Edition: U.S. / Global

Economic Scene; Who Is No. 1? It's Hard to Say

By Leonard Silk
Published: July 27, 1990

WHICH country has the strongest economy in the world?

The question has assumed growing importance at a time when economic strength is perceived as the cardinal component in national power and when the industrial world may be dividing into three regions centered on the United States, Japan and a united Germany. Finding an answer involves complex issues of concept and measurement.

As measured by gross domestic product - the total volume of goods and services produced by a nation, within its borders - the United States still has the largest economy by far. United States G.D.P. in 1989 was $5.17 trillion, compared with Japan's $2.82 trillion and a united Germany's $1.5 trillion, at current exchange rates between the dollar, the yen and the mark.

But much of the difference is attributed to population size. With the American population nearly twice as large as Japan's and more than three times Germany's, America's per capita gross domestic product was $20,766 last year, less than Japan's $22,855 but ahead of united Germany's $19,230. These comparisons are misleading, however, because they are measured at current exchange rates, which have swung widely and are a poor indicator of the real value of money spent in one's own country. For instance, Japan is expensive for Americans earning dollars and the United States is cheap for Japanese earning yen.

To correct this distortion, three University of Pennsylvania economists - Irving Kravis, Robert Summers and Alan Heston - have developed measures of international output and income based not on exchange rates but on so-called purchasing power parities, which are conversion rates that equalize price levels among countries.

The Kravis-Summers-Heston data, prepared for the United Nations International Comparison Project, which compares income and output of various countries, show that Japan's per capita domestic product was only 75 percent as large as that of the United States in 1987, on a purchasing power basis. Commenting on that large gap, Herbert Stein, a senior fellow at the American Enterprise Institute, says, ''There is already so much paranoia about Japan in the United States that it seems to me important to get this comparison right.''

But measures of economic strength should be dynamic, and Japan has been steadily narrowing the gap with the United States. From 1980 through 1989, Japan's real gross domestic product, measured in purchasing power parities, grew at an average annual rate of 4.2 percent, compared with the United States' 2.6 percent. If those disparate growth rates continue, Japan's per capita gross domestic product in the year 2000 would equal 95 percent of that in the United States, and Japan would pass the United States by the year 2004.

In an article, ''Capital Investment: Key to Competitiveness and Growth,'' in the current Brookings Review, Ralph Landau of Stanford University examines the reasons why productivity has been lagging in the United States. He finds a high correlation between national growth rates of capital per worker and labor productivity. Japan had a growth rate of capital per worker of more than 8 percent and a growth rate of labor productivity of nearly 5 percent from 1964 through 1985, while United States gross capital per worker rose less than 2 percent a year and labor productivity less than 1 percent a year.

The Council on Competitiveness, a group of economists, executives and union officials, reports that in absolute terms Japan has overtaken the United States, with investment in new factories and equipment at $549 billion in 1989, compared with $513 billion by the United States.

Without basic changes in United States policy, Professor Landau concludes, ''The high cost of capital, greater uncertainty, inadequate savings and investment, increasing reliance on foreign capital in an open world capital market, and short time horizons by corporate managers and public policy makers will continue to gnaw away at the American standard of living.''

Further concern on that score emerges from the 1990 Human Development Report of the United Nations. A Human Development Index prepared by a group of economists ranks 130 nations according to life expectancy at birth, adult literacy and real gross domestic product per capita, measured on a purchasing power parities basis. The United States was 17th on the list - tied with Austria and Ireland - with a life expectancy at birth of 76 years, an adult literacy rate of 96 percent and a per capita G.D.P. of $17,615. The index rated Japan first, with life expectancy of 78 years, adult literacy of 100 percent and per capita G.D.P. of $13,135.

The low United States savings rate and chronic budget and trade deficits inhibit the strength of the United States in dealing with foreign and domestic problems and issues, compared with Germany and Japan. This may be no cause for paranoia but it certainly calls for a lot of soul searching.