Stephen King: Deng's revolution means China is set to overtake America as biggest economy within 30 years

Travelling through some of America's major cities last week, I detected a degree of anxiety confined not just to the latest George Bush revelations on the threat from al-Qa'ida. People in the United States worry about terrorism, but they also worry about economic threats. In some US quarters, the latest economic bogeyman is China.

It's not the first time that a foreign power has led to economic unease at home. In the 1980s, America feared economic success in Japan and Germany, a reaction which, 20 years down the road - and after stagnation in both countries - seems nothing short of remarkable.

Perhaps it's the fear that allows the US economy to stay one step ahead: the 1980s may have been a difficult decade for the United States economically, but from the mid-1990s onwards American productivity growth flourished, while elsewhere productivity performance was disappointingly weak.

The concerns about China, however, reflect deeper-rooted anxieties. China has nuclear weapons and a large army, but I met relatively few people last week who believe that China poses a serious military threat. The key concern, rather, is China's incredible rate of economic progress in recent years. How can China, a Communist country, be succeeding when other anti-capitalist nations - the Soviet Union, for example - eventually stumbled? And, if China is succeeding, does this eventually provide a threat to American economic and political hegemony?

In 2005, China's GDP stood at $2.3 trillion (£1.3trn). US GDP is worth about $12trn. China's economy is, therefore, still a lot smaller than America's. However, through rapid economic expansion in recent years, it has been picking off an increasing number of other G7 countries. By the end of 2004, China was bigger economically than France, Italy and Canada. Last year saw China overtaking the UK. It won't be long before Germany and Japan also fall by the wayside. China will then have the United States firmly in its sights.

Of course, these aggregate numbers hide a multitude of sins, not least the fact that China's economy is big in economic terms because it has lots of people, not because each person, individually, is rich. There may be plenty of bling on show in the trendier parts of Beijing and Shanghai, but average income per head in China amounts to $1,500, tiny relative to the average American's $40,000 or thereabouts. For all its success in recent years, China remains a poor country compared with the post-industrial West.

When it comes to national anxieties, however, overall size clearly matters. And some Americans worry about China not just because of its success to date, but also because of what China's future progress might mean for the relative position of these two economic superpowers. Simple extrapolation is never a good idea in economics, but for illustrative purposes alone, should the US continue growing at about 3.5 per cent per annum and China maintain a 9 per cent annual growth rate, China would be the biggest economy in the world by 2038: food for thought for those people who worry about shifts in the geopolitical balance of power.

For those on the Republican right, there's a great deal of puzzlement about China's success. Surely, goes the argument, we know from the Soviet Union's demise that Communism and state planning just don't work. China's leadership would doubtless bristle at this view: they would offer an alternative explanation that would certainly provide an enlightening perspective on what's been going on in recent years.

Historically, China, like Russia, has been an insular nation. For centuries, its leaders chose to keep China separated from the rest of the world. Whereas Europe stood for progress and openness, China stood for tradition and insularity. By doing so, it spurned the economic potential of its earlier technological advances and increasingly fell behind in the economic league tables.

Deng Xiaoping revolutionised China's relations with the rest of the world, not through the abandonment of the one-party state, but rather through a new policy of openness. His pragmatic approach to policy is best summarised in his now-famous remark about means and ends: "It doesn't matter if a cat is black or white as long as it catches mice." Openness most definitely catches economic mice.

To see why, it's worth thinking about the drivers behind China's success over the past 25 years. Deng Xiaoping's approach involved a greater dialogue with the West. In particular, his policies reflected a growing awareness of China's own economic failings. China undoubtedly had labour in abundance, but that wasn't enough. Someone needed to organise that labour, make it competitive in international markets and ensure that China produced the kinds of goods that the world as a whole wanted to buy. The Chinese authorities knew that these organisational skills didn't exist in China: they needed help from outside.

And that's exactly what's happened over the past 25 years. China's success is not entirely a home-grown affair: it reflects a huge surge in foreign direct investment as companies in the G7 and elsewhere have tried to take advantage of China's low labour costs. By doing so, they have turned China into the world's assembly plant. Sixty per cent of China's exports and imports are today accounted for by so-called foreign-invested companies. Chinese manufacturing skills and Western talents in management and capital allocation have combined to lead to a more efficient allocation of scarce resources. China may be a one-party state, but the authorities certainly know all about Adam Smith and the division of labour.

Ironically, then, America's unease about China is, indirectly, the result of actions by American companies in China. Should the protectionist faction in Congress ever manage to impose tariffs on China, they would be very much shooting themselves in the foot: tariffs on Chinese imports into the US would be tariffs on the profits and economic success of American companies operating in China.

In purely economic terms, then, China's economic success owes a lot to investment activities in China by Western companies. Does that mean that the geopolitical tensions that may occasionally come to the fore amount to very little?

Not necessarily. China offers other challenges to US dominance. If China continues to grow, it will surely demand more of the world's scarce resources: oil prices are already high and they may go higher still. Other commodity prices may also end up rising further in the years ahead. China's success, therefore, increases the commodity bill for Western consumers and increases global competition for access to raw materials.

China, recognising this, may seek to make alliances with countries that, in Bush terms, are not with but against the US. This may come in two forms. First, China may be happy to do business with regimes that the US finds difficult to stomach (Iran is the most obvious current example). Second, there are plenty of countries who don't see the Western democratic model as either the most appealing or the most obvious model to pursue. Russia's wavering attitude towards the West in recent years is a good example: given its autocratic past - under either the Tsars or the Communists - and with roubles aplenty as a result of higher global oil prices, Moscow may regard China as an interesting alternative bedfellow: policies don't have to be made in Washington. China's strength not only changes its relative economic position vis-à-vis the US, but, through boosting the incomes of commodity-producing nations around the world, is making them think twice about their support for US economic and political hegemony.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com