Photographer: Qilai Shen/Bloomberg via Getty Images

The balance of power

Economics will be key in the looming new Cold War between the US and China

Tim Congdon

Rarely has the international economic and financial situation been more confusing. Not only has the coronavirus pandemic closed down major parts of the world economy and made a mockery of forecasts of stable growth, but the position of the United States — for so long the leading power — has become unclear.

President Donald Trump is widely regarded as out of his depth in international relations, but there is little confidence that his potential Democrat replacement, Joe Biden, will be much of an improvement. Trump seems determined to start squabbles with China, the only other nation that might be seen as a superpower, while China shows every sign of wanting to get its retaliation in first.

In particular, China has taken steps to end the autonomy of Hong Kong, supposed — under the terms of an agreement with the United Kingdom — to be legally and politically distinct from the communist-ruled mainland until 2047. On 28 May four nations — the US, the UK, Canada and Australia — issued a joint statement denouncing China’s imposition of a new security law in Hong Kong as a breach of its international obligations.

Two days later Trump announced the cancellation of a long-planned June meeting of the G7 countries and proposed an alternative meeting in September, to which the G7 plus Russia, India, South Korea and Australia would be invited. The precise status of this G11 meeting is uncertain at the time of writing in early June, but the event is plainly supposed to serve as a warning to China. (To remind, the G7 membership is the US, Japan, Germany, France, Italy, the UK and Canada.)

We seem to be on the threshold of a new Cold War between two superpowers

We seem to be on the threshold of a new Cold War between two superpowers. So this is a good time for stocktaking, for putting together information on the relative economic significance of the main countries. Comparisons of national output are the heart of the subject, because the size of a nation’s output is the key determinant of both hard and soft power. Hard power is to be understood — above all — as the ability to create weapons and maintain armed forces, and to deploy them effectively wherever they might be needed.

Soft power is more elusive. The concept was developed by Joseph Nye in a 1990 book, Bound to Lead: The Changing Nature of American Power. A nation possesses soft power, in his words, when it “gets other countries to want what it wants”. This co-optive ability can be contrasted with “the hard or command power of ordering others to do what it wants”.

The size of national output is clearly a critical influence on the affordability of defence expenditure, the main expression of hard power, and on the ability to import products from other countries, which is a method of exerting soft power. Further, a nation with a big economy may also have particularly good news media and iconic cultural artefacts, and these also promote a shared outlook and spread soft power.

Unfortunately, the subject is bedevilled by a difficult conceptual issue. A straightforward and seemingly plausible approach is to add up all the incomes and outputs of various nations, and to apply the prevailing exchanges rates to the valuation of non-traded goods and services as well as traded goods and services. But this quickly leads to nonsense — or at any rate to an outcome contrary to common sense. Exchange rates can move around dramatically from year to year, often by over 20 per cent. As a result, the valuation — at so-called “current prices and exchange rates” — of the non-traded output in a country with an exchange rate fall of 20 per cent goes down by 20 per cent when the actual volume of non-traded output has been stable.

The alternative approach is to recognise that the purchasing power of money varies between countries and to adjust estimates of different countries’ national outputs for these variations, generating figures for national outputs on a so-called “purchasing power parity basis”. A systematic feature of these PPP numbers is that relatively poor developing countries are positioned higher in the league tables than when current prices and exchange rates are used.

The explanation is technical: that the relative price of non-traded goods and services to traded goods is higher in rich countries than in poor because of deep-seated productivity patterns. More simply, a haircut may be more or less the same in Mumbai as in Manhattan, but the Manhattan version will be much more expensive for just the same quality. PPP numbers are therefore more notional than GDP estimates based on current prices and exchange rates, as they depend to a significant extent on how large an adjustment is made for the over-valuation of such non-traded output as haircuts in Manhattan.

The table on the next page compares gross domestic products of the main nations on both of the two bases just discussed, with the left-hand column showing the current prices and exchange rates numbers, and the right-hand column those on a PPP basis. The contrasts between the columns are dramatic.

On a PPP basis some quite poor countries (India, Egypt) register as important. Their importance stems from their high populations which imply correspondingly large numbers of such locally-provided things as haircuts (or beauty treatments or beverages served in small cafes). No one disputes that haircuts (and beauty treatments, and the occasional cup of tea or coffee) are of human benefit, but they do not signify in international trade and finance or cut the mustard in geopolitical calculations.

At any rate, on a current prices and exchange rates basis, the US remains by far the most significant nation, and the combined GDPs of the US, the UK, Canada and Australia come to more than $27,000 billion, almost double the GDP of China. On a PPP basis the conclusion is radically different. China is far ahead of the US, and China’s national output is just ahead of the combined GDPs of the US, the UK, Canada and Australia.

Most economists regard the PPP basis as preferable, in that it better reflects economic well-being. But — in geopolitical discussion — the current price and exchange rates basis is surely the one that is most meaningful. The argument here has been it is the more effective and relevant if we want to translate economic weight into hard-power military capability. After all, actual sums of money are required to pay for international troop deployments, the components of raw materials and semi-finished goods needed in modern weaponry, and the like.

Different measures of the national outputs of the world’s main nations

Another point is that some of the low-income countries high up in our table on a PPP basis have high tariffs and import restrictions, so that they do not exercise the soft power that comes from offering a large home market to foreign producers. India may have the world’s third largest GDP when GDP is estimated on a PPP basis, but it is a minor player in the import stakes. In 2019 it imported goods to the value of $319 billion, about half as much again as the United Arab Emirates ($214.7 billion) and Ireland ($208.7 billion), but the UAE and Ireland are not deemed to be major powers in any terms.

A demonstrable ability to purchase large amounts from other countries gives bargaining clout (and hence soft power) in many contexts. For that also GDPs on a current-prices-and-exchange-rate basis seem the most useful. But China is unusual, in that its economic prominence is clearest on a PPP basis, with a high valuation to non-traded goods and services, and yet it is also a huge international trader. In fact, last year its imports of goods were about three-quarters of the USA’s and greater than those of the UK, Canada and Australia taken together.

Chairman Mao (Photo by Bettmann/ Getty Images)

In the 1970s the international trade of Hong Kong, a tiny colonial enclave, was a multiple of that of communist China, the much larger nation that surrounded and perhaps threatened it, while the people of Hong Kong had vastly higher living standards. After the death of Mao in 1976 the Chinese seemed to have learned a vital lesson from Hong Kong’s success. Adam Smith, the champion of free trade, was a better economist than Karl Marx, the advocate of common ownership of the means of production. For the next 35 years the Chinese copied Hong Kong, by opening up their economy and embracing capitalist institutions if “with Chinese characteristics”.

China and the rest of the world would gain more from increased economic cooperation

Readers must make up their own minds about the relative power of China and its reluctant antagonists. It has to be said that, while the US and other countries of the advanced West have higher incomes per head than China, China’s overall economic weight in the world is much the same as the US’s.

A key imponderable is whether China needs the markets of other countries more than other countries need its market. The obvious truth is that both China and the rest of the world would gain more from increased economic cooperation and cultural interaction, and that even a partial return to the isolationism of Mao’s China would be a tragedy.

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