China Derangement Syndrome

Once again, an economic yellow peril is exaggerated.

The 1979 book, Japan As Number One: Lessons for America, by East Asia scholar Ezra Vogel stoked fears that the United States was about to be outcompeted by the land of the rising sun. And why not? The United States had just suffered through a decade of stagflation and was about to enter what was then the worst recession since the Great Depression. By the late '80s, the case seemed ironclad. "I don't mean to be an alarmist, but I get the uneasy feeling that America is history," wrote Robert Kuttner, then the economics correspondent for The New Republic, in the Los Angeles Times in May 1988. Kuttner supplied evidence for his concern: "The total value of stocks listed on the Tokyo stock exchange is now $3.54 trillion dollars, compared to $2.34 trillion for the New York Stock Exchange."

In his 1988 book, Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It, former Reagan administration trade negotiator Clyde Prestowitz warned, "The power behind the Japanese juggernaut is much greater than most Americans suspect, and the juggernaut cannot stop of its own volition, for Japan has created a kind of automatic wealth machine, perhaps the first since King Midas." (I confess that I was a producer for the national weekly PBS television program American Interests at the time on which we regularly featured Japan alarmists.)

Two decades later, we know that the panic over Japanese economic competition was greatly exaggerated. Japan is not Number One and in fact as of last year it became Number Three, behind China.

Twenty-five years ago, what the Japanophobes were worried about were the differential economic growth rates of the United States versus Japan. At times in the 1980s, Japan's GDP was growing at nearly 10 percent per year whereas the GDP in the U.S. was growing at a merely respectable 4 percent per year. (All figures are unadjusted for inflation.) In 1988, Japan's GDP was $3 trillion and the U.S. GDP was about $5 trillion. If Japan's economy continued to grow at 10 percent annually and the U.S. grew only at 4 percent, Japan's GDP would have exceeded that of the U.S. in just 10 years.

Instead, the Japanese financial bubble burst. In 2011, Japan's GDP in current dollars is $5.5 trillion whereas U.S. GDP is nearly $15 trillion. Per capita GDP (adjusted for purchasing power parity) for Japan is $34,000 while the figure is $46,000 for Americans. Japan has suffered through essentially two decades of stagflation and no one is any longer recommending that the U.S. adopt Japanese style top-down industrial policy as an economic panacea.

Now comes China. "We are getting our clock cleaned by Chinese state capitalism," wrote Robert Kuttner, now editor of The American Prospect, earlier this year at The Huffington Post. "The U.S. could lose its status as the world's biggest economic power within five years," reported The Daily Mail in April. The Mail article was based on calculations released by the International Monetary Fund projecting that total Chinese GDP will surpass U.S. GDP by 2016 on a purchasing power parity basis.

Can that be? China's total GDP is around $6 trillion today. Assuming 10 percent GDP growth for the next 20 years, China's GDP would rise to $40 trillion. If the U.S. economy grew at say, 3 percent per year, total GDP would be $27 trillion. Back in 2007, before the financial crisis, the investment bank Goldman Sachs issued a report [PDF] that projected that Chinese GDP would be $26 trillion in 2030 compared to $23 trillion for the U.S. It bears noting that current Chinese purchasing power parity per capita is about $6,000 compared to $46,000 for Americans.

But it is unlikely that China's economy can sustain 10 percent economic growth for two more decades. Economic history suggests that once countries catch up with leading economies in terms of technologies and business management, growth slows down. In which case, China's growth might slow down to a mere 5 percent. Assuming sustained respective 5 percent and 3 percent growth rates for China and the U.S. for two decades, China's total GDP would reach $16 trillion, not $34 trillion. In 30 years, it would grow to $26 trillion, by which time U.S. GDP would be $36 trillion. In 40 years, China's GDP would $42 trillion and U.S. GDP would be $49 trillion. In 50 years, China's GDP would finally surpass that of the U.S. reaching $69 trillion compared to $66 trillion.

Anyone who thinks that they know what the purchasing power parity might be between the two countries by 2060 is seriously deluded. These kinds of calculations can only provide rough scenarios for the economic future.

As the recent history of Japan shows, it is possible to adopt economic policies that would cause our economy to stagnate for decades. In which case, China's GDP may well surpass ours sooner rather than later. 

On the other hand, China has picked most of the low-hanging fruit, economically speaking. Future productivity increases will not come from merely copying technologies developed in other advanced countries. In addition, growth depends on the kind of innovative management that can only thrive in open societies. Unless China makes the transition to an open society, its future is not growth, but stagnation. If it does make the transition, then China will not be a rival, but a partner. 

Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.