China's rise, revised

HONG KONG Headlines about China's advance have been coming thick and fast this past week. The economy is 17 percent bigger than previously estimated. It is about to surpass every country in Europe except Germany and still growing at 9 percent. China's information technology exports have surpassed those of the United States. It now exports more cars than it imports. Beijing seems almost embarrassed by all this good news and published a document emphasizing that its "peaceful rise" is no threat to anyone. But before we all get overwhelmed by China's great leaps forward, let's put them in context. First, big upward revisions of the official economic estimates are hardly surprising given that in terms of "purchasing power parity," an alternative way of measuring economies, China's per capita gross domestic product was already about $5,700, or more than four times the more often cited 2004 level of $1,230. On both measures China's GDP is roughly double India's. As China (and India) develop, one can expect the official GDP to grow very rapidly but the gap between it and the purchasing power parity estimate to narrow. There will also be rapid growth because there still seems to be undercounting of China's services sector, which at 33 percent of the total is very low by any standard, suggesting that statistical methods have not yet caught up with the changes in the economic and social structure. The bigger GDP numbers have both good and bad implications for China. On the positive side, investment and foreign trade are both relatively smaller. The level of overinvestment may not be quite as massive as the investment ratio of 45 percent of GDP in previous data suggested. Nor is the nation as vulnerable to setbacks in foreign trade, which are quite possible because of resentment at China's surpluses. On the negative side, the new numbers, taken in conjunction with the purchasing power parity ones, suggest that income distribution is even worse than already assumed. The already advanced cities and regions with their industrial and export bases are now seeing the growth of high valued-added services. The divides are increasing both between rural and urban areas and between regions. China's income distribution is now more akin to the wealth divides in Latin America, which continue to stifle that region's growth, than its East Asian neighbors, which vie with Scandinavia for income equality. The implication is that China is going to have to focus far more resources, through tax and spending policies, on reducing those gaps in the interests of social harmony and reversing the environmental damage done by years of growth at any price. As for the export successes, they should not be as troubling for China's developed country rivals as the raw numbers imply. The IT exports are largely the output of foreign companies, particularly from Taiwan, Japan and South Korea. Indeed, China's willingness to attract foreign investment to catch up with its neighbors may be effective in the short run but hinder the development of local know-how. When Japan and South Korea were at a similar stage, they bought foreign technology but mostly kept foreign companies at arm's length. The car exports success seems to owe more to excess capacity at home, plus the implicit subsidies of low-cost credit to state-owned companies through the banking system, than to any very obvious comparative advantage or superior manufacturing technology. They are mostly low-quality vehicles sold into low-end markets. This is not to disparage China's achievements, merely to emphasize that it remains unclear whether it really is following the path of Japan and South Korea - or is heading down the Stalinist road of massive but low productivity investment-led growth and excessive military spending, which crowds out consumption. The other possibility is the past Brazilian example where investment-led growth spearheaded by the state was inefficient and income distribution too skewed to spur growth led by mass consumption. The Soviet Union and Brazil were both successful for many years in achieving high growth and narrowing the gap with the most developed nations of Western Europe and North America but never managed the breakthrough to advanced status. So the jury will remain out for some time as to whether China can get to the top table economically, as Japan and South Korea have done. The rise may indeed be peaceful, and full of bumps. The military issue is of a different caliber. As with the Soviet Union, size matters, particularly when you are also the sole East Asian possessor of nuclear weapons and long-range ballistic missiles. It is no wonder that Japan is worried, particularly at a time when America's global position is being eroded. Japan's legitimate concern is reflected in its recently announced willingness to spend upward of $1 billion on joining the U.S. missile shield. But that makes Prime Minister Junichiro Koizumi's diplomatically disastrous visits to the Yasukuni Shrine all the less defensible.