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There have been plenty of reports that China’s economy is overtaking the U.S. economy and that it may soon outstrip the U.S. As an example, in a recent piece, my MarketWatch.com colleague Brett Arends, reported on a study by the International Monetary Fund on the size of China’s economy. The IMF study suggested that by one economic measure China’s economy would look almost as big as the U.S. economy in a few years. Of course, that set off my innate skepticism so I did a little digging. In this post, my goal is to cover two questions:

  • How big is China’s economy compared with ours?
  • Is it really going to surpass our economy in size any time soon?

To get started, check out the opening from the Marketwatch report:

The International Monetary Fund has just dropped a bombshell, and nobody noticed.

For the first time, the international organization has set a date for the moment when the “Age of America” will end and the U.S. economy will be overtaken by that of China.

And it’s a lot closer than you may think.

According to the latest IMF official forecasts, China’s economy will surpass that of America in real terms in 2016 — just five years from now.

Yikes. Sounds pretty scary doesn’t it? Some folks might find a report like this disconcerting because they want the U.S. to be the #1 economic power. I don’t really care one way or the other about our economy being #1 or #2 in the world. Size has both advantages and disadvantages.

If that concerns you, don’t worry. Despite the gloomy reports, the U.S. is likely to remain the world’s largest national economic power for many years to come. And, if we would stop wearing cement shoes while running against competitors in lightweight Nikes, it wouldn’t even be close, but that’s a story for a different day.

A trillion here; a trillion there

To do my own research, I went to one of my favorite sources, the CIA World Factbook. I’ve used it many times before and I have more confidence in the Factbook’s data than most sources. According to the Factbook, in terms of comparing Gross Domestic Product (GDP) straight up, we’re #2 at $14.62 trillion and China is a distant #3 at $5.75 trillion. Japan is close to China at $5.39 trillion. We would be #1, but when the European Union is viewed as a single entity, it is at $15.95 trillion. Viewing the European Union as a single, unified entity is a bit of a stretch, but let’s not quibble.

We’re #2 and China is a distant #3

So, if we are north of $14 trillion and China is a bit over $5 trillion, how the heck can the IMF legitimately claim that China is catching up and may even be on its way to #1 in a few years? Well, without massaging the numbers a lot, they cannot.

A straight up comparison shows China is far behind us. However, the IMF report used an alternative way to measure economic output called purchasing power parity (PPP).

Purchasing power parity: what the heck is that?

Purchasing power parity attempts to compare economies that have very different price levels for basic goods and services. The most famous example of using PPP is the Big Mac Index which is described by the Economist this way:

…[the Big Mac Index] is based on one of the oldest concepts in international economics, purchasing power parity (PPP), the notion that a dollar, say, should buy the same amount in all countries. In the long run, argue ppp fans, currencies should move towards the exchange rate, which equalises the prices of an identical basket of goods and services in each country. In this case, the basket is a McDonalds’ Big Mac, which is produced in more than 100 countries. The Big Mac PPP is the exchange rate that would leave hamburgers costing the same in the United States as elsewhere…

This chart from the CIA World Factbook shows the world’s economic powerhouses in terms of GDP, as adjusted for purchasing power parity. According to this, the EU is #1, the U.S. is a close #2 and China is still #3. This data is from 2010. (Click charts to enlarge.)

Source: CIA World Factbook

PPP tries to look at economic output across countries by leveling the playing field. In China personal incomes are lower, but the cost of rent or food is also lower, so by using PPP, you can perform a useful comparison of economic output between the two countries. Another aspect of PPP is that it helps compare economies adjusting for currency disparities. Even the CIA World Factbook suggests that currency differences need to be accounted for to compare our two economies. I agree.

In GDP per person, China ranks…

A further way to look at economic output is to divide GDP by the number of people in a country. This is GDP per capita. It takes the same data used in the chart above, which is GDP adjusted for purchasing power parity, but divides that number by population. So, for China we have to divide by more than 1.3 billion people. For the U.S., we have to divide by a bit over 300 million.

Here are the top 10 countries for GDP per person:

Source: CIA World Factbook

As you can see, the top 10 countries for GDP per capita are very small nations that are either oil producers or financial centers. The only large country is the U.S., with a GDP per person of $47,400. What about China? Well, it’s nowhere to be seen on this top 10 list. Would you like to guess at where China stacks up by this comparison?

China is #126 in GDP per capita:

For GDP per capita, China ranks between two economic powerhouses — Turkmenistan and Albania. And, remember, for this ranking, we are using the PPP adjusted GDP so this is favorable to China compared with the U.S. In other words, China has a big economy overall, but it has a very low ranking when you adjust for population:

Source: CIA World Factbook

Does this mean China’s economy is bad? No, of course not. China has come a long way since its leaders adopted limited free market reforms back in the late 1970s. Nonetheless, it is also clear that much of China’s large economic impact in the world is a function of the size of its population.

China is not #1 on any economic ranking

Even with a generous methodology such as PPP, the highest China gets is #3. And, adjusted for economic output per person, it is #126 and that’s not exactly something you crow about. At a per capita GDP of $7,400 China is a long, long way from the $47,400 we have in the U.S. In fact, I’ll make a prediction. China will not come close to our per capita GDP. Not next year or even 10 years from now.

In terms of overall economic output, China would have to grow at a very high rate for many years to catch up to the EU or to the U.S. I hope it does keep growing because that is good. And, China has vastly improved its economy over the past few decades, particularly in terms of export industries. I’m not trying to knock those accomplishments at all. However, the idea that it is an economic power comparable to the U.S. is clearly not accurate.

Editor: The following ETFs all give U.S. investors access to China: CHIB, CHIE, CHII, CHIM, CHIQ, CHIX, CHXX, CNY, CQQQ, CYB, CZI, CZM, ECNS, FCHI, FXI, FXP, GXC, HAO, PGJ, TAO, XPP, YAO, YXI

Source: China: Still Far From No. 1