Recently, people have been discussing a heated topic: the gap between China’s gross domestic product (GDP) and that of the United States is getting bigger and bigger.

According to statistics from the International Monetary Fund (IMF), calculated by the exchange rate method, in 2021, China’s and the United States’ nominal GDPs were US$17.76 trillion and US$23.59 trillion US dollars, respectively, with China’s nominal GDP accounting for 75.27% of the United States’.

In 2022, China’s nominal GDP and that of the US were US$17.85 trillion and US$25.74 trillion, respectively, with China’s nominal GDP accounting for 69.33% of the United States’; and in 2023, the nominal GDPs of China and the United States were US$17.66 trillion and US$27.36 trillion, respectively, with China’s nominal GDP accounting for 64.56% of the United States’.

The data show that the gap between China’s nominal GDP calculated by the exchange rate method and that of the United States is getting bigger and bigger.

However, according to statistics from the same IMF database, in 2021, 2022 and 2023, China’s real GDP growth rates were 8.4%, 3% and 5.2%, respectively, while the real GDP growth rates of the United States were 5.8%, 1.9% and 2.5%, respectively.

This brings up a question since China’s actual GDP growth rate is much higher than that of the United States: Why has the gap between China’s nominal GDP calculated by the exchange rate method and that of the United States widened?

Reasons for widening gap

GDP represents the total value of goods and services produced within a country and measured in monetary terms.

It reflects the economic scale of a country. However, GDP cannot fully reflect the level of economic development of a country.

The level of economic development of a country is reflected in the level of science and technology, per capita GDP, industrial structure, and other factors. There are two points that should be noted in the international comparison of GDPs.

First is what to compare.

GDP can be divided into nominal GDP and real GDP.

Nominal GDP refers to GDP calculated at current prices, that is, the product of the price of the current year multiplied by the number of goods produced in the current year.

Real GDP is calculated at constant prices, that is, the product of the price of a certain period as standard multiplied by the number of goods produced in the current year.

At present, a GDP of a certain year announced by a statistical agency of a country is usually nominal GDP, but the GDP growth rate announced is usually the real GDP growth rate.

Second is how to compare.

If the comparison is made using the exchange rate method, the average exchange rate of the local currency against the US dollar in the foreign exchange market is used to convert the GDP of each country calculated in local currency into GDP calculated in US dollars.

The exchange rate of each country’s local currency against the US dollar is determined by the supply and demand situation in the exchange process of the two currencies in the foreign exchange market, and has no necessary relation with the production of these countries’ goods, but the appreciation or depreciation of the local currency against the US dollar has a great impact on the GDP figures calculated by the exchange rate method.

China’s real GDP growth rate is higher than that of the United States, but the gap between China’s nominal GDP and that of the United States is widening. The reasons lie exactly in these two points above.

First, in 2020, the Covid-19 pandemic outbreak occurred worldwide, and the US economy fell into recession.

The US Federal Reserve (Fed) issued a large amount of currency in an attempt to overcome the recession by stimulating demands of consumption and investment.

However, due to the excessive issuance of currency, severe inflation occurred in the United States.

According to statistics from the Bureau of Economic Analysis of the US Commerce Department, the average prices of goods and services in the US GDP rose by 7.05% and 3.63% in 2022 and 2023, respectively.

During this period, the People’s Bank of China also issued a large amount of currency, but not excessively, so there was no inflation in China.

The National Bureau of Statistics of China did not publish the GDP converted price index, but in 2022 and 2023, China’s consumer price index (CPI) rose by 2.0% and 0.2%, respectively, and the industrial producer price index (PPI) rose by 4.1% in 2022 and shrank 3% in 2023.

The increase in the price level of the United States was greater than that of China, offsetting the impact of the smaller real GDP growth than China, resulting in a higher nominal GDP growth rate in the US than in China.

Second, in the case of severe inflation in the United States, the Fed began to shrink the currency and aggressively raise the benchmark interest rate in 2022 to curb inflation.

The US dollar is the most important international reserve currency.

The rise in the US interest rates led to the inflow of funds from other countries into the United States, and the exchange rate of the US dollar against other currencies has appreciated.

According to statistics from the People’s Bank of China, the average mid-point exchange rate of the yuan against the US dollar in 2021, 2022 and 2023 was 6.42 yuan, 6.7 yuan, and 7.02yuan, respectively.

This means that in order to convert the nominal GDP calculated in yuan to the nominal GDP calculated in US dollars, the nominal GDP in 2021, 2022 and 2023 must be divided by 6.42, 6.7 and 7.02, respectively, and China’s nominal GDP in US dollars would naturally be less.

As demonstrated above, the so-called widening gap between China’s nominal GDP and that of the United States is mainly caused by the rise in US price levels and the appreciation of the US dollar against the yuan.

China’s real GDP

Among the international economic comparison methods recognised by the international economics community, there is not only the exchange-rate method, but also the purchasing power parity (PPP) method.

Purchasing power refers to the number of goods that can be purchased by one unit of currency, and PPP is used to calculate the parity between two currencies based on their purchasing power.

For example, for the same set of goods, if it costs US$100 to buy one unit of the set of goods in the United States and 400 yuan to buy one unit of it in China, then the purchasing power parity between the yuan and the US dollar is four yuan to US$1, that is, the purchasing power of four yuan is equal to the purchasing power of US$1.

In the process of calculating the PPP of currencies of various countries led by the World Bank, the main rules are as follows.

First, the chosen commodity types must be sufficient to ensure the accuracy of PPP.

In the process of calculating PPP, the commodity categorisation adopts the standard of the national economic accounts system released by the United Nations in 1993.

The smallest item is “headings”, but “headings” also includes many commodities.

Second, the so-called commodity price must be the price paid for purchasing the commodity in the real market, and it is the average of the commodity prices over various regions and periods of a country or region within a year.

Third, the final commodities of various countries must be comparable, that is, they have similar quality and the same physical or economic characteristics.

At the “headings” level, the price of the commodity is calculated according to the arithmetic average method. At the level above “classifications”, the price of the commodity is calculated according to the weighted-average method.

According to statistics from the IMF, if calculated with the PPP method, China’s real GDP exceeded that of the United States in 2017.

In 2021, China’s and the United States’ real GDPs were 27.3867 trillion international monetary units and 23.5941 trillion international monetary units, respectively, and China’s real GDP was 1.16 times that of the United States.

In 2022, China’s and the United States’ real GDPs were 30.1911 trillion international monetary units and 25.7441 trillion international monetary units, respectively, and China’s real GDP was 1.17 times that of the United States.

In 2023, China’s and the United States’ real GDPs were 32.9314 trillion international monetary units and 27.3578 trillion international monetary units, respectively, and China’s real GDP was 1.2 times that of the United States.

These statistics show that the extent to which China’s real GDP exceeds that of the United States tends to expand, which is consistent with the conclusion that China’s real GDP has been growing at a higher rate than that of the United States.

Regarding the use of the PPP method for international comparison of GDP, two points need to be understood.

First, GDP calculated by the PPP method is not nominal GDP, but real GDP.

The higher the price level of a country, the lower the purchasing power of its currency.

In this way, the use of the purchasing power parity method can exclude the impact of rising price levels on GDP.

Second, when comparing GDPs using the PPP method, international monetary units are used.

Comparing the US nominal GDP calculated by the exchange rate method and the US real GDP calculated by the PPP method from 2021 to 2023, it can be seen that the numbers obtained by the two calculation methods are the same.

This means that in the calculation, the purchasing power of US$1 in the United States each year is used as one international currency unit, and then the GDP of other countries is calculated based on the purchasing power parity.

Therefore, the use of PPP method excludes the impact of exchange rate fluctuations on GDP.

Comparison methods

The exchange-rate method and the PPP method are both international economic-comparison methods recognised by the international economics community, but there are great differences in the calculation results of the two, which brings up the question which international comparison method is more adoptable.

The exchange-rate method is the first to be examined.

The exchange rate refers to the exchange ratio of two currencies, which is determined by the supply and demand of the two currencies in the foreign exchange market.

The advantage of the exchange rate method is that it is simple and easy to use.

The exchange rate formed in the foreign-exchange market can be directly used for comparison without complicated calculations. However, the exchange-rate method has its flaws.

First, the exchange rate method can only reflect the value of a part of goods and services.

A country’s goods and services are divided into those that participate in international trade and those that do not.

For example, a country’s catering services, medical services, legal services, hotel services and many other service industries will not participate in international trade, and the exchange rate method does not reflect the value of these goods and services.

In developed countries, due to the high wage level of workers, wage costs are higher, and service prices are also higher.

Therefore, providing a service of the same quality in developed and developing countries will result in a large difference in GDP.

In addition, the service industry is the main industry in developed countries.

In 2023, the added value of the service industry in the United States accounted for 71.7% of GDP, which leads to an underestimation of the GDP of developing countries or an overestimation of the GDP of developed countries.

Second, the exchange rate of two currencies is directly affected by the competitiveness of both sides.

In international trade, developed countries have an advantage in competitiveness, which results in a certain amount of a developed country’s currency being able to be exchanged for a larger amount of a developing country’s currency.

In addition, the currencies of developed countries are widely accepted as international reserve currencies, while the currencies of developing countries are not.

Countries need more currencies of developed countries for the purpose of international transactions.

This imbalance in currency supply and demand also results in a certain amount of a developed country’s currency being able to be exchanged for a larger amount of a developing country’s currency.

The inferiority of developing countries in the international economic field has resulted in the need to use more of their own currencies to be exchanged for a certain amount of developed countries’ currencies, but now this exchange rate is used to measure how much goods and services developing countries produce, which will obviously seriously underestimate the GDP of developing countries.

Third, the exchange rate of two currencies is directly affected by capital flows.

International capital flows include international lending, securities investment and direct investment, among other things.

International lending and direct investment will also have a certain impact on the production of a country’s GDP, while securities investment in the secondary market does not contribute a bit to a country’s GDP.

However, securities investments flowing into a country will lead to an appreciation of the local currency, while securities investments flowing out of a country will lead to a depreciation of the local currency, thus affecting the calculation of the country’s GDP.

From this analysis, we can see that the exchange-rate method cannot accurately measure GDP.

If we only compare the GDPs of developed countries, the error would be smaller. If we compare the GDPs of developing countries and those of developed countries, the error would be large.

Exactly because the exchange-rate method has such a major flaw, the University of Pennsylvania, under the authorisation of the United Nations Statistical Commission and funded by the World Bank and the Ford Foundation, started the International Comparison Programme (ICP) in 1968 to search for a relatively objective method for comparing the output values of all countries.

The PPP method was proposed by this research project.

After a long period of research, a relatively complete purchasing power parity statistical method was finally formed in 2011.

A total of 199 economies, or more than 90% of the economies in the world, participated in the project.

China began to provide price data for commodities in 11 provinces and cities to the project in 2005, and provided price data for all commodities to the project after 2011.

From the perspective of the method itself, the PPP method is obviously more scientific than the exchange rate method.

The PPP method avoids both the influence of exchange-rate fluctuations and the impact of price-level changes on international economic comparisons. However, the PPP method also has disadvantages such as cumbersome and difficult calculations.

First, PPP is calculated based on the actual prices of goods and services.

However, the marketisation level of developing countries is different from that of developed countries, and the governments of developing countries have more or less restrictions and subsidies on prices.

Calculating the purchasing power of a currency based on the actual prices of goods and services will overestimate the purchasing power of the currency of developing countries, thereby overestimating their GDP.

Second, the calculation of PPP involves a huge amount of goods and services.

Although goods and services are chosen according to a unified categorisation in the specific calculation, it is an extremely difficult problem to select goods and services of the same quality.

Generally speaking, the quality of goods and services of the same type and grade in developed countries is higher than that in developing countries, so their prices should also be higher.

If it is difficult to accurately distinguish the quality, and the purchasing power is calculated only according to the price of goods and service grades, the purchasing power of the currency of developing countries will be overestimated, thereby overestimating the GDPs of those countries.

The exchange-rate method seriously underestimates the GDPs of developing countries, but the PPP method overestimates the GDPs of developing countries. Therefore, the true result should be somewhere between the two calculation results, while closer to the result obtained by the PPP method.

Since both international comparison methods have defects, most countries are still accustomed to using the traditional exchange rate method.

Conclusion

The argument that the gap between China’s GDP and that of the United States is getting bigger and bigger is a conclusion drawn by calculating nominal GDP using the exchange-rate method.

This is caused by the significant increase in the US price level from 2021 to 2023, and the appreciation of the US dollar against the yuan due to the aggressive increase in the benchmark interest rate by the Fed.

But in fact, China’s real GDP growth rate has been higher than that of the United States since 1980, and in many years it has been much higher than that of the United States.

If calculated using the PPP method, the margin by which China’s real GDP exceeds that of the United States is getting larger and larger.

However, it should be noted that the exchange-rate method will seriously underestimate China’s GDP, but the PPP method will overestimate China’s GDP. China’s real GDP should be roughly equivalent to that of the United States.

It should be pointed out that GDP is only an indicator of economic scale, and the level of economic development is comprehensively measured by per capita GDP, scientific and technological level, industrial structure, and other factors.

China’s overall scientific and technological level lags behind that of the United States. The per capita GDP calculated by the exchange-rate method is a sixth of that of the United States, and the per capita GDP calculated by the PPP method is about a third of that of the United States.

China’s economic development level still lags behind that of the United States, and China is still a developing country.