World Bank Report on China's Economy Surpassing the U.S.'s Misreads the Data

According to a World Bank report released Wednesday morning, the United States is on the cusp of losing its economic global supremacy for the first time since it took the crown from the United Kingdom in 1872.

However, after its last report in 2005 found that China’s economy was only 43% as large as the U.S.’s, the World Bank faced criticism that forced it to correct its statistical data. 

The new World Bank analysis stated that China’s economy had grown to 87% the size of the U.S.’s by 2011 and will be larger than the U.S.’s this year. 

Americans should ignore this bogus headline; China’s $8.2 trillion gross domestic product (GDP) in 2012 was only 51% of the size of America’s $16.2 GDP. It will be a long time before China takes away America’s economic crown.

The report from the World Bank’s International Comparison Program (ICP) uses what economists refer to as “purchasing power parity” to compare how much the same amount of money buys for the same “basket of goods” in different countries.

The report was started in 1968 as a joint venture of the UN and the University of Pennsylvania. The report was expanded to include the developing world in 1993 by incorporating World Bank Development Data Group’s statistics for purchasing price parity. Every three years through its 2003-2005 analysis, the ICP presented reams of credible purchasing price parity data that geeky economists like me would wade through to try to identify emerging regional trends for investment purposes.

The data collection became controversial in 2005 when the World Bank and United Nations estimated that on a purchasing price parity basis, China’s economy was only 43% of the size of the U.S.’s. According to the World Bank website, “The 2003-2005 round of the ICP marks a turning point in the program with aims to meet criticisms leveled at the ICP and the quality of its data following the 1998 round.” “Quality of data” for the United Nations and World Bank are code words that the statistically low percentage for the economic importance assigned to China and other developing countries was politically incorrect.

The theory of purchasing power parity states that the exchange rate between one currency and another currency is in balance when a standard product in both countries can be purchased at the same price. This is referred to as the “Law of One Price.” Any differences in price is assumed to mean that the currency exchange rate between countries must be adjusted up or down to reflect more or less purchasing price parity.

The McDonald’s Big Mac hamburger that is sold in 120 countries can be compared for differences in pricing that can affect purchasing price parity because the Big Mac in every country will be almost identical for inputs of agricultural commodities, labor, market advertising, and real estate costs. Yet the price at different currency exchange rates may be higher or lower from country to country. The percentage difference in price is referred to as the “Big Mac Index,” an idea first invented by The Economist.

The price of a Big Mac is currently $4.62 in U.S., but the price is only $2.74 in China after exchanging the U.S. dollar for the local Chinese renminbi currency. Since a consumer in the U.S. is paying $1.88 more for the same item as compared to the Chinese consumer, the Chinese renminbi currency is deemed 41% undervalued in purchasing price parity.

The World Bank in its new International Comparison Program study performed this type of comparison to determine how much the GDP of China should be adjusted upward for greater purchasing price parity. If the Big Mac index for China’s currency being undervalued by 41% held true for the ICP “basket of goods,” then China’s $8.2 trillion GDP in 2012 was really $13.9 trillion in purchasing price parity. This ratio is virtually identical to the World Bank’s new estimate that China’s economy was 87% as large as that of the U.S. in 2011.

What the World Bank study conveniently forgets to mention is that prices in China and other collectivist countries are “administered.” That means the government in China buys commodity foodstuffs from farmers at a premium price to curry political favor with rural constituents. The government then sells those commodities to McDonald’s to make Big Macs at a highly subsidized price to curry favor with urban constituents.

Mark Twain said it best: “There are three kinds of lies: lies, damned lies, and statistics.” The World Bank’s ICP study showing the size of the Chinese economy is about to pass the U.S. this year is definitely a bogus statistic.

The author welcomes feedback and will respond to comments by readers.