A new report released by the International Monetary Fund (IMF) states that China has surpassed the United States as the world’s largest economy.
The report admits that in terms of overall GDP and raw currency value, the U.S. is still outpacing China. But the IMF also claims that China is now the world’s largest economy based on data that has been adjusted for purchasing power.
But what is purchasing power exactly? You can think of it like this:
There’s two men- one in Shanghai and one in Los Angeles. The man in Los Angeles makes $80,000 a year, while the man in Shanghai only makes $60,000.
But the average price of goods in Shanghai is significantly cheaper than in LA. So although the man in LA technically has more money, he actually has less purchasing power than the man in Shanghai.
The IMF was taking these factors into account by adjusting each country’s GDP for purchasing power. The resultant data paints a very different picture of the wealth comparison between China and the United States:
According to the IMF report, by the end of this year China will make up 16.48% of the world’s purchasing power adjusted GDP ($17.632 trillion), while the US will make up just 16.28% ($17.416 trillion).
This doesn’t come as a surprise to many economists, however, who have been predicting the switch for a while now.
But it’s also worth noting that a difference in the way China and the U.S. calculate GDP may have skewed the data a bit.
According to Michael Pettis, a finance professor at Peking University in China,
“Chinese lenders, banks as well as households, treat a substantial portion of the debt as if it were implicitly or explicitly guaranteed by central or local government agencies.”
Pettis basically argues that China’s GDP figures don’t account for a substantial amount of debt, and are therefore artificially inflated. You can read more about Pettis’s argument from Quartz.
If you’re interested in learning more about purchasing power, the Economist’s Big Mac Index is a great place to start. It uses the price of a Big Mac as a standard to compare currencies.
For example, as of July 2014, an average Big Mac in the U.S. cost $4.80; in China it was only $2.73 (at market exchange rates), so according to the Big Mac index, the Yuan (China’s currency) is undervalued by 43%.
The actual indexes used by the IMF are much more complex, factoring hundreds if not thousands of price comparisons, but the Big Mac Index is a cool quick way to compare purchasing power.
Read the original story from Business Insider.