As an engineer who has argued that there has never been sound theory of economics (see link below), I thought it might be interesting to apply my heterodox approach to the recent headlines which reported China's PPP derived GDP as narrowly surpassing that of the USA.
To begin this analysis lets start with a few textbook definitions. Without getting overly complicated, GDP is the total "value" (dollar amounts) of goods and services produced in a nation each year. Since my goal is to do a back of the envelope calculation, I'll risk oversimplifying and suggest we treat this as nothing more than a nation's total wages embedded in the price of goods and services.
As we argued in" The Fair Trade Fantasy", two nations using the same currency and having same population (identical total labor units) could have identical GDPs yet radically different output: 1 million toothpicks vs 1 million automobiles. In short, I concluded measuring GDP amounts to nothing of real consequence (i.e. labor units), because real wealth cannot be measured (replace 1 million boats for toothpicks and ask yourself who is richer now). With this in mind, lets ask if an application of a PPP calculation can help us resolve the problem of comparing the wealth production between nations.
Let's modify our example of the two nations and create a set of baskets of identical goods as an economist might. Each basket for discussion's sake consists of 1 million boats and 1 million cars (it is critical to assume the cars and boats are identical to make this approach work). In other words, both countries are now producing cars and boats (unlike the example before). Assume nation A's basket costs 1 Trillion Ziggles, and nation B's basket costs 1 Trillion Rittas. Since the baskets are identical we can immediately determine a Purchasing Power Parity (PPP) exchange rate: 1 Ziggle = 1 Ritta. Then if Nation A's GDP is 10 Trillion Ziggles and Nation B's GDP is 5 Trillion Rittas, we can now estimate Nation A's economy to be roughly twice as large as B's. So far so good.
But a strange discrepancy begins to arise if we compare say average wages and PPPs. There seems to be a tremendous disconnect. Let's make the model a little more realistic and add trade deficits and a new set of numbers that are only roughly similar to China-USA economics to illustrate the point. At this point, we are not interested in accurate numbers, because our contention will be that using dollar figures is a flawed approach. T is shorthand for $1 Trillion. China = 9T domestic + 0.5T exports= 9.5T GDP and USA = 17T domestic - 0.5T Imports= 16.5 GDP. Say the PPP for basket of goods is calculated to be 2 against China, with a PPP GDP of 19T as a result. Thus we have a similar estimate of GDP for both nations.
Before we make a change to our model, consider the cost of a supersized soda at a fast food chain is based on the cost of production (i.e. # of labor units to make it). With that thought in mind, we turn GDP calculations on its head by modeling wage differences, instead of PPP. Take this same example, and instead of using PPP, simply assume for argument sake China has 1/6 the average wage of the USA. Because the wage differential is a factor of six, the imports to the USA have an actual value in terms of B's domestic labor of 6x0.5T = 3T. Suddenly, instead of having roughly the same GDP in PPP, we have China 6 x 9.5T= 48T GDP in terms of labor units, while USA = 17T domestic - 3TImports = 14T. China suddenly is over 4 times larger. China is mysteriously supersized.
But is such a discrepancy between PPP and wage differential realistic? While an economist might use thousands of goods in his basket to make such a calculation, or give the Big Mac example found in textbooks, I'd suggest neither approach is worth pursuing. I prefer something more fundamental when both economies have achieved a similar state of technology (the engineer in me requires it): Simply compare the number of workers in manufacturing. The assumption here is that the workers of each country have a similar level of productivity, because both nations have mastered all aspects of science and technology.
If this is indeed the case, we simply observe one set of rough numbers of interest to complete the calculation. In 2009, China had roughly 99 million vs 14 million American workers in manufacturing. Is there any reason not to simply extrapolate this workforce into a real GDP differential of six? Yes. Though China is a steady stream of technological headlines ranging from record breaking bullet trains and anti-satellite missiles, to world-class supercomputers, thus implying the needed "intellectual infrastructure" is in place, a case can still be made that urban manufacture and rural manufacturing ( i.e. a blacksmith) do not exhibit the same use of technology. Let's try to be conservative and simply use the number of 34 million for urban manufacture that we assume has full access to modern technology, and fudge rural numbers with a .2 efficiency factor for sake of discussion. We still end up with an effective manufacturing force of three times the US and thus in my view at least three times the GDP. Clearly, such a calculation has moved me to crank status. Of course, that is nothing new given my previous writings.
Yet, if the conclusion is based on reason, then there should be ample evidence in real terms. To understand the notion of real output, simply consider the obvious difference in a supersized soda compared to a regular soda. You can tell the "real" difference by the volume of the drink. To extend this logic, one simply needs to take a glimpse of Chinese output in terms of cement, steel, and sulfuric acid (top chemical), as a random example of real output. The absolute differences are absolutely astounding. For example, China recently produced NINE times the amount of steel, THIRTY times the amount of cement, and produced more than double the amount sulfuric acid than the US. China is clearly supersized in my opinion. Obviously, we can argue over various distortions in various sector (i.e. China needs more cement than the USA because it is catching up), but pick your sector output of choice and you will be hard pressed I suspect to conclude otherwise.
If anything, I suspect my calculation seems to understate the comparison. To appreciate this, contrast China's supersizing manufacturing, while we meanwhile seem to be supersizing government services, which, in case you're wondering, is part of the GDP calculation. The supersizing of government services strikes me as so extreme--and I gladly stand corrected--that I cannot really accept my own conclusion. To appreciate why, consider the simple calculation of total fed, state, and local spending at roughly $6 Trillion divided by a ball park of full-time American workers at say 115 Million, gives a supersized load of roughly $52K per worker (please tell me I'm wrong). How such a component of GDP would impact the PPP calculations is not clear to me at the moment, since I have yet to get my hands on the actual PPP formulas used by the mainstream analysts. If nothing else then, it is this type blurring of manufacturing vs government spending in the GDP calculations which I think only strengthens my position of counting factory workers to get a clearer picture of relative GDP of nations.
So where does this leave us? Under an intellectual free trade spell that seems impossible to break. How strong is this spell? Simply consider the proposition that China's economic miracle really amounts to a full-blown demonstration of the failure of 200 years of mainstream economic theory. Yet in spite of this "China test model", we cannot break the the spell of free-markets, contempt for capitalism, or flawed sophisticated models which are cast over both our political parities and academia. And if that wasn't enough of a demonstration of its power, then simply consider that China achieved this record-breaking economic miracle by studying America's forgotten protectionist history, a point made in veteran intelligence expert Michael Pillsbury's new book The Hundred-Year Marathon when a Chinese defector reveals their education/training in America economic history. For the reader inclined to understand intelligence failures, and China's "Warring-States" perception of us, I strongly recommend this book.
But with that said, my focus remains basic economic theory in order to fix ourselves, not global conflicts or politics. China obviously does not need my advice; it understands economics. As one American importer observed, "China gets it." The proof is in the real GDP.
As always, critique is welcome.
Links to new model of economics: