Now do Japan – Econlib

I have often argued that China has the largest economy in the world, at least measured in PPP terms. (Of course, they are still only a middle-income country per capita.) Others continue to stick to using market exchange rates, suggesting that the U.S. economy is still significantly larger. Reasonable.

But you need to be careful when drawing implications based on market exchange rates. They tell us something about China compared to the US, but they don’t tell us anything about it China in absolute terms. So it is a mistake to look at charts showing that China’s GDP (in US dollars) has stagnated in recent years and assume that China’s economy is no longer converging towards developed country status. After all, there are more than one pair of exchange rates. So now let’s do Japan.

The following graph shows the ratio of China’s GDP per capita to Japan’s GDP per capita. I got married in Beijing in 1994. At the time, China’s GDP per capita was about 1% of Japan’s. That’s really low. In 2022 (the last year shown), this was more than 37% of Japan’s, and is still rising rapidly. Now it is almost 40%. So if we really believe that market exchange rates are the right way to think about China’s growth (I don’t), we should conclude that China is rapidly converging to developed country status. Only since 2010 has this increased from about 10% to 40% of Japan’s per capita income.

Of course, the weak yen exaggerates China’s rise. But just as the yen is an outlier on the low side, the US dollar is an outlier on the strong side. Most other developed countries have relatively weak currencies compared to the US dollar, and therefore it makes more sense to view the dollar as unusually strong: we are the outlier.

This leads to quite a bit misleading graphs if you rely on comparisons using market exchange rates:

Note that Japanese workers have gone from almost twice as well paid as American workers in the mid-1990s to just over a third today. To be clear, I’m on record as saying that the poor performance of the Japanese economy is somewhat real (and not just demographically), but this vastly overstates the problem. The yen has weakened dramatically, especially in real terms. Japan’s economy is mediocre, but not terrible.

P.S. Some have argued that Chinese data is unreliable. But any tourist who visits China (both urban and rural) soon discovers that the country looks considerable richer than represented by official GDP per capita (about $13,000, versus $85,000 in the US). And China is now about 70% urban, so poor rural areas (which are not nearly as poor as they were) are no longer a plausible explanation. China as a whole still has middle-income status, but significant parts of China look quite developed. (Shiny new airports, subways, highways, shopping malls, affluent urban neighborhoods, etc.)