Etalkinghead

China may be smaller than we thought. The Chinese economy is not a $10 trillion economy about to pass the United States, but a $6 trillion economy – 40 percent smaller than previously calculated. India’s economy is 40 percent smaller, too. The figures are from a World Bank statistical report of the economic output of 146 countries. What does this mean?

For one thing, it means that lots of people disagree with the World Bank’s figures and the methodology behind them. The International Monetary Fund has different figures. So do other agencies, financial institutions and international organizations. The disagreeing experts may confuse, not clarify, the situation.

The media have never attracted editors and reporters who have a firm grounding in economics and statistics. Therefore, the mainstream media are not prepared to analyze and report this news. So the media, especially in the U.S., have neglected the report and its possible ramifications. Those politicians who claim to understand the significance of the report have jumped into the debate and used the figures to support various projects and positions that they favor.

The old figures predicted that China would pass the U.S. and become the world’s largest economy in 2012. The new figures put the Chinese economy at about half the size of the U.S. economy. If the World Bank is correct, China will not challenge the U.S. for global economic leadership for decades and perhaps even centuries. Economic leadership in the past has translated into political leadership.

Will China lack funds?

Other important implications flow from the report: If the World Bank is correct, China will have less money to spend on its infrastructure and military, and the Chinese will face much deeper social and economic problems at home than previously assumed. China will have to go slower in curtailing pollution and cleaning up the environment. Of concern to importers of Chinese goods, China will not have the funds to convert all the industries that have produced toxic or tainted products.

So what happened to that $4 trillion in Chinese gross domestic product? That is where the disagreement comes in. The economists at the World Bank calculate a country’s gross domestic product by adding up the prices of the goods and services its economy produces. Each country’s GDP is stated in the local currency – dollars for the United States and yuan for China. But to make comparisons, the economists convert each country’s GDP into U.S. dollars. The easiest way to make the conversion is to use prevailing exchange rates.

For 2006, the World Bank calculated that China produced 21 trillion yuan in goods and services. Using the exchange rate of 7.8 yuan to the dollar, the Bank figured that China had a GDP of $2.7 trillion. Because China artificially manipulates the value of its currency, the Bank figured that $2.7 trillion was too low.

The economists know that goods and services tend to cost less in developing countries such as China. To adjust for that, the economists compare prices from one economy to another and compute an adjusted GDP based on the principle of “purchasing-power-parity.” Each country’s GDP is adjusted to get a more realistic measure of relative economic strength. Each country’s actual living standard is analyzed. This is where economics moves from science to art, from mathematics to appraisal and forecasting.

Comparing hundreds and even thousands of prices in over 140 different economies all over the world is a huge job, even with today’s computing power. Over time – and not all that much time – the purchasing-power-parity numbers tend to become less meaningful. So the World Bank started from scratch and reviewed the assumptions and data that composed the GDP adjustments. For the first time, China assisted the Bank in the analysis. The result was surprising: There is less difference between China’s domestic prices and those in mature economies than previously assumed. Therefore, the revised purchasing-power-parity adjustment is smaller than the old one. There goes $4 trillion in Chinese GDP.

The experts disagree

Is it really gone or is this just a case of garbage in and garbage out? Remember that old saying that figures can lie and liars can figure? Is something like that going on here? Ah, that’s the rub: The experts disagree. In the U.S., for example, some proponents of the development of weapons systems to combat the anticipated rapid expansion of the Chinese military dispute the new figures. The fact is that they may not sell as many weapons if Congress does not perceive as great a threat.

The political consequences of the new figures are only beginning to be understood. A major implication is clear: If the new figures are right, the U.S. will remain the world’s largest economy well into the future. That means that China will not be able to challenge the U.S. for global political leadership any time soon. Another finding of the new figures reinforces that: Differences in Chinese and U.S. living standards are larger, much larger, than previously assumed. On a comparative basis, the average income in China is less than one-tenth the U.S. level. With its people this poor, compounded by the growing wealth of China’s eastern coastal regions, China will have a hard time staving off internal dissension, much less spending enough on a military buildup to challenge the U.S.

More ominous problems may arise. China’s political stability may be threatened. China has an aging population. The percentage of people over 65 will increase from about seven percent now to nearly 25 percent by mid-century. Those seniors will be concentrated in rural areas. They will be without social security or a healthcare system that can cope with the tremendous increase in the elderly population. The traditional family support system will be disrupted as children migrate to the urban areas in search of jobs.

The financial system will be stressed. The stress may dwarf the problems in the U.S. sub-prime mortgage market. In short, China’s problems are as big as before. But China has fewer resources to meet the problems.

Poor air quality, acute water shortages, pollution in major river systems: These are problems that require massive investments to eliminate or forestall environmental disasters. We will find it harder to get China (and India) to make domestic sacrifices to address world problems such as global warming.

Other relationships will change. Japan’s economy was not downsized by the World Bank revisions and, therefore, China’s economy has shrunk by 40 percent compared with Japan, too. With the U.S., Japan may balance China’s military power in Asia for decades to come.

China and India are not alone. Sub-Saharan Africa’s economy is 25 percent smaller than thought. An important consequence is that the ambitious United Nations campaign to reduce world poverty by 2015 will need to be revised and extended. We have all underestimated the extent of poverty throughout the world.

Overestimated progress

As a consequence, we have overestimated progress in alleviating poverty. Any business from the developed world that hopes to expand in China and India will need to modify forecasts to account for a smaller middle class and a larger underclass. Investors will need to reassess the risk in China and India. Companies with growth plans based on the previous Chinese and Indian figures will need to change their business plans. The booming Chinese market may turn sour quickly as investors realize that the new World Bank figures are correct.

For Americans and Europeans, the new numbers are no real comfort. Billions of people are much poorer than we thought. Poor people cannot buy Western products and services. True, U.S. economic and political leadership may extend through the next generation and beyond, challenged only by Europe’s rise and Russia’s assertiveness, but the third world will look to Americans and Europeans for more help.

On the other hand, the new figures may be wrong. The same people who decided the old assumptions needed changing may change their minds. Or new people may come along and new figures may follow. This is not an exact science. These figures, however, will guide great commercial and military decisions because economists guide the decision-making in almost all large organizations.

President Harry Truman was confounded by the conflicting and ever-changing forecasts of his economists. He remarked that they would give him their opinion and then hedge by saying, “on the other hand.” Then they would come up with a completely different forecast. Finally, Truman was exasperated:

“Bring me a one-armed economist.”