China Passes Japan, Not As Important As It Seems

After months of speculation, it’s finally official: the Chinese economy, as measured by GDP, is larger than the Japanese economy. In the second quarter of 2010, the Japanese economy was valued at about $1.29 trillion, the Chinese economy at $1.34 trillion. The gap will widen next year and for the foreseeable future.
The swap of the number two and three spots in the world, behind the U.S., is heralded as (i) a sign of Chinese ascendance and Japanese stagnation; and (ii) proof of the superiority of the PRC’s state-led development model.

This swap is certainly not the result of a superior development model and it might not even say too much about Chinese ascendance. This is because, while GDP does measure size, it is a flawed measure of economic performance and prosperity.
Start with what GDP does measure. On simple GDP, China just became larger than Japan. However, the PRC repeatedly revises its own GDP higher and is still missing some service sector and rural transactions. It probably passed Japan several years ago. Also, GDP calculations adjusting for different prices within economies —known as purchasing power parity—indicated China’s economy was larger than Japan’s as early as 1995. This is old news.

It’s true that simple GDP does matter. The increasing size of China’s economy means the entire world is now affected by its voracious demand for oil, iron ore, and other commodities, as well as its low-cost supply of consumer electronics, clothing, and other goods.

But for successful economic development, what matters far more is the wealth of individuals and families. Japanese economic weakness is not shown in its still impressive 3rd place in world GDP but in its roughly 40th place on measures of personal income. From an economy once thought better managed and better performing than the U.S., the average citizen of Japan is now poorer than the average citizen of Mississippi. American citizens are noticeably richer than citizens of most other developed countries, such as in the EU. But Japan, in particular, is moving backward.

In contrast to Japan’s 20 years of weakness, there has been stunning growth in Chinese GDP per capita for 30 years. Yet China is still a developing economy. Chinese GDP per capita, even adjusted for purchasing power, is about 15 percent the level of the U.S. Further, GDP per capita actually exaggerates China’s performance.

The PRC’s incomplete data revisions undermine comparisons but, from the middle of 2000 to the middle of 2010, GDP per capita increased by more than 9500 yuan or, at present exchange rates, another $2800 in annual income. However, urban disposable income increased less than 6800 yuan, or about $2000 in annual income. And rural income increased less than 2000 yuan, or $600 in annual income.

Urban and rural income increases don’t average to the GDP per capita increase because most households see little of China’s GDP gains. Instead, the benefits of the PRC’s growth are captured by state-owned enterprises. Japan is struggling, but this moment of apparent Chinese triumph requires a disclaimer: fast GDP growth is overrated when individuals and families lag behind.

Author: Derek Scissors, Ph.D.