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China's economy is #1, so now what?

China's economy is #1, so now what?
Published 6 May 2014 

So China officially becomes #1 in purchasing power parity (PPP) output and that is indeed a BFD. But there is both less and more here than meets the headline, and that's what's interesting.

It's obvious that China surpassed the US several years ago in sheer volume terms, as revealed by PPP adjustment. Indeed what's surprising is that official recognition took this long. It appears Beijing resisted publication of this finding, perhaps mindful of the burdens of 'China responsibility' or perhaps fearful of its own 'Organski moment.' China out-produces and  (importantly) out-consumes the US in many important categories including food and staples, consumer durables like autos and appliances, industrial goods, and basic materials. Chinese luxury shoppers, tourists and gamblers bestride the globe.

Steel, a symbolic measure of industrial power, provides a stunning illustration. China's steel industry is almost ten times larger than America's and as big as the rest of the world's steel industry combined. Why China makes and uses so much steel is obvious: fixed asset investment, on buildings and infrastructure. China will construct fifteen times the residential floorspace built by Americans this year, and if you include unofficial construction, maybe much more.

That China's GDP should match the US is also unremarkable considering its population; it simply means Chinese on average are now one-fifth as productive as Americans. But having reached the first quintile of American 'frontier' productivity, how does China make the next 80%? Simply doing more of the same looks unsustainable. Looking again at construction, consider this fact: China uses more cement than any other nation. Per capita. Ever.


Source: Credit Suisse.

By some estimates, China has poured more concrete for its roads, railroads, dams, bridges, factories and skyscrapers in the three years between 2009 and 2011 than America did during the entire 20th century. To be sure, with depreciation-adjusted Chinese capital stock at one-third US levels, there is a lot of infrastructure building needed and yet to be done. And China will continue to consume ever more oil (where it still lags American usage intensity) as its car population swells. But it is clear that qualitative growth must soon prevail over quantitative, materials-intensive growth.

The challenge is how this will be accomplished. China already resembles a thoroughly modern economy in many respects. Smartphone penetration in China is 80% and the internet has reached nearly half the population. Indeed with so much technological 'leapfrogging' going on, thanks to the likes of Huawei and Alibaba, China already leads many developed countries in areas such as e-commerce. [fold]

Price (or 'value'), not volume, is the key to future growth. Chinese companies must produce higher quality, innovative goods. A Great Wall SUV appears comparable to a VW or Toyota model, but it sells at only half the price — evidently for good reason. China doesn't need 'more stuff', it needs better stuff. Given the country's huge size and ambitions, it will need literally dozens of successes on the scale of Huawei and Alibaba.

China must also develop a productive service sector, notably in health care, finance, education and leisure. Measuring prices (or value) of services is devilishly hard, especially on a PPP basis (which properly should compare things like medical outcomes across countries). After all, a large part of US 'GDP' is so produced because American doctors charge high fees! That may seem perverse, until you consider that wealthy Chinese still travel to the US for medical treatment — again, evidently for good reason. China will need to create an economy where its own doctors get paid more than barbers and deliver better health care accordingly.

China has reached a quiet milestone in its economic progress; Beijing will consider the path one-fifth traveled. Australians and others have prospered serving China in 'volume' trade so far. In future they must compete in advanced 'price' sectors like services: wealth management, medical treatment, specialised training, cuisine, lifestyle, entertainment and so on. In the meantime, Chinese companies are figuring out how to do it themselves.




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