Settle Down, China Isn't Overtaking U.S. Economic Power and Here's Why

Story was updated to reflect 2012 U.S. and China GDP in trillions

NEW YORK (TheStreet) -- Quit worrying about China.

Headline consumers in the past week learned that China's economy this year is passing the U.S. economy, and Chinese e-commerce giant Alibaba finally filed for an initial public offering on American public markets.

The news isn't insignificant for a country that across some 30 years developed into an international heavyweight from a once, literally, starved nation.

But the headlines miss the reality that China, despite its unprecedented growth, remains in the economic shadows of its more powerful and innovative 'competitors, namely, the United States.

TheStreet spoke with three China experts this week to give investors a clearer picture of where the People's Republic of China (PRC) stands among its global peers, and provide critical points that will encourage a more informed discussion at your dinner parties.

Guy de Jonquieres, senior fellow, European Centre for International Political Economy

"To be honest I don't think it matters much, other than the shock value in the U.S.," de Jonquieres said in a phone interview from London.

What may have misled some readers was that an International Monetary Fund report said China will this year surpass the United States in purchasing power parity, meaning that one Chinese yuan will go further in purchasing goods and services in China than one U.S. dollar will in purchasing goods and services in the U.S.

While this is a legitimate way to determine comparative economic power, it doesn't match the way most people think of strength of economies, which is by nominal gross domestic product. U.S. GDP is $16.24 trillion annually, while China's GDP is about half that at $8.23 trillion a year, according to 2012 estimates by the World Bank.

Further, per capita GDP in dollars ranks the U.S. 12th in the world at $51,749, but China is 90th at $6,091, right behind St. Vincent and the Grenadines.

Stats like those may help explain why nearly 60% of Americans still view their country as the dominant economic power, while just 28% say China.

De Jonquieres last year wrote a paper detailing China's lagging innovation compared with the West, touching on the quality vs. quantity of patents issued, engineers trained and various other issues.

Less than a third of China's patents are classified as innovation patents, leaving the remaining two-thirds in the category of lower-quality "design and utilty-model patents"' also called "junk" patents, de Jonquieres said.

Put another way, the research said that China in 2011 earned $1 billion on patent royalties, while shelling out $18 billion for foreign royalties. That means China ran a $17 billion patent royalty deficit, whereas the U.S. posted a $82 billion surplus.

Education also poses another misconceived sector. A few years ago media repeatedly cited a Program for International Student Assessment survey that said Chinese teenagers in Shanghai outpaced their international peers in reading, math and science. A large part of U.S. success in innovation is because of the talent produced by its higher education system -- another area in which it outperforms China.

In his paper, de Jonquieres cited studies by Duke University and professional body Engineering UK, which found that engineering degrees in the U.S. were "generally" of higher standard than those from China and that the United Kingdom trains 2.5 times more employable engineers than China.

And the sizable number of Chinese citizens who attend American universities? De Jonquieres said they're not all returning to China.

"Basically, I think the problem with China is not the people but first of all there are limitations to their education sector," de Jonquieres said on the phone. That limitation, he said, is incentives.

Aaron Friedberg, East Asia professor of Politics and International Affairs, Woodrow Wilson School at Princeton University

Friedberg, speaking by phone from Princeton, N.J., began the interview by saying that China's rising power relative to the U.S. is fueled by perception.

"China is growing fast, though not as fast as it was, and faster than the United States and faster than other countries of the world," Friedberg said.

It's true. Researchers, investors, businesses, politicians and middle-class Americans understand that China is a major player in the global economy and our daily lives. The reason market observers stayed up until late hours on Sunday to peek at China's manufacturing data is because a slowdown in China directly impacts the American economy. Contraction in the manufacturing sector for the sixth-consecutive month isn't something to cheer about as the interconnectedness of economies contributes to the strength and weakness of global economic trends.

"The question is not about whether [China] will slow, but when and how rapidly it will slow down," Friedberg said.

China is entering a new phase of its economic development. Always eager to downplay its progress and quietly maintain its perception as a developing nation that posses international economic power, the country won't be posting GDP growth figures of 8% or more on a regular basis. That's not necessarily a bad thing. The Chinese Communist Party understands that the makeup of its economy must transform from a manufacturing-only country to one that drives growth by consumption.

Friedberg pointed out that the Communist Party has been saying this for 10 years, but that it hasn't started to make the changes or transitioned, which he thinks is because of the structure of the political system.

Following Deng Xiaoping's careful rejection of Mao Zedong's style of communism (socialism with Chinese characteristics), the country managed to reform the mangled economic system by launching massive state-owned enterprise programs and supporting the successful township and village enterprises, which incubated some of China's best entrepreneurship.

But tight control of massive state-owned enterprises, coupled with hidden corruption, has hindered domestic business successes. (de Jonquieres cited a report that said state-owned enterprises have failed to earn more than the subsidies given to them).

While many American observers think that ultimately China must reform is political identity in order to trigger a true economic renaissance, it would be unwise to think such revolutionary reforms are near. Nor is it fair to argue that China won't figure out how to solve its poverty, middle-class underperformance and other pitfalls by remaining a one-party system. Without delving deeper into it here, the Chinese Communist Party is a complex political body with deep differences of opinion among its power brokers across many serious social, political and economic questions.

"China is much more capable and well off than it was a decade ago," Friedberg said, recounting the party's ability to adapt.

Donald Lewis, former academic coordinator for the World Trade Organization's Regional Trade Policy Course for Governments of Asia-Pacific

"China is here to play ball and they understand it, and China needs to get up the value chain and it needs to become a real player here," Lewis said on the phone from near San Francisco. "It is not yet."

Lewis said what's surprising about China surpassing the U.S. in purchasing power parity is how rapidly it happened, and how even the most profitable predictors misjudged the jump.

Lewis said most economists were expecting this event to happen sometime in 2016, while other powerful banks -- Goldman Sachs around 2027, Citi around 2020, HSBC near 2022 -- and the World Bank (2030) guessed later time frames.

Fears are rising that China is facing a credit crunch, especially after issuing large credit lines following the 2008 global financial crisis. The banking/financial system is woefully unregulated when compared to the U.S. and Western Europe.

But while China's competitors attempt to follow rules set by the World Bank, IMF and WTO, the country doesn't exactly fit the mold of a model international citizen.

Providing access to credit will help transfer real wealth to the Chinese consumer, but China's rise also has huge implications for governance in the IMF and World Bank. For example, the IMF must determine if the renminbi will be added to the IMF basket of currencies, which would add greater weight to China in voting.

The World Bank's book-length research about the necessary reforms China must undertake to avoid the middle-income trap said the country must review its energy, environmentral and industrial policies. It must improve the fiscal system and accelerate the pace of innovation. And, as Lewis focuses on, China must seek beneficial relations with the world.

"And, of course, what are the consequences for the planet?" Lewis asked. "It's not really a full-fledged international economy yet, because they don't even have a convertible currency."

China's rise as the world's greatest economy by GDP and purchasing power parity and numerous other indicators is inevitable, these China experts agreed. But how it reaches these milestones will be critical.

-- Written by Joe Deaux in New York.

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