How Large is China's Economy? Does it Matter?

How Large is China’s Economy?
Does it Matter?
Wayne M. Morrison and Michael F. Martin
Foreign Affairs, Defense, and Trade Division
Summary
China’s rapid economic growth since 1979 has transformed it into a major
economic power. Over the past few years, many analysts have contended that China
could soon overtake the United States to become the world’s largest economy, based on
estimates of China’s economy on a “purchasing power parity” (PPP) basis, which
attempts to factor in price differences across countries when estimating the size of a
foreign economy in U.S. dollars. However, in December 2007, the World Bank issued
a study that lowered its previous 2005 PPP estimate of the size of China’s economy by
40%. If these new estimates are accurate, it will likely be many years before China’s
economy reaches U.S. levels. The new PPP data could also have an impact on U.S. and
international perceptions over other aspects of China’s economy, including its living
standards, poverty levels, and government expenditures, such as on the military. This
report will not be updated.
Measuring the Size of China’s Economy
Since embarking on a road of free market reforms nearly three decades ago, China
has been one of the world’s fastest growing economies. The actual size of China’s
economy has been a subject of extensive debate among economists. China reports that
its 2005 gross domestic product (GDP) was 18.4 trillion yuan.¹ Using average annual
nominal exchange rates (at 8.2 yuan per dollar) yields $2.2 trillion, equal to less than one-
fifth the size of the U.S. economy.² China’s per capita GDP (a common measurement of
living standards) in nominal dollars was $1,761, or 4.2% of U.S. levels. These data would
indicate that China’s economy and living standards in 2005 were vastly below U.S.
levels. However, economists contend that these figures are very misleading. First,

¹ National Bureau of Statistics of China, 2006 China Statistical Yearbook.
² China’s currency is the renminbi, which is denominated in yuan.

nominal exchange rates only reflect the price of currencies in international markets, which
can vary greatly over time.³ Secondly, some exchange rate mechanisms, such as between
the dollar and the Chinese yuan, may be significantly distorted by foreign government
intervention.⁴ Finally, nominal GDP data fail to reflect differences in prices that exist
across nations. Surveys indicate that prices in developing countries (such as China) are
generally much lower than they are in developed countries (such as the United States and
Japan), especially for non-traded goods and services. Thus, a measurement of a
developing country’s GDP expressed in nominal U.S. dollars will likely understate (often
significantly) the actual level of goods and services that GDP can buy domestically.
Purchasing Power Parity and GDP Size
Economists have attempted to factor in national price differentials by using a
purchasing power parity (PPP) measurement, which converts foreign currencies into a
common currency (usually the U.S. dollar) on the basis of the actual purchasing power
of those currencies (based on surveys of the prices of various goods and services) in each
respective country. In other words, the PPP data attempt to determine how much local
currency (yuan, for example) would be needed to purchase a comparable level of goods
and services in the United States per U.S. dollar. This “PPP exchange rate” is then used
to convert foreign economic data in national currencies into U.S. dollars.⁵ One of the
largest PPP projects in the world is the International Comparison Program (ICP), which
is coordinated by the World Bank. The ICP collects price data on more than 1,000 goods
and services in 146 countries and territories (and makes estimates of 39 others).⁶
The ICP’s New PPP Estimates of China’s GDP. Prior to December 2007,
data from the ICP and various private economic forecasting firms all seemed to agree that
China’s economy, measured on a PPP basis, was close to $9 trillion in 2005, ranking it
as the world’s second-largest economy, after the United States. Based on these estimates,
and projections of continued rapid economic growth, many analysts predicted that China’s⁷
economy would surpass that of the United States within a few years. Such projections

³ Thus, a country’s GDP could rise significantly in one year, but if its currency depreciated
sharply against the dollar during the same period, it could appear that the actual size of the
economy decreased over the previous year when data is converted to dollars.
⁴ The Chinese government intervenes heavily in exchange rate markets by buying dollars in order
to limit the yuan’s appreciation against the dollar. Many analysts contend that the yuan is
significantly undervalued vis-a-vis the dollar. See CRS Report RL32165, China’s Currency:
Economic Issues and Options for U.S. Trade Policy by Wayne M. Morrison and Marc Labonte.
⁵ Some analysts contend that PPP exchange rates reflect the “true value” of what a country’s
exchange rate with the dollar would be if market forces prevailed and contend this can be used
to calculate a currency’s “undervaluation.” However, others, including the World Bank, reject
this theory.
⁶ The ICP is an international program that conducts statistical price surveys of a comparable
basket of goods and services across countries in order to estimate PPP values. The data is used
by the World Bank, the International Monetary Fund, the United Nations, and other international
agencies to develop programs and policy goals, such as poverty reduction.
⁷ The Economist Intelligence Unit (EIU) and Global Insight both projected in November 2007
(continued...)

helped fuel the growing debate over whether China posed an economic threat to the
United States.⁸ However, newly revised PPP data released by the World Bank in
December 2007 purport to show that China’s economy in 2005 was 40% smaller than
previously estimated.⁹ The ICP’s previous 2005 PPP estimate of China’s GDP
(hereinafter referred to as ICP 1) at $8.8 trillion fell to $5.3 trillion (down by $3.3 trillion)
under the ICP revision (hereinafter referred to as ICP 2 revision).¹⁰ In addition, China’s
per capita GDP on a PPP basis dropped from $6,765 to $4,091 (see Table 1). The size
of China’s GDP relative to that of the United States fell from 71.3% under ICP 1 to 43.1%
under ICP 2 revision, while per capita GDP relative to the United States dropped from
16.2% to 9.8%. Finally, the new revision decreased China’s 2005 share of world GDP
from 14.2% to 9.7% (the U.S. share rose from 20.5% to 22.5%).
Table 1. Comparison of Various Estimates of Chinese, U.S., and
Japanese GDP on a PPP Basis: 2005
ChinaUnited StatesJapan
GDP values ($billions)
Using nominal exchange rates2,23512,3764,549
PPP basis (ICP 1)8,81912,3764,013
PPP basis (ICP 2 revision)5,33312,3763,870
Per Capita GDP ($)
Using Nominal exchange rates 1,76141,67435,604
PPP basis (ICP 1)6,76541,67431,401
PPP basis (ICP 2 revision)4,09141,67430,290
Average annual exchange rates:
local currency unit per dollar
Nominal exchange rate8.21.0110.2
PPP rate (ICP 1)2.11.0125.1
PPP rate (ICP 2 revision)3.41.0129.6
^Source:^T^h^e^W^o^r^l^d^B^a^nk,^{2005 Int}^e^r^natⁱ^onal^Prⁱ^{ce C}^o^m^parⁱ^s^{on P}^r^o^g^r^am^{, Pr}^elⁱ^mⁱ^nar^{y Res}^u^l^t^s^{, Decem}^ber
^{17, 2007.}
According to the ICP, the major difference between the old and new estimates of
China’s economy is that the latter reflects, for the first time, the inclusion of recent price¹¹
survey data provided by China. Previously, the ICP estimated China’s PPP data based

⁷ (...continued)
that China’s economy on a PPP basis would overtake the United States by the year 2010.
⁸ See CRS Report RL33604: Is China a Threat to the U.S. Economy?, by Craig K. Elwell, Marc
Labonte, and Wayne M. Morrison.
⁹ The World Bank, 2005 International Comparison Program, Preliminary Results, December 17,

2007.

¹⁰ The ICP made revisions to its estimates of GDP size for several other countries as well.
India’s estimated GDP fell by 40%, and the overall size of world GDP in PPP also dropped.
¹¹ Although the new PPP estimate for China is likely to be much more accurate than previous data
(continued...)

on a 1986 comparative survey of prices in the United States and China and subsequent
extrapolations of that data. ICP 2 revision significantly increased price level estimates
within China’s economy. The new data estimated that Chinese prices were on average
42% of U.S. levels (compared to 26% under the previous estimate), which is reflected in
the change in the estimate of China’s PPP exchange rate from 2.1 yuan to the dollar to
3.4. The revised data indicate it will likely take many more years than previously thought
before China’s GDP and living standards reach U.S. levels.¹²
Implications For China and For U.S.-China Economic Ties
Although China’s access to assistance and loans from international development
agencies may be unaltered by the ICP PPP revision, the data may directly or indirectly
effect China’s economic policies and its attitudes in international trade discussions.
China may attempt to use the PPP revisions to boost its claim that it is a “poor” country
and that, given its development needs and large numbers of people living in poverty, it
should not be pressed to adopt economic reforms (such as changes to its currency policy)
that could prove disruptive, or be expected to adopt policies that slow its economy, such
as curtailing its energy use in response to international concerns over global climate
change. As a recent article in The Economist put it, “China would probably be quite
happy to see its GDP revised down, hoping that America might stop picking on a smaller,
poorer economy.”¹³ In February 2008, the World Bank stated that the ICP’s revised
estimate of China’s PPP exchange rate data would affect its estimates of poverty levels
in China, based on the daily cost of basic needs (estimated at roughly $1 PPP) and
household surveys on consumption. The Bank estimates that the new PPP revisions
would raise the estimated poverty rate in China in 2004 from 10% to 13-17%, or an
increase from 130 million to between 169 to 221 million. Thus, previous estimates may
have underestimated the number of Chinese living in poverty by up to 91 million people.¹⁴
Regardless of how China seeks to present the overall status of its economic
development, commentators are speculating on the possible implications of the smaller
GDP estimate of China for its socio-economic situation and policies, including:
^!China’s political stability may be weaker than previously thought — In
the past, dissatisfaction with China’s economic condition has lead to
public unrest (e.g. — Spring 1989). The rising number of protests and
demonstrations over the last few years may reflect, in part, the

¹¹ (...continued)
that relied on an outdated survey, the data reflects price surveys over a limited part of China —
11 cities and surrounding rural areas — and it is not clear whether the PPP data accurately
reflects average national price levels, especially since a large segment of the population lives in
the countryside. Thus, the new China PPP estimate may somewhat overstate the national average
of prices (which might increase the PPP exchange rate and GDP values), although the World
Bank contends that this figure is not likely to exceed 5%.
¹² To illustrate, under the revision, China’s GDP on a PPP basis, China could overtake U.S. GDP
within roughly 13 years (from the 2005 baseline data), assuming average real GDP growth of 3%
for the United States and 10% for China (both of which are optimistic projections), and no
changes in price differentials between the two countries (which are unlikely).
¹³ “A Less Fiery Dragon?” The Economist, November 29, 2007.
¹⁴ World Bank, China, Quarterly Update, February 2008, p. 21.

dissatisfaction of China’s poor with their lack of economic progress. ¹⁵
A 2005 article in People’s Daily described China’s growing income
disparity as a “yellow alert” that could become a “red alert” in five years
if the government failed to take proper actions.¹⁶ A 2005 United Nations
report stated that the income gap between the urban and rural areas was
among the highest in the world and warned that this gap threatend social
stability. The report urged China to take greater steps to improve
conditions for the rural poor, and bolster education, health care, and the
social security system.¹⁷ The new PPP measurement may increase
pressure within China to expand efforts to promote development in the
rural areas where over 800 million people reside. According to a recent
article in the Atlantic Monthly, some Chinese question why the
government does not use its massive foreign exchange reserves to help
alleviate poverty and respond to increasing income disparities across the
country, rather than invest those funds overseas assets, such as in U.S.
Treasuries.¹⁸ Such a reallocation of China’s investment portfolio might
have repercussions for the U.S. economy.¹⁹
^!Lower prospects for democracy — Prior to the release of the ICP
revision report, some analysts had speculated that, once China reached
a certain level of economic development and possessed a large and
educated middle class, it would follow the examples of Taiwan and
South Korea and begin to institute democratic reforms. The lower
estimate of China’s economy and living standards may dampen
expectations in the West that China might soon move to adopt political
reforms.²⁰
^!Lower commitment to market reforms and trade liberalization — In an
effort to reduce income disparities and improve conditions for China’s
poor, there may be a return to some of the “command economy” methods
of the past. The recent decision to impose strict price controls on basic
food items and other household necessities might be seen as a temporary
retreat from market reforms.
Finally, the ICP study may also alter how the U.S. government and the U.S. business
community perceive China. The possible new view of China includes:

¹⁵ See CRS Report RL33416, Social Unrest in China, by Thomas Lum.
¹⁶ “Party School Journal Warns Against China’s Widening Income Gap,” People’s Daily,
September 21, 2005.
¹⁷ China’s Human Development Report 2005.
¹⁸ The Atlantic Monthly. The $1.4 Trillion Question, by James Fallows, January-February 2008.
¹⁹ For an analysis of the possible repercussions of a reallocation of China’s investments in U.S.
Treasuries, see CRS Report RL34314, China’s Holdings of U.S. Securities: Implications for the
U.S. Economy, by Wayne M. Morrison and Marc Labonte.
²⁰ Conversely, some contend that a growing middle class may hamper democracy in China,
especially if political reforms are seen as a threat to their own economic interests or to political
instability. See, the Daily Yomiuri. For China, Stability Comes Before Democracy, January 13,

2008, p. 8.

^!Reevaluation of the Chinese government’s budget — The PPP data may
affect how U.S. policymakers evaluate China’s spending levels on
policies that affect U.S. policy. For example, the U.S. Defense
Department’s annual report on China’s military spending includes
conversions of China’s budget data by the Chinese People’s Liberation
Army (PLA) from nominal U.S. dollars into PPP levels. The report
estimated the PLA’s 2003 budget in $30.6 billion in nominal dollars and
$141 billion on a PPP basis.²¹ The World Banks’s PPP revision could
significantly decrease this estimate and other measurements of Chinese
military spending as well as various public spending programs.²²
^!Smaller export market potential — As a senior fellow at the Council on
Foreign Relations wrote, “U.S. businesses and entrepreneurs hoping to
crack the Chinese and Indian markets must come to terms with a middle
class that is significantly smaller than thought. Companies with growth
plans tied to the Indian and Chinese markets could face disappointing
results.”²³
However, it is important to note the limitations of PPP estimates of GDP — and
where and when they provide useful insight in economic analysis. Although the estimated
size of China’s economy decreases under the PPP revisions, other aspects on China’s
economy remain significantly large. For example, trade and international financial data
are generally unaffected by the reduction in China’s PPP GDP. It is estimated that in
2007, China overtook the United States to become the world’s second-largest exporter
(after the European Union).²⁴ Similarly, in 2006 China was the world’s fifth-largest
recipient of foreign direct investment, the largest steel producer, the second-largest
consumer of oil, and by some accounts, the largest emitter of carbon dioxide (CO2). In
addition, since 2006, China has been the world’s largest holder of foreign exchange
reserves ($1.5 trillion at the end of 2007).²⁵ Thus, despite the ICP results, China remains
a major trade and economic power and a major potential global player in international
finances and investment flows.

²¹ U.S. Department of Defense, Annual Report to Congress, Military Power of the People’s
Republic of China, 2007, May 2007, p. 26.
²² The Department of Defense report does not describe how it arrived at its PPP estimate for
China (or if that data was obtained from another source). The PPP exchange rate used by
Defense was about 1.8 yuan per dollar, while ICP’s rate was 2.0 (in 2003). If the new ICPs’
revised PPP exchange rate (3.4)were used, the estimated PLA budget on a PPP basis would fall
to $85 billion.
²³ Walter Russell Mead, “The Great Fall of China,” Los Angeles Times, December 30, 2007.
While the level of Chinese consumer buying power may not be as large as once thought, the very
size of China’s population (1.3 billion) and its rapid economic growth make it a potentially huge
market for U.S. goods and services. In 2007, China overtook Japan to become the third-largest
destination for U.S. exports (after Canada and Mexico).
²⁴ Source: The Economist Intelligence Unit (EIU) DataServices. The EIU estimated U.S. and
Chinese merchandise exports at $1,190 billion and $1,225 billion, respectively.
²⁵ China invests a large share of those reserves overseas, including in U.S. securities. See CRS
Report RL34314, China’s Holdings of U.S. Securities: Implications for the U.S. Economy by
Wayne M. Morrison and Marc Labonte; and CRS Report RL34337, China’s Sovereign Wealth
Fund, by Michael F. Martin.