The International Comparison Program (ICP), a subsidiary of the World Bank, released a report on April 30 which predicts that China will replace the United States as the world’s largest economy as early as 2015. 
The report uses economic surveys, which are conducted on 150 countries every three to five years. The findings are then categorized and turned into comparable data based on Purchasing Power Parities (PPPs). PPPs are forms of exchange rates that take into account the cost and affordability among common items in different countries, usually expressed in terms of U.S. dollars.

The development of PPPs attempts to compare standards of living across an array of countries worldwide. Rather than evaluating only the Gross Domestic Product (GDP) levels of a given country, which are influenced by prices for internationally traded items and neglect the cost of domestic goods and services, the ICP uses PPPs. Purchasing Power Parities take into account the volume of goods and services that are produced in each country, and compare them to what the value of these goods and services are worth.

In simple terms, since most consumer products are cheaper to purchase in Shanghai than they are in New York, 1 Renminbi (RMB) buys more in China than $1 will buy in the U.S.

Taking into account the value of domestic goods and services with GDP rates, poorer countries are cheaper and richer countries are more expensive than initially found. As a result, the volume of goods of services produced in China is actually higher than it is in the U.S. – meaning China’s economy is larger than originally thought – had these countries been evaluated using strictly GDPcalculations.

As illustrated in the image below, the economic size of countries like China, India, Russia, Indonesia and Mexico increases when taking into account the domestic goods and services that are comparatively cheaper than the likes of Japan, Germany, France, United Kingdom and the U.S.

Based on ICP 2011 Statistics, Thomas Hansen

Focusing on a strictly exchange rate-based evaluation of GDP, the United States’ economy is 12 percent larger than China’s. And yet, taking into account the effect of domestic goods and services, which is represented through PPPs, China’s economy is merely two percentage points smaller than that of the United States – a gap that is expected to diminish as early as 2015.

China’s economy is large but not rich

The ICP surveys and the use of PPPs are influential in establishing the sheer size of countries’ comparable economies across the globe. However, without taking into account per capita incomes, some may believe that people’s actual living conditions are not properly represented.

According to World Bank 2012 statistics, the U.S. per capita income ranks seventh in the world at $51,749 and China’s ranks much lower, 90th, at $9,083.

Even though the price of domestic goods and services are drastically cheaper in China than in the U.S., the stark difference in ranking suggests that living conditions in China are far less developed – despite the size of the country’s economy.

In a report released by the University of Michigan on April 28, researchers revealed that China’s Gini coefficient (an international measurement for income inequality) rose from 0.30 in 1980 to 0.55 in 2010. Anything above 0.5 indicates a severe gap between the rich and poor.

Xiang Zou, author of the report, outlined the reasons for the rise of income inequality in China.

“The rapid rise in income inequality in China can be partly attributed to long-standing government development policies that effectively favor urban residents over rural residents and favor coastal, more developed regions over inland, less developed regions,” Zou explained.

Economic prosperity, but poor living conditions

With a growing GDP and exports 14 percent higher than U.S.levels, China’s economy appears to be flourishing. However, with a sweepingly low per capita income and over 13 percent of its population living on less than $1.25 a day, China has much work to do in order to compete with western levels.

Ning Shumei, a taxi driver in Beijing, admitted that wages are not adequately representing costs of living throughout rural and urban China, while income inequality is becoming an unstoppable force.

“I am not happy with the fact that people are not paid and respected according to what they can do. The rich remain rich, the poor remain poor,” Shumei said in an interview with CNBC.

Still, with a healthy mix of annual GDP growth and proactive government policy committed to reducing rural, urban and regional disparities, China is on its way to becoming the most dominant global force of the 21st century.