The United States has been the world’s biggest economy since 1871, but that top ranking is now under threat from China. The Asian giant has achieved economic growth averaging 10% since it initiated market reforms in 1978 and, in the process, lifting almost half of its 1.3 billion population out of poverty and becoming the undisputed second-largest economy. China’s gross domestic product (GDP) – in terms of current prices and market exchange rates – was estimated by the IMF at approximately $8.25 trillion in 2012, which is just over 50% of US GDP of approximately $16 trillion for the same year. While that is a significant gap that may take China many years to close, using another measure known as Purchasing Power Parity (PPP), China is forecast to race past the U.S. in just a few more years.
 
PPP and Its Relevance
PPP is essentially the implied exchange rate at which the currency of one country would have to be converted into that of another country to buy an identical basket of goods and services in each country. One of the best-known examples of PPP is the “Big Mac” index, published by the Economist magazine, which calculates simplified PPP exchange rates based on the popular McDonald’s sandwich. The biggest advantages of PPP exchange rates is that they have greater stability over time as compared to more volatile market exchange rates, and they provide a better estimate of consumers’ purchasing power in developing nations.
 
When Will China Surpass the U.S.?
In November 2012, the Organization for Economic Cooperation and Development (OECD) published an authoritative study on global long-term growth prospects. The study concluded that on the basis of 2005 PPP rates, China may surpass the Euro area’s GDP within a year, and that of the U.S. in another few years to become the world’s largest economy.
 
Specifically, China’s GDP (based on 2005 PPP) is forecast by the OECD at $15.26 trillion for 2016, exceeding the forecasted U.S. GDP of $15.24 trillion for the very first time. China is estimated to pull ahead of the U.S. steadily in the following years; the Chinese economy is estimated to be 1.5 times as large as the U.S. by 2030 and 1.7 times bigger by 2060. India, for its part, is only projected to surpass the U.S. in 2051, when its GDP is forecast at $33.1 trillion, compared with U.S. GDP of $33 trillion. The IMF reached a similar conclusion in its October 2012 World Economic Outlook report, projecting that China’s GDP of $20.20 trillion in 2017 (based on current, rather than 2005, PPP rates) will exceed U.S. GDP of $19.75 trillion for the first time.

Will It Even Matter?
Only for bragging rights! With a population less than one-fourth that of China, the U.S. is still projected to remain one of the world’s most prosperous economies by 2060. The OECD study forecasts U.S. per capita GDP or income to more than double over the next 50 years, from roughly $43,000 in 2012 (based on 2005 PPP rates) to $92,000 in 2060. China is forecast to boost its per capita income by a stunning seven-fold over this period, from $8,000 in 2012 to $55,000 by 2060. The difference in income levels between China and the U.S. are estimated to narrow substantially as a result. While 2012 per capita incomes in the U.S. were more than five times higher than in China, by 2060, they would only be 67% higher.
 
How Will the U.S. Cope?
The U.S. will undoubtedly continue to be one of the world’s most important economies for the foreseeable future. The World Economic Forum ranked the U.S. economy seventh out of 144 countries in its 2012-13 Global Competitiveness Report. Although the U.S. has slipped in terms of competitiveness in recent years, it remains one of the most dynamic economies thanks to the innovation of its companies, strong R&D, excellent university system and flexible labor markets. China is ranked 29th, with the WEF noting some deterioration in areas that have become critical for its competitiveness, such as financial market development, technological readiness and market efficiency. Growth isn’t always a great thing, with rapid economic growth over more than three decades leaving China grappling with a host of problems including income inequality, rapid urbanization, environmental issues and demographic pressures due to the aging population.

How Can You Play this Megatrend?
With the countries having grown exponentially over the past decade, investor enthusiasm about the growth prospects for China and India is nothing new. So how can an investor play this megatrend of China, and to a lesser extent India, becoming the world’s biggest economies? As GDP expands, the best-run companies in these countries should also grow. The easiest way for an investor to participate in such long-term growth is either though exchange traded funds (ETFs) or country funds. One such example is the iShares FTSE China 25 Index Fund (ARCA:FXI), which represents the performance of the 25 largest Chinese companies such as China Mobile and PetroChina. Another example is the closed-end India Fund (NYSE:IFN), which has been in existence since 1994 and holds Indian blue-chips including HDFC, ICICI Bank, Tata Consultancy Services and Infosys.
 
The Bottom Line
While the Chinese economy may be poised to surpass the U.S. on a PPP basis in less than five years, the U.S. will continue to be well ahead on most indicators related to living standards and quality of life. However, China’s surging economic clout may result in the country increasingly challenging the U.S. on a number of fronts, including diplomacy and military.

Related Articles
  1. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  2. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  3. Forex Education

    China's Devaluation of the Yuan

    Just over one week ago the People’s Bank of China (PBOC) surprised markets with three consecutive devaluations of the yuan, knocking over 3% off its value.
  4. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  5. Forex Education

    These Are The Best Hours To Trade the British Pound

    The best times to trade the British pound are centered around economic releases at 1:30 am, 2:00 am, 8:30 am and 10:00 am U.S. ET.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  8. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
  10. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
RELATED TERMS
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  3. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
  4. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  5. G.19 Report

    A monthly statistical report from the U.S. Federal Reserve that ...
  6. Labor Productivity

    A measurement of economic growth of a country. Labor productivity ...
RELATED FAQS
  1. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
  2. Is Brazil a developed country?

    Brazil is not a developed country. Though it has the largest economy in South America or Central America, Brazil is still ... Read Full Answer >>
  3. Are Social Security payments included in the US GDP calculation?

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP). Transfer Payments For ... Read Full Answer >>
  4. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  5. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!