China: neither too much, nor too little
Thursday, January 10, 2008 at 1:36AM ARTICLE: The great fall of China, By Walter Russell Mead, Los Angeles Times, December 30, 2007
This is interesting stuff for the PPP [purchasing power parity] weenies, but hardly earth-shattering. It is an equivalency statistic, an all-things-being-equal notion.
No one conducts business or cuts contracts in PPP. If you were one of the Fantastics who predicted China's economy would soon surpass America's, then you are shocked--SHOCKED--to discover it won't happen.
Say you come to my neighborhood and I make a lot more money than my neighbor. But say everything in his house costs less, so his money goes a lot further than mine, because stuff costs more in mine. We could develop a calculation to take into account my neighbor's cheaper lifestyle and on that basis, we could equate the purchasing power of his buck versus mine.
Could we then extend that analysis and say his household economy is actually larger (more bang for buck?)?
Yeah, sort of.
But at the end of the day, I still have more income, despite my more expensive lifestyle, so you don't want to take that equivalency argument too far.
If I make 100,000 and my neighbor makes 50,000 but everything he buys costs half as much as my purchases, but they're basically the same goods and services with differences according to our households, then we basically have parity in purchasing power.
But again, that doesn't exactly makes our household incomes equivalent by most people's understanding. It just means we live similar lives in different circumstances.
Again, at the end of the day, the absolute amounts involved are dissimilar. We're just calculating a rough equivalency, as in, this is a middle class life in the States and this is roughly the same lifestyle in China.
So what this new calculation says is that money and income doesn't seem to go as far as we previously thought. Before we had one calculation and now it's 40 percent less. What we had previously was too high and I'll bet we soon decide that this current calculation is somewhat low. The guessing part comes in comparing the goods and services, because expectations differ. The acceptable meal in China differs from the one here, and so on.
But, again, understand this: no one conducts business or investment in PPP calculations. At the end of the day, the money needs to make sense in your own currency, not just his "equivalent" purchasing power.
So while these estimates are interesting to the rank-ologists, and while they give businessmen a sense of what price expectations are in any market (this is what the average Chinese expect to spend on this sort of thing), taking these new figures as somehow indicating China's economy is far smaller is misleading. What the PPP estimates is the power of China's purchasing function in relation to our own ("If China's economy was like America's, it would really be worth this much."). While "students" of global economics love this sort of stuff, actual practitioners are less impressed.
China's economy is the same. What is different is how we construct a sense of equivalency to our own economy. The 1800 or so in real bucks that we know the average Chinese makes doesn't equate to something like $7k in U.S. spending but something more like $4-5k (I do this from memory, so I may be off).
What really matters in China is demand and investment and how both will be met. At the end of the day, we can now say that China's current income travels less far, so we can ditch a lot of the crazy hypology of China's imminent "global domination," but overhyping in the other direction now is equally unwarranted, because most of our assumptions of how China will cost out future challenges will likely be significantly off base.
Mead may think he's uncovered a "shocker," but BusinessWeek and the WSJ already covered this news, and neither lost their grip on reality over it, so neither should we.
(Thanks: Bill Millan)
Reader Comments (8)
Jargon chuckle from a fellow consultant and TED-Lecture evangelist. Keep up the good work.
1) While I agree that it is correct to say nothing actually physically happened to the chinese economy, your analysis implies that we should be looking at nominal exchange rates to compare the outputs of two countries. This would lead to a MUCH smaller estimate of the chinese economy -- about $2.5 trillion, instead of $6trillion.What has happened is that economists have realized the REAL ouput of china is approximately equal to that of a $6 trillion US economy, not a $10 trillion one. Much less than we thought. It's not a perfect estimate...but it's much better than the nominal one.
2) As the chinese economy grows further, goods will become more expensive, hence it will likely take even longer than a decade (what a simple extrapolation of chinese grow rates implies) for their PPP to overtake US PPP even if they continue to grow at current rates. PPP of the Renminbi will continue to fall (as the study implies, it's fallen by 40% over about 20 years) as the CHinese economy continues to grow.
3) If econometricians extrapolating prices from baskets of goods collected back in the 1980's can be off by 40% twenty years later in the face of real exchange data like the Big Mac index (which is much more accurate than their previous PPP estimates), this has VERY powerful implications for the Stern Report and other studies and meta-studies done to assess the future economic costs of climate change policies.
The US has 13 identical pieces of furniture in our house.
Converting from China's currency to ours we'd expect them to 2.7 pieces of furniture.
But, upon closer analysis, we thought they had 10 pieces.
In reality they have closer to 6.
Big difference?
Not from the operational standpoint of a business because their on-the-ground surveys are more accurate estimates of potential demand for their product than the PPP estimates. But, when it comes to public policy it could matter a great deal -- in particular when it comes to convincing congress to vote certain ways on: 1) defense spending priorities; 2) bilateral trade policy; 3) condemnation for currency manipulation; it also has implications for estimates of future energy consumption (the chinese economy is a lot less efficient than previously thought), as well as the percieved need in the white house to form coalitions to counter-balance chinese economic influence.
Perceptions matter a lot.
This also has a large implication in terms of the ultimate level of disposable income of the average chinese consumer given the 4-2-1 demographic in china.
But, conventional wisdom states that demographics determines economics which is the largest source of soft-power. I would argue that in the 21st century, NBIC technologies in general -- and robotics in particular -- will to a large extent decouple a nation's economic power from it's demographics and human resources.
in this case, it's 'purchasing power parity'
I had written this at WDW and had the first couple of versions die in my Treo. I sent the third version in chunks to Sean, hence the choppy repetition.
Trying to understand PPP and what I remember from econ. For equivalent of $10 (10,000 Won), I could have lunch with 3 co-workers at a restaurant in Kunsan City, South Korea. If I were eating lunch in America, using 1000-1 conversion, I could eat lunch for $2.50. We know that isn't going to happen (especially since I live in Miami), so that $2.50 has less purchasing power here than the 1000Won does in South Korea.
Tom (throught Matt's comment), did you comment on this article imply that people in China have 2.7 pieces of furniture to every 10 pieces, or that the furniture in a Chinese house costs 27% of what the furniture in the American house costs?Related to categorization of costs, much of the discussion in American now surrounds the divying up of the income at the basic, 1 house=1unit level. Americans are putting more into housing costs and more into health care, and instead of curtailing discretionary spending, most reduce savings (which can be thought of as self investment). Will a similar reduction in not just self investment, but overall investment occur in China?