Conventional wisdom says that America is in decline, that the American century is over, and that the future belongs to the rest, especially the rest in Asia. Dates vary, but predictions that China’s gross domestic product will soon surpass that of the US to become the world’s largest economy are legion. In 2011, the International Monetary Fund predicted it will happen in 2016. More recently, The Economist put the date at 2019. Regardless of the exact time, prominent authors such as CNN commentator Fareed Zakaria (The Post American World) and Lee Kuan Yew School dean Kishore Mahbubani (The Great Convergence: see review page 66) have rushed to publish books predicting an historic shift in the global balance of power as a result of this change in relative share of global GDP. Indeed, the Australian government recently indicated its agreement with this thinking by moving to redeploy its resources and reorient its policies in response to a white paper on Australia in the Asian Century.
Yet, there is growing evidence that all of this analysis may be a bit premature and that America is not only coming back but that this century may well wind up being another American century. For one thing, the numbers can be slippery. As Mark Twain once noted, there are “lies, damned lies, and statistics.” The prediction that China’s GDP will surpass that of the US in the next few years is based on GDP calculated at what is known as purchasing power parity. This is a way of adjusting the GDPs of different countries to account for the fact that their citizens have different standard market baskets and pay different prices for them. For example, Americans tend to eat potatoes while Chinese eat rice. Potatoes may be relatively cheap in the US and relatively expensive in China with the reverse being the case for rice.
So if you compare the two countries on a potatoes-to-potatoes basis, China’s GDP may appear small. But if you consider then on a rice-versus-potatoes basis, the two would be more equal. Another example is the McDonald’s Big Mac burger. Since it is popular in both countries, we can compare the prices easily. Let’s say a Big Mac costs $1 in China and $2 in the United States. So the purchasing power of $1 in China is equal to that of $2 in the US and China’s GDP should be adjusted accordingly in comparing it to the US GDP.
This PPP method of adjustment is very useful and important but it is not a completely satisfactory or meaningful means of comparison. On the one hand, obtaining completely comparable market baskets in two countries is quite difficult, and the more so when comparing relatively open, free market economies to those that are more closed and highly regulated. On the other hand, all international transactions are done at the nominal exchange rates, not at some adjusted PPP rates. In terms of international buying power, you can’t take your $1, or RMB 6.5, that buys a Big Mac in Beijing and use it to buy a Big Mac in Seattle. There, you would only get half a Big Mac. The point is that at PPP, China’s GDP is presently calculated at about $12.4 trillion, or about three-fourths the US GDP of $15.6 trillion. At nominal exchange rates, however, the Chinese GDP is $8 trillion, or only about half the US GDP.
If China grows at 8 per cent annually while the US grows at 3 per cent, it’s clear that at PPP the Chinese GDP would pass the US GDP in the near future as predicted. But it’s also clear that it would not do so at nominal exchange rates. And, indeed, if China’s growth rate slowed a bit, its GDP might never surpass the US GDP. China’s growth rate has been slowing and almost surely will continue to slow as its work force shrinks (it shrank for the first time last year) and its population ages rapidly over the next thirty years. Moreover, even if China were to surpass the US in size of GDP, no one is predicting that it will come anywhere near the GDP per capita of the US, which is, after all, the truest measure of wealth and power.
When the commentators talk about a shift in the balance of power they often compare China surpassing the US to the passing by the US of Great Britain in the late 19th century. But, in fact, that was an entirely different phenomenon. America not only passed Britain in terms of GDP at PPP. It also passed Britain in terms of GDP at nominal exchange rates and in terms of GDP per capita. The US became the world’s largest economy on all counts. That is not going to happen in the case of China and the United States.
Indeed, it is not at all clear that China will surpass US GDP even at PPP. Keep in mind the next time you are in China and find yourself choking on the foul air that the things making the air foul are counted as positives for GDP. If you adjust the Chinese GDP for environmental degradation and for over-investment in things that will never be used, it falls in size by 30–50 per cent. Much of this would show up as non-performing loans in most economies but since such loans are never recognised in China, it will show up as slower growth in future years. Either way, it means that the predicted shift in economic balance may not occur even at PPP. Or, if it does occur, there may be a shift back in the not too distant future.
Beyond the statistics, other even more powerful factors are at work. A recent trip around the world confirms that all is not well in many parts of the global economy. Japan, facing population decline from 128 million to perhaps only 88 million people over the next thirty years and with extremely rapid ageing and a national debt of 240 per cent of GDP, is making a desperate gamble with Abenomics that it can shake off two decades of deflation by having the Bank of Japan engage in massive buying of assets. Even if it works, this so-called quantitative easing will not solve the population and other deep structural problems of Japan. And the chances that it won’t work are significant. Long the world’s second largest economy, with a GDP that at one point equalled about three-fourths the US GDP, Japan now has a GDP only one-third that of the US. South Korea appears to be in somewhat better shape, but its population decline and ageing rates are worse than Japan’s, and any recovery by Japan will entail damage to South Korea’s export dependent economy.
China has been the great story of the past quarter century and still is a good story. But as several analysts, including Martin Wolf of the Financial Times, have recently noted the miracle days are past. China has followed a growth strategy based on huge investment, sometimes in excess of 50 per cent of GDP. It has now hit a point of diminishing returns. Each new dollar of investment yields a bit less growth than the previous dollar. Beijing must make a shift to a more consumption and services driven economy.
This is an extremely difficult shift to make, as demonstrated by the failure of Japan and Korea to yet make it. To offset the impact of the Great Recession of 2008–2011, China opened the flood gates of public works and easy money, especially for construction. On 17 April, the Financial Times reported that one of China’s top auditors warned that local government debt is “out of control”. Also out of easy control are the demographic factors touched upon earlier. Because China’s work force is now shrinking, it must dramatically increase its productivity to have any chance of matching the size of US GDP. Some analysts think this would require a tripling or even quadrupling of Chinese productivity. For a long time the key question has been whether China would get rich before it gets old. The answer increasingly appears to be no.
India has good demographics with a growing, youthful population, but beyond that the Indian story is a very mixed one. Corruption is rampant and constitutes a huge drag on growth. The political system is slow, inconsistent, and often incoherent. The title of one best seller — India Grows at Night — says it all. The government isn’t working at night. India will probably continue to grow at 5–7 percent for some time, but here too the miracle appears to be over.
As for Europe, it is a nightmare. Austerity is the order of the day. Germany’s is the only economy with any growth at all and it’s not much. Most European countries have rapidly ageing and shrinking populations and increasingly difficult to carry welfare burdens. Whether the European Union and the Euro will survive are still open questions. In any case, there is no chance that Europe will lead a global revival.
That brings us to the US. Certainly, it has significant problems. Its government debt is high and federal budget deficits large. Unemployment is stubbornly hanging around 7.7 per cent despite strong quantitative easing by the Federal Reserve. Its infrastructure was just given a grade of D — very poor — by one of the leading engineering societies. Its students score only in the middle on the Program for International Student Assessment international comparison tests, and, of course, its banking practices and financial policies were a large source of the global economic crisis of the past five years. All true.
But where would you most like to put your money? The record highs of the Dow Industrials and the S&P 500 tell us that for a lot of people, the US is the place. Why?
For all the problems, the future is looking brighter and brighter and, in comparison to the likes of China, more stable. Start with the big trends. US demographics are among the world’s best. It will have steady 1–2 percent population growth for as far as the eye can see, both as a result of domestic births and of continuing immigration. Thus, compared to the rest of the world, with the possible exception of India and Africa, the US work force will expand and will become relatively younger. The US dollar is and will remain the world’s main reserve currency for a long time. It appeared for a while as if the Euro might be a viable alternative to the dollar, but that fantasy is now on life support.
The Chinese keep complaining about the role of the dollar and keep making bilateral deals to do trade settlements in renminbi and local currencies. But until Beijing is ready to open its capital markets, the RMB is unlikely to become a reserve currency. Since open capital markets have enormous implications for political power and stability, few are holding their breath waiting for Beijing to throw wide the gates. Thus, printing the world’s money will continue to give America a degree of flexibility and invulnerability that no other country can have.
Serious as the US debt and budget numbers are, they are beginning to get better. Households and businesses have largely repaired their balance sheets and the federal budget deficit has declined from 10 per cent of GDP to a bit over 4 per cent and is heading lower. The US economy is now headed for 3 per cent growth in 2013 according to a number of leading analysts. As this continues, government revenues will rise and the deficit will continue to fall. Ugly as it may look, the sequestration of US government funds is leading to substantial cuts in spending, so that more than half the target debt gap of about $4 trillion has already been filled.
Of perhaps greatest significance are two dramatic technological and geological developments. Of course, technology, inventiveness, venture capital, and entrepreneurial spirit have always been American strong points. In few other places do such endeavours as Google, Apple, and Facebook sprout up as frequently as in America. But these bright spots didn’t seem to reverse the trend of decline. Apple, for example, became the world’s most valuable company, but it did most of its production outside the United States. GE was another iconic American company that led the world in things like avionic technologies. But it transferred these to China, Brazil, and elsewhere.
In the last five years, however, the technology to obtain natural gas and oil from shale rock formations by fracking has turned the world upside down in America’s favour. The US has extensive shale formations over much of the country and these contain as much oil and gas as Saudi Arabia and enough to power America for more than one hundred years. Even more importantly, the cost is very low. The price US factories pay for gas is one third that of German factories and a quarter that of South Korean factories. Cheap gas is also translating into cheap electricity so that US factories pay half for electricity what a Mexican factory pays and a quarter of what an Italian factory pays. Nor is it just a matter of gas. US oil production has risen by a third over the past four years and America will soon overtake Russia and Saudi Arabia to become the world’s biggest producer of oil and bio-fuels.
Needless to say, any industry for which energy is an important input is suddenly looking at investing in the US. The gas/oil boom is making America largely energy independent while sparking a huge investment and job creation wave that is adding about a half a per cent to GDP growth annually as a lot of manufacturing moves back to America. Given that about a third to a half of the US trade deficit is energy related, fracking is likely to reduce the deficit dramatically.
The second technology revolutionising production and manufacturing in America’s favour is 3D printing. In this process, printers like those that do computer printouts deposit layers of metals, plastics, and other materials to create such things as auto and airplane parts, furniture, toys, and almost anything else you might want to make.
Indeed, in one case, a whole house was built from scratch by 3D printers. The beauty of the technology is that it can be designed to make unusual shapes at low cost and production and can be expanded gradually and evenly without huge investment in capital equipment. Because production can be done economically in relatively small batches, the production can be done close to the location of demand, thus avoiding large shipping and handling costs. This technology is, of course, not unique to America, but because America is a country of such high demand supplied by a long global supply chain, 3D printing is likely to have the most revolutionary impact by moving much of the production closer to the source of demand, and thereby rearranging the supply chain while greatly reducing the US trade deficit.
Thus America emerges as the major country with the best demographics; the best energy picture; an improving budget and debt picture; the best technology, research and development, and innovation picture; the main currency; the most powerful military; and the most balanced economy.
Perhaps Australia would do well to commission another white paper: Australia in the New American Century.