The end of American dominance?

China has had a remarkable 30 years of growth since introducing market-oriented reforms

A researcher at the World Bank has looked at several data sources and concluded that China has again become the world's largest economy — a position held by the US for 150 years that has, or has nearly, come to an end. I have provided the link for anyone who would like to go through the various computations.

The premise for this assertion is that once GDP is properly adjusted for purchasing power, that is adjusting for what a US dollar buys around the world so it tends to raise the size of the economy for a developing country like China, then China's economy is larger, or about to be, and thus the era of US dominance is just about over.

But, does it matter? Does China's rise mean the decline of the US?

Actually, I get asked this question frequently and it always makes me think of how some things are measured on a relative basis. For instance, how poverty and happiness are gauged. Or, how you weren't unhappy until some eager researcher came around asking if you had a car or holiday home like your neighbours.

First, to give the economist's answer to the question, China's rise doesn't necessarily imply the United States' decline. This is because if both countries trade, then both benefit from specialisation that raises efficiency. The problem is of course some people and industries lose, while others win — so the key is the distributional effects from trade as opposed to the overall economy gaining. Of course, there will be areas where the countries are competitors and both have been known to raise barriers in their markets which are problematic.

Long way to go

Okay, that's enough theory for now. When I answer this question, I often go back to my opening thought which is that the problem with power is that relative changes matter. So, the US could still be growing and even retain its place as the world's largest economy for a while longer, but it could feel like decline.

One of the reasons is that the U.S. has been in the position of being the sole economic superpower for much of the past century. It's been nearly without rival except for the USSR, and America's dominance has shaped the modern world economy.

Now, there's China. It has had a remarkable three decades of economic growth since it introduced market-oriented reforms in 1979. Within this past decade, average incomes have risen from less than $1,000 (the level of the poorest countries in the world) to middle income at around $6,000 or $8,000 when adjusted for purchasing power parity (or what a US dollar will buy). But because of its sheer size -- 1.3 billion people or one-fifth of the world's population -- it has become the world's second largest economy.

It's also the reason why China has a long way to go before it can rival the U.S. China already has clout, but it has a tough road ahead. And China expects its growth to slow after 30-plus years of strong expansion that is already extraordinary.

Should China succeed, it doesn't imply that America will be in actual decline. China has been growing faster than America — which is expected for a country that is still "catching up", so it feels like the US has been out-paced. Plus, the 2008 financial crisis has added hardship and unemployment that have exacerbated this feeling. Of course, there are industries where the U.S. has lost manufacturing jobs to cheaper countries like China. At the same time, it has gained in higher skilled jobs as American companies are a significant part of the foreign firms that produce more than half of China's exports.

'Man exploits man'

In any case for China to succeed, it will need to become more innovative and competitive not just on cost but quality. To do that, it needs to compete with the best in the world. Thus, America will be key.

So, China needs America. And, to state the obvious, America needs China too.

The 1.3 billion people in China represent an under-developed market that could benefit the U.S. as well as the rest of the world. Although still poor, cities like Beijing and Shanghai already offer middle income consumers, who are much in demand now as the U.S. and Europe slowly recover. It could help with America's re-balancing which is towards exports, so selling to overseas consumers instead of relying too much on debt-fuelled domestic consumption.

The U.S. may just need to get used to not being the world's sole economic power.

But, the rest of the world would benefit from having more than one engine of growth, particularly if there is more than one large market to sell to.

Finally, there is one more thing to bear in mind should the world end up with two economic superpowers that look rather different. As the distinguished economist John Kenneth Galbraith observed: "Under capitalism, man exploits man. Under communism, it's just the opposite."