Evidence that Gregg Easterbrook doesn’t understand economics, in two parts (Pt. 1)

There were a lot of silly things written in response to China surpassing Japan as the world’s #2 economy, but this column from Gregg Easterbrook had to be the stupidest.  The title – China as number one? Remember Japan in the ’80s – more or less sums up Easterbrook’s entire argument, which essentially rests on two points: China is likely to stumble by following the same path as Japan, and that the math for China overtaking the US in the near future doesn’t add up.  He’s dramatically wrong on both points.

Lets start with the math question, which is really pretty embarrassing.  Easterbrook writes:

As for those experts who think China will pass the United States for number one economy in just 20 years?

This year China is on track for a $5.2 trillion GDP, very impressive compared to where China was economically just a generation ago — but still staring at taillights of the United States, whose GDP should finish the year at around $15 trillion. Even if China’s annualized growth stabilizes at 6 percent — and most nations would be quite happy with that level — it will take China until about 2030 to match America’s $15 trillion GDP.

But the United States won’t be sitting still. If U.S. growth is 3 percent, half of China’s, in 2030 the American GDP will be about $27 trillion, comfortably ahead. If the United States sustains half the growth rate of China indefinitely, China’s GDP will not pass America’s for several generations.

There are two glaring mistakes here.  The first is that Easterbrook writes of China’s growth rate “stabilizing” at 6 percent, which I think most people would take to mean growth slowly decreasing from the 9-10 percent range today, down to perhaps an average of around 8 percent in 2020, down further to 6 percent by 2030.  This sounds reasonable, and is indeed probably fairly close to the path that most of the “experts” Easterbrook mocks think China will take.  But it turns out Easterbrook’s calculation isn’t based on growth stabilizing at 6 percent over the next 20 years, but rather growth *averaging* 6 percent over the next 20 years [$5.2 tn * (1.06)^20 = ~$15 tn].  Switching out “averages 6 percent” for “stabilizes at 6 percent” is at best misleading and at worst a flat out lie, and I’m surprised the Reuters editors let him get away with it.  Were China to follow a path of growth actually stabilizing at 6 percent in 2030, like that laid out above, the average annual compound growth rate would be about 7.5 percent, and the 2030 GDP figure would be ~$22 tn, or closing in on the US pretty fast.

But that’s only half of Easterbrook’s problem; his other big mistake is that he fails to account for exchange rate appreciation.  Easterbrook’s calculation assumes absolutely no appreciation of the renminbi over the next 20 years.  This is preposterous;  every country that’s gone from poor to rich has experienced significant exchange rate appreciation, this is part of the process of becoming a developed economy.  It’s true that China’s intervened to keep its exchange rate artificially low in the past, but there’s no chance that this will continue for the next 20 years – neither China nor its trading partners would let that happen.  As a conservative estimate, we can guess that China’s exchange rate will appreciate against the dollar by about 1 to 2 percent a year over the next 20 years, which would still probably leave it below its “fundamental” value.  If we factor average annual exchange rate appreciation of 1.5 percent into the above equation, China’s 2030 GDP value jumps to $29 tn – or above Easterbrook’s 2030 value for the US.

Now I also want to address Easterbrook’s other main point – that China’s likely to fall off track just like Japan did – but it’s already taken me 600 words just to cover these basic calculation problems, so I think the second part will have to wait for another post.  As a short preview, I really don’t understand why so many people talk about how China will either end up successful or will end up like Japan.  Newsflash: if China ends up like Japan — a technologically-advanced economy with incomes nearly as high as those in the US — it will have succeeded far beyond anything China bulls like me could imagine.

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3 Responses to “Evidence that Gregg Easterbrook doesn’t understand economics, in two parts (Pt. 1)”

  1. 1 babs November 2, 2010 at 5:44 pm

    hmm…it’s nov.2. when is part 2 coming?
    what else is new?

  1. 1 Japan’s Secret Success « Tomorrow's Economy Trackback on January 8, 2012 at 10:35 am
  2. 2 Were Japan’s Lost Decades Worth It? « Tomorrow's Economy Trackback on January 11, 2012 at 1:45 pm

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