What are the driving forces of US economic growth? Economic background to Xi Jinping’s US visit

The following article was written for the Chinese media as economic analysis of Xi Jinping’s visit to the US. However it also demonstrates that capital investment is the key source of US economic growth. It originally appeared at China.org.cn.

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Chinese President Xi Jinping‘s forthcoming state visit to the U.S. offers an opportunity to understand the great potential for mutually beneficial economic relations between the two countries. This goes well beyond them being the world’s two largest economies to revealing their fundamentally complementary economic character.

Analysing their most fundamental economic features demonstrates this clearly, and helps explain why China-U.S. economic relations can be stable and mutually beneficial for decades to come. It also shows why the anti-China attitude of American neo-conservatives damages not only China, but also the U.S.

In 2014, China-U.S.trade, standing at US$650 billion, was the largest between any two countries in the world outside the North American Free Trade Area (Canada, Mexico and the U.S.). For the U.S. it was second only to trade with Canada – the latter now being almost a domestic base for U.S. production.

In the period 2007-14, namely, since the beginning of the global financial crisis, U.S. trade with Canada increased by US$121 billion, but that with China increased by US$237 billion.

The driving force of such rapid trade expansion goes beyond them being the world’s two largest economies to the fact that China is by far the largest developing economy, while the U.S. is the world’s most advanced economy. They complement each other rather than directly compete.

Measured at current exchange rates, preferred by China, it is the world’s second largest economy. Measured in terms of Purchasing Powers Parity (PPPs), as many Western economists prefer, China is the world’s largest economy. Whichever you use, the productivity gap between China and the U.S. remains huge.

At current exchange rates, China’s per capita GDP is 14 percent of the U.S., while in terms of PPP, it is 24 percent. The fact they are at very different productivity and wage levels, means China provides a gigantic market for U.S. high value added products, while China can supply medium technology products at prices the U.S. cannot match due to its far higher labor costs.

If the latest year’s growth rate of per capita GDP for the two countries were maintained, 6.8 percent for China and 1.6 percent for the U.S., China would not be able to reach U.S. per capita GDP until 2043.

The reason this gap cannot be closed rapidly is also clear. Contrary to neo-liberal myths, the U.S. economy is essentially powered by capital investment. Analysed in fundamental terms, an economy’s sources of output and growth can be divided into capital investment, labor input and Total Factor Productivity (TFP) – the latter measuring the effects of economic policy, improvements in technology etc.

Using the latest statistical methods of international economic agencies such as the OECD, Figure 1 shows that capital investment accounted for 51 percent of U.S. economic growth in 1990-2014, while capital and labor inputs together accounted for 76 percent. Only when it can match U.S. input levels, above all capital investment, can China achieve a U.S. level of development and productivity.

In 2013, China’s annual fixed investment per person was US$3,199 compared to the U.S. figure of US$10,017.

To take another example, in 2012, the latest available data, there were 15 km of railway track per person in the U.S. compared to 1 km per person in China, a big factor in the productivity of the logistics system.

It is, therefore, impossible for China to close the gap in capital inputs to reach U.S. levels in the short to medium term. Even if China adopts brilliantly flawless policies, it will not reach U.S. levels of productivity for decades. Equally, even a U.S. economic collapse on the scale of the Great Depression, which will not occur, would not reduce U.S. investment per person and wages to the Chinese level.

As China is by far the world’s largest developing economy, the U.S. will also not find any alternative comparable source of supply to China for price-competitive medium technology products.

It can, therefore, be predicted with certainty that, in 10 years’ time, when the presidents of China and the U.S. meet, these fundamental parameters will be unchanged – U.S. productivity will still be higher than China’s and the two economies will still be fundamentally complementary. The stability of such fundamentals offers a firm foundation for mutually beneficial relations.

China certainly loses by any restrictions on exports of U.S. high value products, but equally neo-conservatives, by limiting trade with China, simply drive up costs for U.S. consumers – and therefore drive down U.S. living standards.

Restrictions of trade between the world’s two largest economies also have negative economic consequences for other countries as they slow overall world growth and create a “lose-lose” scenario, for everyone. The stable economic basis of China’s concept of a “new model of major country relations” is a win-win for the people of China, of the U.S. and of third countries which results from trade and investment between mutually complimentary economies.

John Ross is currently Visiting Professor at Antai College of Economics and Management,Shanghai Jiao Tong University, where he leads research on globalisation and on China and the international financial crisis. Check out his blog: http://ablog.typepad.com/keytrendsinglobalisation/ , or follow him on twitter @JohnRoss43