Questions for the new number 2
In Beijing they have been celebrating for a while, but today it's official: China has overtaken Japan as the second largest economy in the world.
It's easy for economists to be sniffy about "psychologically important" landmarks which are measured in dollars and cents. "Purchasing Power Parity" (PPP) estimates of national income, which allow for the fact that a dollar goes a lot further in China than it does in Japan, have put China second in the world ranking for years.
In PPP terms, Chinese gross domestic product (GDP) is more than twice Japan's; in that sense, China is already much richer than the nominal rankings suggest. But it is also much, much poorer. It may be number two by size, but ranked by income per head it is about 95th: slightly above Namibia, but behind Belize. China's average living standards are now roughly a fifth of America's. That is where Japan was in 1950.
And yet, this 'nominal' landmark comes at a time of real importance for China and its global role. Suddenly, it seems, we all care what happens to China. And we all seem to have a view on how the next stage of its extraordinary economic and political transition will unfold.
Historically, the birth of new economic superpowers has caused great global instability - and conflict, more often than not. Much ink has been spilled on how China's role will affect the global balance of power.
Some, such as the US commentator and foreign policy expert, Les Gelb, say that China will not be as disruptive as Germany or Japan were, in the first decades of their development, because China's sheer size, and poverty, mean they have to put economic development before anything else. On the other side, Stewart Patrick, writing in the November/December edition of Foreign Affairs, is one of those who warn that China could be more of a "spoiler", long term, than the White House likes to think.
These are interesting geopolitical questions for the rest of the world to ponder. I want to very briefly list the big economic questions for China and its government, as they get used to being number two.
First, does it really want to have a global currency? This might sound like a small piece of the puzzle, but it actually gets to the heart of whether China is ready to be an economic superpower. As I discussed in my recent blog about the dollar's status (link to "Exhorbitant Privilege" blog from Davos), even if China overtakes the US in terms of national output, its currency won't be a serious rival to the dollar until China opens its capital account and frees up its financial system.
Put it another way - the authorities have to be willing to not just let foreign investors put money in China, but for Chinese people to send money out. And they have to take the consequences of those inflows and outflows for the value of exchange rate. There's not much sign that the government is ready for that kind of loss of control, even if the leadership are taking small steps towards boosting the yuan's global role.
Second, does China's government really want to move to a consumption-based economy? Aside from the size of its population, the two most striking facts about China's economy are its extraordinarily high investment rate and its low consumption. China's gross investment rate in 2009 was 46% of national income, up from 32% in the late 1990s. The flipside to rising investment has been declining consumption by households, which has fallen to only 36% of GDP.
As in Japan and South Korea in the 60s and 70s, very high levels of investment has produced a large quantity of growth - but its quality leaves a lot to be desired. Hundreds of millions of people have been lifted out of poverty since 1980, but Chinese living standards have not grown nearly as fast as the country's economic growth ought to imply.
Why? Because throughout this period of rapid development, the government has put industry and exporters first. Wages and the exchange rate have been kept artificially low and, as I wrote in detail a few months ago, households have had their savings constantly taxed away, by state-controlled banks offering interest rates well below the rate of inflation - if they offer an interest rate in savings at all. (The financial system doesn't provide reliable finance for smaller private companies either, which is why the corporate savings rate is also unusually high in China.)
Again, China's leaders say they want to move to a more consumption-based economy. But as a simple matter of arithmetic, China cannot raise its consumption, or reduce its national savings rate - not to mention its counterpart, which is China's enormous current account surplus - without also reducing its rate of investment. And that is not a simple matter of arithmetic at all.
Of course, China is acquiring the external trappings of a consumer-based economy; go to Beijing or any other major city and you'll see plenty of people ostentatiously spending a lot of cash. But that is scratching the surface. For those national savings and investment numbers to change, and for ordinary households to get a larger share in the country's success, the entire axis of China's economic policy-making needs to shift, so it stops revolving around exporters and producers, and revolves around households and consumers instead.
China's leaders are not very far down that road today. Indeed, some might question whether they were on it at all.