Ok, riddle me this, when is 9.7 trillion larger than 16 trillion? Answer: When you want to scare people. You may have heard this weekend that China has "finally" overtaken the US in terms of GNP. Apparently, we’re all second class now... put a fork in us, we’re done. The problem is, this is a false claim. The US economy produces GNP of $16 trillion per year right now. The Chinese economy produces GNP of $9.7 trillion. See the problem? 9.7 is not greater than 16! So how can they claim that China’s economy is miraculously bigger than ours? By adding a fudge factor to China’s economy to convert the real $9.7 trillion figure into an imaginary $16+ trillion figure.
Sadly for them, this approach is ridiculous.
The fudge factor in question involves what they are claiming is an adjustment for the difference in cost of labor between the two countries. In other words, since Chinese labor is cheaper, China can buy more of it for the same amount of money. Thus, even though our GNP is bigger, we can’t buy as much stuff as the Chinese for it. Ergo, our economy is actually smaller.
Here’s the thing though, the $9.7 trillion v. $16 trillion already accounts for the difference in labor costs. And what the people advocating the fudge factor are ignoring is productivity. Consider this: a Chinese employee may demand a smaller wage, but that is because their labor isn’t as valuable as American labor. The principles of international trade assure us of this or ALL the jobs in the US would flee to China. Instead, only the lowest level American jobs left for China and that stopped about a decade ago as China became too expensive compared to America for more to leave.
Let me see if I can make this more clear. Between an American high school grad and a Chinese laborer, the Chinese laborer will be much cheaper to employ if I’m looking for someone to dig a ditch. It is this assumption which these “experts” are using to claim that China has this advantage which requires us to double their GNP because China can afford so many more ditch diggers than we can. Said differently, China can employ about two laborers to dig a ditch for the same price we would pay to an American. Ergo, China’s economy is really twice as strong as it appears because they get twice the bang for the buck that we do.
The problem is, that's wrong. This formula may work if you're purely talking about basic physical labor, but it definitely does not work once you move beyond that and the reason is productivity. Take the example of an engineer. A Chinese engineer may be paid two times less than an American engineer, but the American engineer is capable of turning out 10 times more and better work than the Chinese engineer. If that weren’t true, then engineering jobs would be racing to China, but they aren’t. The only jobs racing to China are unskilled labor jobs, and even those are now leaving China.
What this means is that when you look at building something, it actually takes 10 Chinese engineers to produce the same product as the American does. That may only cost 5 times more because of the cost of labor, but it still costs more. This is what the "China are beating us" advocates are missing. They are just looking at the wage difference without factoring in productivity. In fact, I could flip their argument around by ignoring price and looking only at productivity and then declare that our economy should be doubled in size and China's considered even smaller. But that wouldn't be right either because I would be ignoring the price difference.
So how do we compare price and productivity? Well, it turns out we already know the difference. The difference is captured in the exchange rate which gives us the GNP measures of $16 trillion v. $9.7 trillion.
Think about it. Our GNP and China’s GNP represent the value both countries were able to produce in the last year given the cost of labor, the cost of regulations and real estate and other inputs, and the offset for productivity. That’s what these numbers are: the total value each economy is capable of producing. And as productivity or costs change, the exchange rate fluctuates to reflect the lost value to the economy and the $16 and $9.7 trillion figures will shift accordingly. Trying to impose a half-assed adjustment on top of that only doubles up on a single adjustment that has already been factored in by the laws of economics. Hence, this idea is of adjusting China's GNP is simply false.
Moreover, the method they are advocating completely ignores the fact that the official exchange rate is what these countries will pay to buy foreign goods or services and what they will be paid to export their own. Thus, even if we accept that there is some logic to the idea of the fudge factor for local products (there isn’t), the fudge factor still needs to be ignored for anything the country does that involves other countries. In other words, even if costs are cheaper in China, that doesn’t get them a discount when they import an Audi nor does it get them a bonus when they export a television set. About 60% of China's economy is direct exports or imports, so you tell me if the advocates are right to dismiss this idea?
And on that point, consider this. To compare GNP from two countries, the only meaningful way to do it is to ask yourself what it would cost for some third party country to buy up everything they produced that year; to figure out what an arms-length buyer would spend to buy each. That gets you an objective value which you can then use to compare the two. That's the only way to make a straight up comparison, because it wipes out subjective valuations that may exist within a country but nowhere else. If you don't do that, then you aren't comparing anything real... it's like comparing the value of two family photos, which may be priceless to each family, but meaningless to everyone else. The exchange rates do this automatically. That's why you use them to make the comparison.
Finally, to prove to you just how silly this idea is of using this fudge factor, consider this: if we consider their argument valid, then the American economy would be better off if we closed all of our schools and disallowed anyone from working in an industry where they could demand a higher salary than anyone else off the street, i.e. if we converted all of our labor to unskilled labor. Then wages would crash and we would have the same “advantage” China has. Does that pass the sniff test? It shouldn’t. No one anywhere in the world thinks that degrading their workforce is a good idea. Hence, there is obviously something fundamentally wrong with the idea.
What this is, is an attempt to scaremonger you. They want you to believe that China is somehow better than we are, even though their GNP is stuck at about half of ours. Some Chinese miracle.
