America to Become # 2 Global Economy—And That’s Not Great News

In an op-ed for the Washington Post this past Sunday, Charles Kenny writes that America is No. 2! And that’s great news, referring to the day soon to come when China’s GDP surpasses that of the United States. Kenny writes that this is an eventuality that should not distress Americans, because “losing the title of largest economy doesn’t really matter much to Americans’ quality of life,” particularly because it is America’s superior per-capita GDP that matters more than aggregate GDP, and so “living in an America that ranks second in GDP to China will still be far, far better than living in China.” While certainly Kenny is correct that average per-capita GDP is the proper measuring stick, there are actually a number of compelling reasons why China’s impending eclipse of U.S. GDP will not be the sanguine moment Kenny characterizes it as.

First, the United States has held its position as the world’s largest economy since surpassing Britain for that distinction in 1871; that the United States should be losing that position in 2016 or 2017 is not preordained. Many argue that China’s immense population of 1.36 billion people, over four times larger than the United States’ population of 317 million, just naturally means China will eventually have a larger economy than the United States. Yet China has always had a larger population than the United States, including obviously over the prior century, though not always a larger economy. Moreover, India’s population, at 1.23 million people, is likewise approximately four times larger than that of the United States, yet the U.S. economy remains eight times larger than India’s (and China’s 4.4 times larger than India’s) and India isn’t positioned to become the world’s largest economy any time soon, so clearly population isn’t the key explanatory factor.

Rather, what makes the difference is the economic policies that countries put in place that shape markets, set the environment for business to flourish, and empower the competitiveness and productivity growth of firms, industries, and workforces through investments in science, technology, innovation, infrastructure, and skills. Unfortunately, as ITIF has documented in numerous reports and books including Innovation Economics, the United States is increasingly falling behind in the race for global innovation advantage, in part due to subpar policies such as having: the highest effective corporate tax rate among OECD countries, an unstable and increasingly less generous R&D tax credit system, stagnant investments in scientific research, a lack of policies to support advanced industrial production, a faltering education system (as Kenny notes, U.S. students place 28^th in math skills), a broken immigration system, an increasingly burdensome regulatory system, and rapidly rising public debt.

Such policy dysfunction has given rise to a U.S. economy that’s not performing nearly as well as it should be and—as Kenny laments—that increasingly is not producing broadly shared wealth for American citizens. The evidence is all around us. The U.S. economy has grown by just 1 percent a year, adjusted for inflation, since 2000. The U.S. share of global exports has plummeted from 19 percent in 2000 to 12 percent today, while over that time the United States accumulated a negative $7.5 trillion trade balance in goods and services with the rest of the world. The U.S. share of global exports of high-tech products has fallen precipitously, from 21 percent in 1998 to 14 percent in 2010. Meanwhile, the U.S. federal debt has climbed to $17 trillion (60 percent of which is owned to foreigners). Amidst this cacophony of economic underperformance, it’s no surprise that middle-income Americans are suffering. The U.S. ranks just 23^rd among OECD nations in employment. Median American household income has been stagnant since 1983. And from 2000 to 2010, out of 21 leading economies measured by the International Monetary Fund, U.S. per-capita GDP growth fell to seventeenth. Put simply, it’s not a good thing when part of the reason why the United States is poised to lose its position as the world’s leading economy is that its economy has been significantly underperforming its potential for at least the past decade and a half.

The second reason why the United States’ impending slip to second place is worrisome is that as the U.S. economy becomes relatively smaller, the country potentially loses some of its ability to shape the global economic and trade system according to the norms of market-based economic competition and open, liberalized trade. Indeed, it would be one thing if other countries were playing by the rules of free trade and market-based economics, but in China’s impeding rise to the global economic pole position is a country whose brand of state-led capitalism represents a departure from traditional competition and international trade norms. In fact, as ITIF writes in Enough is Enough: Confronting Chinese Economic Mercantilism, China’s tremendously rapid economic growth has sprung in no small part from the country practicing economic mercantilism on an unprecedented scale. China has embraced a broad and deep range of mercantilist policies, everything from massive subsidies for state-owned enterprises, abuse of anti-trust policy, currency manipulation, and standards manipulation to the theft of intellectual property and forced transfer of technology as a condition of market access. As Dani Rodrik concurs, “Today, China is the leading bearer of the mercantilist torch…Much of China’s economic miracle is the product of an activist government that has supported, stimulated, and openly subsidized industrial producers.”

Yet as ITIF writes in The Good, The Bad, and The Ugly of Innovation Policy such mercantilist policies degrade the international trade system, undermine confidence in trade’s ability to produce globally shared prosperity, and reduce global consumer welfare. Indeed, China’s extensive use of such mercantilist polices has distorted global trade and investment patterns and significantly hurt other developing nations that might otherwise have received more foreign direct investment and gained some of the global market share that China has captured. Not only has this meant slower economic growth in these third-party nations, more troublingly, it has encouraged these countries (such as Brazil, India, Malaysia, and South Africa, among many others) to ramp up their own trade-distorting policies in response, causing the global trade system to further deteriorate.

In short, it’s not good for the United States when the country taking the lead as the world’s largest economy pursues economic policies antithetical to the core principle of ensuring that global trade and investment activity occurs on the basis of voluntary, competitively determined business decisions. Citizens in all countries will ultimately suffer if the post-WWII model of market-based trade liberalization increasingly takes a back seat to countries employing models of zero-sum state-led capitalism that distort global markets in an attempt to maximize their welfare at the expense of other nations.

Just to be clear, ITIF agrees with Kenny that “the rise of the rest” can be a positive for the United States, especially by unlocking the untapped potential for innovation and creativity that can lead to new drug discoveries, new technologies, and new business models such as “reverse innovation” and “frugal innovation” that have recently come from China and India. And growing developing countries certainly represent growing export markets for U.S. exporters that can support American job growth. To be sure, we want developing countries to become wealthy. In fact, we should strive for a world where, in thirty years, sub-Saharan Africa is at the economic level of Latin America today; Latin America and China are where Korea is today; and Korea is where the United States is today. But that model only works if countries get there by competing through “good” innovation policies that ratchet up the quality of global competition such as investing in science, technology, skills, and digital and physical infrastructure, not through policies designed to grow at the expense of other nations.

One day in 1871, the United Kingdom ceded its position as the world’s largest economy—a position it had held for the better part of the preceding century—to the United States. And after surrendering that position, the UK never got back. After fighting two World Wars, the British economy entered a period of drift that culminated from the 1950s to the 1970s in Britain suffering the greatest industrial decline in modern economic history, the country ever more losing its ability to shape the global geopolitical order.

The United States may not always remain the world’s largest economy, but it’s a precious position, and one the United States needs to fiercely contest and compete for, not to blithely surrender with a c’est-la-vie attitude. The United States needs to start by getting its own house in order by implementing a comprehensive set of policies—as outlined in ITIF’s Winning the Race Memos—designed to bolster the competitiveness of American firms and industries and help the United Sates win the race for global innovation advantage. And it needs to complement that effort by continuing to push back aggressively when countries implement trade-distorting policies and by working with like-minded countries to shape global trade rules in agreements such as the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (T-TIP) which comprehensively remove barriers to global trade and investment and set the conditions in which innovation-based economic growth can flourish globally.