Does it matter if Australia is no longer among the top 20 largest economies?

A recent report by PwC, The World in 2050, suggests that Australia could slip from 19th largest economy in the world in 2014 to 28th in 2050.

The report comes from the UK and contains economic growth projections to 2050 for the 32 largest economies. Not surprisingly, the main interest in the Australian press was where Australia ranked. The headlines included: 'Australia at risk of losing G20 status', 'Australia slips from G20 to G30', and 'Warning of possible global irrelevance for Australia'.

Some of the broader trends shown in the PwC projections include:

• China will clearly be the largest economy in the world by 2030 but its growth rate will likely revert to the global average.
• India could overtake the US and be the second largest economy by 2050.
• The gap between the three largest economies in 2050 (China, India and the US) and the rest of the world could be significantly larger than is currently the case.
• Indonesia will likely be the fourth-largest economy in 2050, and Mexico and Nigeria will push the UK and France from the top 10.
• Emerging markets will make up seven of the 10 largest economies by 2050.

Describing what the global economy might look like in 2050 may seem highly dubious when the record for short-term economic forecasts is less than robust. The authors of the PwC report note that the projections are very uncertain, and they point out that each country's policy settings and institutional arrangements will ultimately determine its growth dynamics. Hence they suggest that the focus should not be on the specific projections but on what could be the broad trends. [fold]

It may be a surprise that Australia is only ranked the 19th largest economy in 2014. In 2012, then Treasurer Wayne Swan announced that Australia was the 12th largest economy in the world. The difference is in how the size of an economy is measured. The PwC projections are made on a purchasing power parity (PPP) basis. This accounts for price differences across countries at different stages of development. Swan was referring to countries ranked on market exchange rates (MER) basis.

Whether it is better to use PPP or MER depends on what you are after. If the objective is to assess the relative size of an economy's outputs or inputs, then PPP is more appropriate. If you are seeking to assess financial flows or the relative size of an economy for business purposes, then MER calculations may be more relevant.

The PwC report does include projections on an MER basis. On this measure Australia would slip from the 12th largest economy in 2014 to 19th in 2050.

Putting aside the technical stuff, it looks like Australia's relative position will slip over the next few decades. Should we be worried?

The first point is that we need to get used to the idea, because it is almost inevitable. Demographics are a major driver behind these projections, along with assumptions around productivity growth. On this latter influence, the projections usually assume that countries will catch up with the technological leader, normally the US. Consequently if it is assumed that developing economies with large and growing populations achieve increased productivity through technological transfers and increased physical and human capital investments, they will record strong growth rates. As noted, whether they achieve this growth will depend on their policy settings.

Australia is currently rated 51st in terms of population size and is already a developed economy, so the scope for 'catch-up' is limited. Hence if developing countries do get their act together, many of them will overtake Australia. As Peter Costello used to say, 'demography is destiny'.

The second and related point is that we should not be concerned if the decline in our relative economic position is the result of strong growth in developing countries. Such a situation will see reductions in global poverty and all countries will be better off, even if there is a change in relative positions. However if Australia's economic position is declining because of its own economic mismanagement, then we have a major worry.

The third point is that there is more to economic progress than the size of a country's GDP. Notwithstanding that many emerging economies may be relatively larger by 2050 than advanced economies, average income per head (GDP per capita) will still be significantly higher in advanced economies, including Australia. Moreover, when it comes to the quality of life, a wider range of variables need to be considered. On the UN's Human Development Index, which includes things like life expectancy, literacy, education and GDP per capita, Australia currently ranks second behind Norway, while China is ranked 101, Indonesia 124 and India 134.

Bottom line: economic size isn't everything.

Photo courtesy of Flickr user Intrinsic-Image

Mike Callaghan