To Evaluate China’s Impact on World Economy, Ignore GDP and Start with Trade

Stock market volatility and a small currency devaluation have in the past few months caused the financial community to take note of Chinese economic weakness. A natural question is what effect this weakness will have on the rest of the world. The answer is very little, with most important reason being that China has not truly contributed to the global economy for at least four years.

The idea that Chinese weakness threatens the world economy melds a number of misconceptions. The first is that the weakness is a new phenomenon. It was actually the initial stock market climb and a rising renminbi that were somewhat surprising; the ensuring partial corrections were late in coming, if anything.

China’s economy began weakening no later than 2008, and probably before. A temporary upswing starting in late 2009 and continuing into 2010 was due to an unsustainable, unwise, and unprecedented explosion in debt. From 2011 on, ups and downs in the global economy have not been due to ups and downs in China – the trend in Chinese performance has been invariably down.

To see this, it’s necessary to be more precise about the term “economy.” Economic growth can be understood as growth in inflation-adjusted (real) personal income. China has long contributed to global growth in real personal income by dampening inflation with low-cost production. A decade ago, this was an important role because inflation could have been considerably higher without low-cost Chinese production.

Now, however, the world faces deflationary pressure and China’s deflationary contribution is extraneous, even excessive. Further, it is hard to see how China can be contributing on a net basis to higher nominal incomes overseas given that it remains a major production competitor and not presently capable of driving commodity prices higher.

Of course, the standard way of discussing the economy is to use gross domestic product (GDP). Most commentators use GDP and “the economy” interchangeably. This is a clear and misleading error. The economy is not tiny in the middle of January, as GDP is. GDP per person has no value – just try to spend it.

GDP does make China look very important. The IMF routinely ranks China as the leading contributor to global GDP growth. At best, this is a very strange notion of a contributor. China raises the global GDP growth average, if its official statistics are accurate. If Beijing were ever to acknowledge that GDP growth was, say, four percent instead of seven, average global GDP growth would fall.

To put it succinctly: who cares? In a situation wher a Chinese GDP growth dro lowers the world average, the rest of the world has not changed. This is not a global recession in any meaningful sense.

More important, China does not contribute to the rest of the world’s GDP. It detracts from it, even when China is in fact contributing to the global economy. This is because a trade surplus (net exports) is counted as a positive in GDP and a deficit is counted as a negative. Treating trade in this way does not make much sense but those using GDP to heighten China’s importance to the world are stuck with its definition.

China’s official trade surplus – its huge goods surplus and sizable services deficit combined –was roughly $180bn last year. This constitutes $180bn subtracted from the rest of the world’s GDP. China has been running large trade surpluses for a decade, each and every year subtracting from the rest of the world’s GDP, not contributing.

Slower Chinese GDP growth would, in itself, mean nothing at all to anyone outside the country. What matters to GDP is the size of the trade surplus. If it rises, then rest-of-world GDP falls by that amount (everything else constant). In this case, the trade surplus is also a reasonable representative for China’s true impact on the world. A rising surplus says China is pushing down prices around, intensifying existing deflation.

It is often the case that GDP does not matter and it is typically the case that China’s claimed GDP does not matter. To evaluate China’s impact on the world economy, ignore GDP and start with trade. (www.chinainout.com)