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Commentary: China's now No. 2. So what?

The news that China has surpassed Japan as the world's second largest economy sent a shiver through the collective soul of economic pundits. It needn't have.

During the late 1980s, we were warned of Japan's expanding economic machine. The Japanese economy was then expanding at a rate that made ours look puny. Everyone looked to Japan as the source for economic inspiration and guidance: Recall the movement to adopt their management techniques or face economic defeat?

Flash forward to the present. Japan's economic malaise over the past two decades is well-documented. Not adopting Japanese management techniques and broad government policies appears to have been the wise thing to do. While the U.S. economy expanded during the 1990s at a pace not seen in the modern post-war era, Japan's economy foundered and sank. Even today Japan's policy-makers seem unable to right their economic ship.

With Japan no longer the threatening up-and-comer, we needed to find a replacement. China more than fits that bill for those hell-bent to find another economy that will overtake ours. Like Chicken Little, they spread a false fear.

Consider the facts. Right now GDP (gross domestic product) in the United States, a measure of the economy's output, is roughly $14 trillion. This isn't necessarily the best measure to use -- GDP combines both changes in prices and changes in the amount of goods and services produced in the economy -- but it is the one everybody has focused on, so we'll use it, too.

How big is No. 2 China? Try $1.3 trillion. No, that's not a typo: China's economy, No. 2 in the world, is only about one-tenth the size of the U.S. economy. Why the angst?

(Note: A comment pointed out that the $1.33 trillion figure is only for the second quarter of this year, not the annualized value. On an properly annualized basis, the Chinese economy is about one-third, not one-tenth the size of the U.S. economy. And, if it continued to grow at a 10 percent rate and the U.S. expanded at 3 percent, China's economy would catch up to the U.S. economy in less time than the 35 years I erroneously stated. Even with those corrections, at best it would take several decades. However, I continue to maintain that the conditions for such double-digit Chinese growth to continue are unlikely to exist over the next few decades. For the reasons I suggested, and there are other potential causes, China's growth rate will slow, thus pushing off the possible time when it would surpass the United States. Of course, if one uses GDP per person as the basis for comparison, a much more widely accepted measure of economic success and well-being than sheer size of the economy, China remains one of the poorest countries in the world. On the basis of that measure, the average citizen enjoys only small fraction of China's aggregate income compared with citizens in the other major economies. — R.W. Hafer)

One reason is the misuse of mathematics to feed the fear-mongering. As a recent New York Times article reads, "Forecasts that China will be No. 1 as early as 2030." This statement is true, but for highly improbable reasons.

Could China surpass the U.S.? It is all based on the assumptions used to make the calculations. If China's economy continues to expand at a 10 percent rate (assuming those official statistics are correct) and if the U.S. economy grows at its long-term trend of 3 percent, then yes, it would take about 35 years for the Chinese economy to equal the size of the U.S. economy. That is just simple algebra -- and it is a big if.

Two key factors will prevent this outcome, however. First, no modern economy has expanded at such a double-digit rate for such an extended period of time. Economic history shows us that developed economies tend to settle in at long-term growth rates around 3 percent. This is true for all of the European economies, for Canada and for the U.S. It also will be true for China. Once it achieves economic maturity, it will see slower economic growth.

Second, the increase in China's economic well-being will promote change. We are seeing the beginnings of such social change in the increased unrest among Chinese laborers over working conditions and compensation. We are seeing evidence of a housing bubble emerging in some fast-expanding urban areas.

Ask anybody who has visited China recently and a common observation is the level of pollution. As incomes rise, Chinese citizens will demand cleaner air and water. This will lead to more regulation of production, reducing productivity and output growth.

There is no denying that China is taking its place among the economic superpowers. But to suggest it will overtake the U.S.economically is at best premature and unfounded by reasonable facts.

R.W. Hafer is the distinguished research professor and chair in the Department of Economics and Finance at Southern Illinois University Edwardsville and a research fellow at the Show-Me Institute.

This article originally appeared in the St. Louis Beacon.

Rik Hafer is a distinguished research professor in the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.