The likelihood of China overtaking the United States to become the world's largest economy is declining? Not necessarily!

Executive Summary:

Prasad, a professor at Cornell University, believes that the likelihood of China overtaking the United States to become the world's largest economy is declining. Economist Magnus believes that the idea of five factors leading to China becoming the world's largest economy may not happen. The views of Western economists such as Prasad and Magnus on China's macroeconomic prospects should be treated in two ways. They have a more objective understanding of the problems that exist in our economy, but they ignore the huge impact of several variables on China's economy.

1. Prasad, a professor at Cornell University, believes that the possibility of China surpassing the United States to become the world's largest economy is declining.

On February 5, Eswar Prasad, a professor at Cornell University and a former official at the International Monetary Fund, published an article in the Nihon Keizai Shimbun newspaper in which he sang the praises of us. With China's economy slowing significantly, the likelihood of China overtaking the United States as the world's largest economy is declining, he said.

In the article, Prasad argues that the United States and China are currently the world's first and second largest economies. But the two are already on opposite tracks, with the United States likely to maintain growth while China continues to face structural problems such as high public debt and a low birth rate.

Prasad bears our argument that we face a variety of vulnerabilities, including undesirable demographics, the collapse of the housing market, deteriorating investor sentiment at home and abroad, and a lack of clarity on the new growth model. And these factors have been driving the explosive growth of the mainland economy over the past few decades.

Prasad's bullish argument for the U.S. is that while inflation in the U.S. soared immediately after the COVID-19 pandemic, raising the cost of living and fueling fears of an impending recession. But the country's economy has proven to be able to cope with the challenges of the past few years. After 22 months of interest rate hikes, US inflation has fallen from a peak of 9.1% to 3.4%, and high interest rates have not cut jobs, adding more than 350,000 jobs in the US in December 2023, and the unemployment rate remains low at 3.7%. The U.S. recession that most people thought was not yet here, and in the fourth quarter of 2023, U.S. GDP grew at an annualized rate of 3.3%, beating expectations.

Prasad argues that the U.S. market-oriented economy is naturally adaptable, that the U.S. labor market is very flexible and strong, and that the U.S. government's fiscal policy and financial system have enabled small and medium-sized businesses and consumers to weather very difficult times. Under the influence of geopolitical conflicts such as the Russia-Ukraine war, the sharp rise and fall of international commodity prices, and the raising of interest rates in most countries to fight inflation, although most major economies are struggling, the situation in the United States is much better. The United States is consolidating its position as a driving force in the global economy.

Prasad also said that it was not all smooth sailing in the United States, and that he was a little concerned about the impact of weaker global growth. While U.S. GDP growth is not heavily dependent on exports, the downturn in other countries could cause some drag. The increase in the U.S. public debt and the increase in interest payments as a percentage of revenue are also significant issues.

Prasad thus concludes that "even a growth rate of 4 to 5 percent will be difficult to sustain in the coming years, and the probability of predicting that China's GDP will one day surpass that of the United States is declining". Prasad even said that in the past, when he worked at the IMF, he thought that China would surpass the United States, but now, he does not think China will surpass the United States.

Second, economist Magnus believes that the idea of five factors that led to China becoming the world's largest economy may not happen.

Similarly, George Magnus, a former chief economist at UBS and now a fellow at the University of Oxford's China Centre, recently spoke out about us in an economic commentary.

Magnus said: Actually, the idea of China becoming the world's largest economy may not happen. The housing market crisis is not the only factor, there are many things that will cause China's economic growth rate to fall back in the next 10 to 20 years. These include:

First, debt, which is obviously included in the real estate market;

Second, the population structure, the rapid aging of the Chinese population;

Thirdly, dynamism, by which he means that the productive forces are no longer really stimulated, because the reform in this direction has not yet taken place;

Fourth, decoupling and de-risking, which somewhat restricts China's ability to develop a new economy and new technologies;

Fifth, directives, the government has become more controlling, the role of the market has been severely weakened, and the demand shortage caused by the distribution system.

Third, the views of Western economists such as Prasad and Magnus on China's macroeconomic prospects should be treated in two ways. They have a more objective understanding of the problems that exist in our economy, but they ignore the huge impact of several variables on China's economy.

On the one hand, they stay out of the way, and there may be an objective cognitive advantage of being a bystander. Some of the negative factors they pointed out for future macroeconomic growth do exist, and we cannot deny it. For example, the debt problems of local government investment and financing platforms and real estate debts are indeed thorny, and now they have begun to be revealed; such as the problems of decoupling and de-risking, the population problem, and the shortage of demand caused by the distribution system, Saburo has mentioned many times in his economic analysis articles in the past two years. In fact, the problems we see do not stop there, such as the problem of the investment-oriented economic growth model, such as the mismatch of funds caused by the planned capital factor allocation system and the market-oriented capital demand, and the problem of affecting the effectiveness of monetary policy. These are all big problems that Saburo has long put forward to solve.

On the other hand, we should not deny the potential of China's economic development just because these problems exist.

I am very disgusted with the very ignorant nonsense that Lin Yifu, dean of the Institute of New Structural Economics of Peking University, proposed in the December 28, 2023 issue of "Special Topics on China's Economy" that China's average annual GDP growth rate has reached 9% for 44 consecutive years from 1978 to 2022, so it is deduced that before 2035, China still has 8% growth potential, and can achieve 5%-6% growth per year.

But I also don't think Prasad's conclusion that "even a growth rate of 4 to 5 percent will be difficult to sustain in the coming years."

This is because the conclusions drawn by Lin and Prasad are based purely on a linear understanding of China's economic growth. The difference is that Lin Yifu may be based on a linear model from 1978 to 2015, while Prasad may be based on a linear model from 2016 to 2023.

But they all made a huge mistake, and that was the huge impact of variables on China's economy.

The first variable is the second reform and opening up, and the second variable is the transformation of the economic development model. As Saburo has suggested many times, if the country can implement the second reform and opening up on the one hand, and transform the investment and development model of the economy to a consumption-driven model on the other, the problems of decoupling and de-risking that Prasad and Magnus are worried about will be easily solved, the excessive control of the market and the serious weakening of the market by the government can be repaired, and the shortage of demand can be quickly resolved.

The third variable is the new and disruptive development of AI technology and intelligent robots, which will basically solve China's population and demographic problems such as declining fertility, shrinking population size and aging.

Although we have not yet seen a clear signal for the first two variables, I have always had hope in the country's ability to correct mistakes and the internal driving force for moving forward when I recall the profound changes in China's economy and society brought about by the first reform and opening up in 1978.

Perhaps the U.S. economy will maintain a considerable growth rate in recent years, or perhaps for some time to come. Perhaps during this period of learning lessons, trial and error, and correction, economic growth may lag behind that of the United States. But if we look at it from another angle, the United States may be overdrawing its future development potential, while we are accumulating the strength to promote a new round of rapid economic development after the second reform and opening up.

[Author: Xu Sanlang]