bn/4.25 = $23 410bn. The same Chinese GDP in US dollar expressed at the official exchange rate was $14 403bn. The Chinese GDP in terms of PPP was 63% higher than the GDP calculated with the OER. This is because the OER considers only traded goods, whereas the PPP considers all goods traded and non-traded. The price of non-traded goods is much cheaper in a developing country than in developed countries; therefore, the PPP conversion factor has the effect of increasing the PPP GDP in dollars in comparison with its estimation at the OER.

· China takes over the US in terms of GDP based on a PPP exchange rate

Figure 1 is striking, China takes over the US in terms of GDP based on a PPP exchange rate in 2017.

Figure 1 GDP based on purchasing-power-parity share of world total

Table 1GDP shares of each country at PPP prices as a % of world GDP

Source: ICP 2017 & IMF WEO Oct. 2020

2 Is the GDP at PPP the most accurate measure of the economic weight of a country?

Well, the GDP at PPP is 63% higher for China than its GDP at the OER. This is a lot, The GDP at PPP increased tremendously the GDP measurement for all countries in relation to the US. The poorer the country, the higher the gap.

As usual nothing is simple in economy, contrary to populist judgment.

Figure 2 The US is still the first country in terms of GDP expressed at OER

Of course, China is still an emerging countries in many ways, its GDP per capita was 26% of the US in 2019.

Table 2 The GDP per capita of China at PPP is rather low 26% of the US

It is too early to declare that China has overtaken the US but Figure 1 is telling, there is a rise and rise of China and a relative decline of the US (and of developed countries). After all this is the catching up effect.

3 The US decline is reinforced by the Trump presidency

The greatest change over these last 40 years indeed is the catching up of China and the (relative) decline of the US. Admittedly, the decline of the US does date back to Trump’s arrival in power but the US decline may worsen with Trump. The Trump’s slogan “America first” is the best way to reduce the US world power in the world.Trump has ruined the US-led alliance system” and ushered in “the best period of strategic opportunity for China since the end of the Cold War”.

Rush Doshi, 2020

· Trump is destroying the rule-based system established after the second WW

He has disrupted the rule-based international system relying on NATO, the UN system, the WHO. Yes, these international organizations are not always very efficient but remain useful institutions to settle conflicts.

Trump’s administration has undermined the WTO by blocking the appointment of new judges to its appeals panel, rendering the dispute settlement mechanism non-operational (see Anne Krueger, “Trump’s Spectacular Trade Failure” in Project Syndicate, Sep 22, 2020).

His withdrawal from many international organizations is seen by China as a chance to replace a declining nation.

· Trump against free trade

President Trump (this paper is written the date of the presidential US election, Nov. 4, 2020) has fought against the ambition of China with its populist (simplistic) and rogue ways, putting the blame on everything on China and slapping tariffs on imported goods from China and the rest of the world.

Trump, as the people who support him, does not understand the beneficial effects of international trade (this is typically a populist reaction, to judge things without concepts).

This is the extraordinary development of the international trade which has made possible the development of the world economy after the second W.W. Whether Trump likes it or not an international economy is based on rules for trade enforced by the WTO. Instead of looking down at the WTO, it would have been smarter to reinforce it, to present its case against China’s behavior.

Trade liberalization with tariff reductions were and still are the motor of world growth. The fact that the US has a structural external deficit is not, as Trumpians think, a sign of weakness, but on the contrary, a signal that the US can live beyond its means without adverse consequences thanks to the dollar pre-eminence.

All Trump ideas rely on bilateral “deals” where he uses the US power to bully its adversary. He lives in a zero-sum game world where the winner takes all. He has never heard of the positive gain of a free trade world.

His objective was to reduce US bilateral trade imbalances. The results are not very impressive, the current account deficit is more or less the same under the Obama mandate (2010-15) 2.5% of GDP, against 2.1% during the Trump’s period (2017-19) (extreme years as 2009 and 2020 are not accounted for). The growth of export in constant prices was 5% a year from 2010 to 2015 and 2.3% under Trump.

Trump does not understand that protectionist policy has the effect to affect trade development in both countries. US consumers must pay more for goods imported from China (and other countries), imported inputs are costlier and thus US competitiveness is declining. China has retaliated (as are going to do EU countries) against US imports undermining US exports.

Trump’s policy on the spot has negative effects for the US trade. The Trans-Pacific Partnership (TPP), negotiated by Barack Obama’s administration, was immediately abandoned by Trump upon taking office. The results of it, US wheat producers have to face a 38% tariff on US wheat exports to Japan (not faced by Canada and Australia). Japan and the US have concluded a free-trade agreement that eliminates duties on autos and other goods, the US does not participate to these trade agreements (see Anne Krueger, 2020).

Trump’s simplistic bilateralism and incompetence in economy has undermined US firms and households. The winner will not be “America” (America is not a country, it is a subcontinent) but the resilient China. If Trump's goal was to tackle China's unfair trade practices, then why alienate all other countries, especially the EU?

· Trump’s inability to lead against the covid disease

Mr. Trump’s response to covid-19 has shown its inability to lead the country in an exceptional time. His only action, in front of a pandemic disease, he does not understand, has consisted to put the blame on China, this is a little bit short for a man who has the pretension to run “America”.

“The American response to the 2020 coronavirus pandemic—which has left over 200,000 Americans dead, millions infected, and much of the US political leadership incapacitated with illness—has reinforced preexisting Chinese views on American dysfunction and decline.”

Rush Doshi, “Beijing Believes Trump Is Accelerating American Decline” FP, Oct. 12, 2020

The need for the US to refocus on itself and to reduce its world involvement does not justify depreciating every country under the sun and to erect trade barriers against every country which does not comply with the whims of this little Ubu. Trump has not understood that if China is its enemy; thus, he needs allies, not adversaries and its allies were in Europe and Asian countries tired of being bullied by China.

If Trump is reelected, the risk may be a confirmation of “America second”.

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