Is China about to overtake US as the world's largest economy?

China US flags

When will China become the world's largest economy?

It's a question that's been asked a lot in the past few years.

With annual GDP growth rates of 9-10% for 30 years, China has quickly become the second largest economy in the world, overtaking all but the United States.

Even with China slowing, its economy is still expanding at double the pace of America's.

So, thanks to the power of compound growth, growing at 7% means the Chinese economy will double in size in about a decade. That would bring the Chinese economy to the same size as America's is now.

With the US growing at only around 3% per annum, speculation as to when China takes the crown is gaining momentum.

The latest look at this comes from a leading international statistics organisation.

Bear with me, as I walk you though the different ways of looking at this.

International comparisons

According to the International Comparison Program (ICP), under the authority of the United Nations and hosted by the World Bank, new assessments put China's economy at 87% of the size of the US in 2011.

That was three years ago. And in 2005, the same organisation put China at only 43%.

But, the latest figures from the International Monetary Fund (IMF) in 2012 put China's economic output at about half the size of the US.

China's gross domestic product (GDP) in 2012 was $8.2tn (£4.9tn) while the US was $16.2tn.

The difference is that these are nominal GDP figures, so they are based on exchange rates.

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Any adjustment for purchasing power parity is fraught with difficulty”

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The ICP figures make adjustments for how much a dollar buys in different countries, so it is a PPP or purchasing power parity assessment.

The difference between nominal and PPP-adjusted measures is how adjustments are made for exchange rates.

For instance, as these comparisons are in US dollars, then there must be a conversion of the size of an economy into dollars.

But, what if China has an under-valued exchange rate?

Then, the size of its economy will be mis-judged. So, economists try to adjust for what a dollar buys in different countries by seeking out prices of goods and services.

The ICP finds that the PPP-adjusted world GDP is $90.6tn versus $70.3tn when measured by exchange rates in 2011.

Under the IMF data for 2011, world GDP is $70.9tn when measured by exchange rates and $79.4tn when adjusted for PPP. So, the difference isn't as significant as the ICP measures.

'Complex process'
china port China's economic output has been rising steadily over the last few years, when compared to the US

Using the IMF PPP measures, China's economy is $12.3tn and the US is $16.2tn, so Chinese GDP is about 76% the size of America.

As the ICP points out: "Because of the complexity of the process used to collect the data and calculate the PPPs, it is not possible to directly estimate their margins of error."

In other words, any adjustment for PPP is fraught with difficulty.

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What ultimately matters more than absolute size is the income earned by the people within a country”

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But, they do attempt to measure the purchasing power of a country's income earned by its citizens, which tends to be under-valued using exchange rates for emerging economies.

For instance, the ICP finds that middle income countries' share of the world GDP is 48% versus one-third (32%) when compared using just exchange rates.

So, China is growing more quickly than the US and has the potential to overtake it. I have seen estimates of that date fluctuate wildly over the years, but many economists see it happening.

Of course, forecasting errors are a subject of another blog.

What ultimately matters more than absolute size is the income earned by the people within a country.

And it will be many more years before per capita GDP in China will overtake that of the US under any of these measures.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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