Move over America, it will soon be China's turn to dominate

Analysts and politicians have been going to town with China's growth story of late -- it's poised to not just become the second-largest economy in the world, but is gearing up to push America off its pedestal too.

Before you get all swept up in the hype, take a closer look at the big picture: China's economy has grown ten-fold in three decades and is set to overtake the US in terms of economic output within the next decade or two; it is the world's largest holder of foreign exchange reserves; and the People's Bank of China is becoming the world's de facto central bank. China, after all, currently owns $755 billion of US Treasury bonds, enough to give it the power of life and death over the American economy.

China's economy grew by 8.7% last year, narrowing its gap with Japan. Indeed, Japan's worst recession since World War II left it with a gross domestic product (GDP) of about $5.08 trillion in 2009, while China's economy was about $4.9 trillion. If exchange rates remain stable and if the economies of Japan and China grow by 1.7% and 10% respectively in 2010 as estimated, China will push aside Japan as the second-largest economy in the world.

China could narrowly miss that target, as some analysts estimate that the mainland will record 9.5% growth in 2010 -- but no matter how you slice it, China is poised to take over that spot soon.

China is setting other notable records too. With outbound shipments totalling $1.2 trillion, it surpassed Germany as the world's largest exporting nation last year. And the former kingdom of the bicycle widened its lead over the US as the world's biggest auto market in January, with passenger car sales almost doubling to 1.32 million vehicles. By comparison, US car sales rose a modest 6% in the month and that was up from a 26-year low of 656,976 a year before, industry reports show.

"China is moving forward more quickly than we thought; the financial crisis is God's favour to China," Jim O'Neill, chief economist of Goldman Sachs, said at a press conference in Hong Kong in February. "China may now overtake the US 14 years earlier than we thought originally -- we now expect it to become the largest economy in the world by 2027, versus 2041 previously." he said.

If China can maintain its economic growth at between 6% and 8% for the next 15 years, it could overtake the US in 2025, said Shen Minggao, China economist at Citi. "It doesn't have to have a double-digit growth to achieve that," he said.

Chinese companies, encouraged by the government, are aggressively seeking outbound acquisition opportunities including into the US.

After recording an aggregate $46 billion of outbound acquisitions last year, Chinese companies will snap up an estimated $50 billion in assets abroad in 2010, said BNP Paribas' Beijing-based economist Chen Xingdong.

The country has made extraordinary progress in the financial arena, and as a result its stock and debt markets have grown rapidly, noted Standard & Poor's in a market outlook report on China. Measured by total market capitalisation, the world's three largest banks are now in China, the agency noted.

The 60th anniversary celebration in Beijing last October impressed, if not frightened, the world with an arresting display of military hardware. Next month's Shanghai Expo will also be similarly dazzling.

Mind the gaps

While that all sounds miraculous, it pays to keep things in perspective. The aggregate gross domestic product ranking should not be taken seriously as a measure of development, economists warn. Even after China overtakes Japan and the US as the largest economy it will still be a developing nation for a long time to come.

China's economy will generate just $4,000 per person by the end of 2010, which is one-tenth of the $40,000 average expected in the US by then. China's per capita GDP, on the assumption that the country grows 7% annually during the next 10 years, will increase to $20,000 by 2020, Citi's Shen predicted, but that will still account for only one-fifth of the estimated $100,000 per capita GDP in the US by that time.

Given that China's population is three times that of the US, "China has to have an economy that's six times bigger [than America's] to stand on par with the US," said Vincent Chan, an analyst at Credit Suisse. A nine times larger GDP is needed based on Citic Securities' calculation.

The US is a relatively equitable society, while China has a rapidly widening wealth gap, even as it is growing richer overall. The good news is that China's leadership understands this. Chinese Premier Wen Jiabao said at the annual parliamentary congress on March 5: "We should not only make the 'cake' of social wealth bigger by developing the economy, but also distribute it more equally." However, the government hasn't announced any concrete plan to remove the stratified social identity system, known as hukou, which is believed to be the root cause of social inequality.

Hukou was first introduced in the early 1950s to help a newly established People's Republic of China manage the planned economy and to limit internal migration. Under the system, everyone in China is obligated to be registered at birth in their parents' location and is designated as a rural or urban citizen.

Urban citizens are far more eligible for social services and education opportunities than their compatriots in the rural areas, who account for 80% of the country's population.

Hundreds of millions of rural migrants have flooded the cities in recent decades to work, but migrant workers are often regarded as second-class or even illegal citizens because they cannot change their hukou status.

The rural citizens' purchasing power parity (PPP) per capita is a third less than that of their urban peers; and the growing gap is a threat to the country's stability.

It is not until this part of the economy starts becoming more affluent and confident in its own future that China will genuinely -- as a whole -- be the economic world leader.

This story first appeared in the April issue of FinanceAsia magazine.

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