India as #1

Since I’ve been making a fool of myself with all these contrarian posts, I might as well get it all out of my system.  When Tyler Cowen asked me for my most absurd belief, one idea that I came up with was that India will have the world’s largest economy in the year 2109.

First let’s ask ourselves why most people would find this prediction a bit far-fetched.  Most of us have never even visited India, but we have seen media images that often show a very crowded and underdeveloped country.  It is very hard to imagine how India’s economy could ever surpass the US.  More astute observers might notice that India does have nearly 4 times the US population, and it is not that hard to imagine that their per capita GDP might eventually reach 30% of US levels.

But the population advantage of India raises an even greater hurtle.  Right now China has a per capita GDP that is twice as high as India’s.  Even worse, China is growing more rapidly.  And China’s total population is larger than India’s.  So how could India possibly overtake China within the next 100 years?

Before delving into the numbers, I’d like to first try to dissuade you from thinking about this problem in terms of mental images.  To do so, I am going to first talk about two other countries; German and Greece.   Which of those two countries has the largest GDP?  Obviously Germany.  And why is Germany’s GDP much larger than Greece’s GDP?  Most of us have mental images of each country:

Germany:  A manufacturing powerhouse full of sleek Bauhaus-style factories churning out turbines and BMWs

Greece:  A beautiful sleepy backwater, full of fishing ports and mountain villages with donkeys walking down the street.

But it turns out that these images are very misleading–and in fact have little or no role in explaining the wide gap between Germany and Greece’s GDP.  The three institutions cited in Wikipedia’s PPP GDP tables all estimate Germany’s per capita GDP at about $35,500.  Unfortunately, the three sources differ on Greece, ranging from $29,000 to $32,000.  Let’s say it’s $30,500, which would make Germany about 15% richer.

The means that the reason Germany’s GDP is roughly 10 times bigger than Greece’s is almost entirely due to it much bigger population (80 million vs. 10 million.)  If you had a country of 100 million at Greece’s level of development, then it’s GDP would be larger than that of Germany.  So among developed countries, variation in total GDP is almost entirely determined by variation in population.  So here is my argument in a nutshell:

1.  I believe that in 100 years the US, China, and India will all be developed countries.

1.  I believe that in 100 years China’s per capita income (PPP) will be at least 75% of US levels.

3.  I believe that in 100 years India’s per capita income (PPP) will be at least 60% of US levels.

4.  I believe that in 100 years both India and China will have populations at least twice as large as the US.

5.  I believe that in 100 years India’s populations will be at least 25% larger than China’s.

I’m going to skip over the US comparisons for the moment, as later I’ll argue that China will surpass the US very soon, indeed much sooner than most people realize.  So it’s between China and India.  To make the case for India I have to make two arguments; India’s population will be at least 25% larger than China’s, and its per capita income will be within 20% of China’s.  Let’s start with population:

The truth is that no one has any idea what each country’s population will be 100 years from today.  But nevertheless we do know more than you’d think.  I had trouble finding estimates, but I did notice that over the past decade India seems to have had about 30% more births than China.  India’s infant mortality rate is still higher than China’s, but rates everywhere have come down to the point where it no longer dramatically affects population growth rates.  So we can be pretty sure that 20 or 30 years from now India will have at least 25% more people of child-bearing age than China.  At that point it is anyone’s guess.  I am going to assume that from that point forward the two countries have the same birthrate.  In two ways this is a conservative assumption:

1.  India currently has a much higher birth rate

2.  The richer parts of China have some of the lowest birth rates on earth (Hong Kong and Shanghai, for instance.)

Cutting slightly the other way is that China’s birth rate has recently picked up a bit (from relaxation of the one-child policy) and India’s has dropped a bit.

Demographers expect China’s population to peak at 1.5 billion (in a few decades), and then start falling.  I have no idea where it is expected to be in 100 years.  India’s population is almost certain to surpass China’s in about 20 years, and we really don’t know where its population will peak.  But again, I see no reason to believe Indian birth rates will fall below those of China (which as I said, are expected to become ultra-low as China gets richer.)  BTW, Hong Kong has perhaps the lowest birth rate on Earth, and they don’t have a one-child policy.

So I think the population part of my argument is very consistent with the best demographic estimates that we have, which admittedly aren’t very good.  What about the rest of my argument; that India will reach about 80% of China’s per capita GDP.  That looks more iffy, especially given the fact that it has fallen from a rough parity with China when Mao died in 1976, to just under 50% of China’s per capita income today.  How can they turn this around?

The answer is that they need to keep growing at 6-8% a year, and wait for China to ”hit the wall.”  Almost every fast-growing economy eventually hits a wall at roughly 80% of US per capita GDP, and then starts growing much more slowly.  The most famous example is of course Japan, which hit the wall in 1990.  But the same thing happened in Western Europe and elsewhere.  The only exceptions are tiny tax havens like Luxembourg, and oil-rich states like the UAE and Norway.  Once China hits that wall, it will no longer be having any population growth, and so its total GDP growth rate will slow to 1-2%, just like Japan.  That may happen sooner than people think.  I’m guessing that places like Korea and Taiwan are no more than 20 years away from that wall, and China is a 20 or 30 years behind those two tiger economies (it’s hard to tell because places like Zhejiang province are even closer to the tiger economies, and western provinces like Gansu are much further away.)

So in about 50 years China will be growing very slowly.  India will be the logical place for the lower wage manufacturing industries, and will be attracting a lot of foreign investment.  Because China will then be highly developed, the “rich world” that India can export to will be something like 3 billion people, not the 1 billion of today.  That is a big market.  With any sort of sensible economic reforms (admittedly a big if) India should be able to continue growing rapidly between 2059 and 2109.  They won’t catch up to China in per capita terms, but they will get close enough to have a larger total GDP.

I’m sure you all remember the 1500 meters part of the 1960 Olympics decathlon:

On Sept. 5, the first day of Olympic decathlon competition ended at 11 p.m. with Johnson leading Yang by 55 points though he had scored highest on only one of the five events. When Johnson hit the first hurdle badly in the next day’s first event, the 110-meter hurdles, he didn’t gain as many points as he had expected. But he made up for that with a personal best of 13 feet, 5½ inches in the pole vault.

… and so it came down to the 1,500 meters. Johnson’s strategy was to stay close, and he dogged Yang throughout. When Yang attempted desperately to pull away in the final lap, Johnson stuck close.

He finished only six yards and 1.2 seconds behind Yang, coming home in a personal best of 4:49.7. Johnson had the gold medal, setting a then-Olympic record of 8,392 points in the process. At the age of 25, Johnson had fulfilled his high school dream.

China’s like CK Yang, they’ll win the per capita race with India.  But India’s like Rafer Johnson, they will stick close enough to China that they’ll eventually have the world’s biggest GDP.

So the message is that one shouldn’t pay too much attention to stories in the media.  Don’t let images of Mother Theresa and Slumdog Millionaire cloud your judgment.  The Indian economy has a lot of growth ahead of it.

Part 2.  When will China surpass the US?

Next year?  Maybe.  In 15 years?  Maybe.  Actually there is no objective answer to the question.  As philosophers would say:  ”There is no fact of the matter.”  This is because there is no well-established agreement as to what we mean by GDP, especially PPP GDP.  In fact, there isn’t even any agreement as to what we mean by “China” and “the US.”  The US isn’t a big problem, as the only significant question is whether Puerto Rico should be included.  But what about Hong Kong, Macao and Taiwan?  Are they part of China?  You may be surprised to find out that both the Mainland Chinese and the Taiwanese constitutions agree that there is only one China, they just disagree as to who should rule over it.  Everyone agrees that Hong Kong and Macao are part of China de jure, but de facto they are separate.  So much so that Hong Kong has an entirely different currency and separate GDP accounts.

Let’s assume that the region called “China” includes Hong Kong but not Taiwan (this will probably get me blocked in China, despite my cowardly use of the term “region.”)

The 2008 figures show that Hong Kong’s GDP is $215 billion, and $306 billion in PPP terms.  Mainland China has a GDP of $4.4 trillion, and $7.9 trillion in PPP terms.  The US has a GDP of $14.4 trillion (the same in PPP terms.)  Now let’s stop right there.  If you’ve ever been to Hong Kong and China you should immediately be suspicious of these numbers.  The Hong Kong PPP numbers look reasonable compared to the US (although if you put a high weight on real estate then they may be too high.)  But in these figures the PPP adjustment for mainland China is only slightly larger than Hong Kong.  This seems absolutely nuts to me.

Hong Kong has a per capita income only slightly lower than the US, whereas mainland China is far below even Mexico.  I think China’s GDP figures, which assume its cost of living is 55% of US levels, is way too low.  Here are some examples.  My wife had tailoring done in Beijing, one of the most expensive cities in China.  The shirt was restyled for $1.20.  She told me it would have cost $20 in the US.  I had my shoes re-soled for about the same price.  I went to a very nice barbershop and had a much more elegant haircut than I get at Great Cuts, and I paid $2.25.  BTW, no tipping in China.  Across the street was a much more rundown hole-in-the-wall type barbershop.  The sign said 5 yuan (75 cents) for haircuts.  That place was much more typical of what haircuts would cost across the vast interior of China, indeed even that is an overestimate.

Why am I boring you with all these stories?  Because the service sector in China is perhaps 10 times larger than the nominal figures would show.  Remember all those articles talking about how only 40% of the Chinese economy is consumption?  What would happen if you added up all the services produced in China in PPP terms (i.e. US prices).  The Chinese haircut industry alone might be larger than the economies of many small countries.

A few years ago the World Bank re-did their PPP estimates for China, and dramatically shrank the size of the Chinese economy.  Instead of assuming the Chinese cost of living was a third US levels, the assumed it was half (and now with the yuan appreciation, 55%.)

In 2010 the US GDP will be about $14.5 trillion.  China’s nominal GDP will be about $5.2 trillion.  If the World Bank were still using the old 3-1 conversion for Chinese PPP, they would already be the world’s largest economy, even without $300 billion from HK.  Let’s assume the HK numbers are about right, is there a reasonable case to be made that Mainland China’s PPP economy will be $14.2 trillion in 2010?  Assuming $5.2 nominal GDP, that would require a 2.73 conversion factor, somewhere between the old and new estimates from the World Bank.

I don’t think there is an objective answer to the question of which ratio is “right.”  The World Bank was criticized for drawing their new estimates from richer coastal cities.  Places like Shanghai have a cost of living that is dramatically higher than the vast interior of the country, where most people live.  Before I had read about the World Bank estimates I had formed my own guesstimates of about 3 to 1 from casual empiricism.  I based that on conversion ratios ranging from 1 to 1 for products like Buicks (made in China and very popular there) to perhaps 3 to 1 for food, to perhaps 10 to 1 for labor-oriented services.  Because the basket of goods consumed in each country is so different there is no objective answer to the question of which country has the bigger GDP.

I think the best way to approach this issue is to use Rorty’s maxim “truth is what your colleagues let you get away with.”  Truth is socially constructed.  So imagine a timeline with a bell-shaped distribution above it.  The distribution shows the point in time when each economist thinks China has surpassed the US.  At the left end in 2010 is me, a China booster who (shamelessly) wants to get credit for being first to notice that America’s more than 100 year reign as number one is over.  The mode occurs when the World Bank says that China has achieved what Italians call “Il Sorpasso.”  And at the far right of the distribution, well into the 22nd century is Lester Thurow.  The mode occurs around 2016.  Mark your calendars.

To conclude:

In one year either China or the US will be number one, India or Japan number three.

In 50 years China will be number one, and either India or the US will be 2nd.

In 100 years either China or India will be number one, and the US will be 3rd.

Does any of this matter?  No, but it is interesting to think about.