Originally published at China Financial Markets
Analysts are increasingly skeptical that China’s very high reported GDP growth rate provides a meaningful picture of the economy’s health. There are, however, at least three very different ways that reported GDP can fail to reflect the underlying economy.
The Chinese economy is not growing at 6.5 percent. It is probably growing by less than half of that. Not everyone agrees that the rate is that low, of course, but there is nonetheless a running debate about what is really happening in the Chinese economy and whether or not the country’s reported GDP growth is accurate.
The reason for the widespread skepticism is the disconnect between the official data and perceptions on the ground. According to the National Bureau of Statistics, China’s economic growth in every quarter last year exceeded 6.5 percent. While that is much lower than the heady growth rates China has experienced for most of the past forty years, it is still, by most measures, a very brisk rate of growth.
And yet, when you speak to Chinese businesses, economists, or analysts, it is hard to find any economic sector enjoying decent growth. Almost everyone is complaining bitterly about terribly difficult conditions, rising bankruptcies, a collapsing stock market, and dashed expectations. In my eighteen years in China, I have never seen this level of financial worry and unhappiness.
These concerns have even breached academia. One of my students told me yesterday that there was a huge increase last semester on the university website in the number of students selling their belongings because they are hard up for cash. They are selling their phones, computers, clothing, and lots of other possessions. He said the amount of selling is noticeably higher than last year, enough so that everyone is talking about it. And he indicated that this is apparently happening at other schools too. It seems that the poor and middle-class kids are squeezed for cash because they are getting much less money from home than they have in the past.
This isn’t what you’d expect to hear from an economy growing at more than 6.5 percent. So what does it mean exactly to say that China’s GDP is growing at that pace? It turns out that there are three completely different sets of problems that affect how China’s GDP growth statistics should be interpreted. Analysts must keep these three problems straight and make sure that they don’t confuse matters by conflating these separate issues.
WHAT DOES GDP MEASURE?
The first set of problems relates to the meaning of GDP itself. This challenge affects not just China but the rest of the world as well. This is especially true for advanced economies with substantial technology and service sectors that employ technology whose value may be substantially understated by an inability to count it accurately.
GDP is typically assumed to measure the creation of real economic value. If a country’s GDP rises by 5 percent over the course of a year, for example, this is interpreted to mean that the amount of wealth the country produced in the last year is 5 percent greater than in the previous year. In other words, it would be assumed that the country’s ability to service debt would have increased by 5 percent, which means roughly the same thing.
But there is no way to truly measure a country’s creation of real economic value, as GDP is just a proxy for whatever it is thought to measure. Economists have agreed which measurements go into calculating GDP, and the resulting sum is referred to as a country’s aggregate GDP, or the value of everything produced locally in that economy.
Of course, not all value-creating activities are counted when GDP is measured. For instance, if you teach your friend Spanish for free, you add to the wealth of the economy, but you do not add to GDP. By contrast, if he does pay you, the country’s GDP does increase by the amount of money you are paid, even though you are adding exactly the same value to the economy itself whether he pays you or not. In addition, not all measured activity actually creates value: building a bridge to nowhere, for example, creates exactly the same increase in GDP as building a much-needed bridge.
No proxy of economic value is perfect, of course, but there are real questions about whether GDP is imperfect to the point of being useless as a proxy. Does GDP really do a good job of capturing all the value creation in an economy? While this is a serious problem everywhere, it may be even more of a problem in China because of the huge amount of investment in nonproductive activities that is counted in China’s GDP data even though this investment does not add to the country’s wealth or its debt-servicing capacity.
HOW ACCURATE ARE CHINA’S GDP STATISTICS?
The second set of problems has to do with how carefully and faithfully Chinese statisticians at the National Bureau of Statistics are calculating the agreed-upon elements that go into measuring GDP. Do they tend to collect the data in the way that introduces mistakes that are systematically biased (upward, to show higher than actual GDP, I would assume)? Or are they actually lying to please their political bosses?
I am pretty sure that China’s economic data collection is distorted in ways that smooth out volatility, but otherwise I assume, at least until very recently, that the National Bureau of Statistics has followed generally accepted rules for calculating GDP more or less correctly. I don’t have a high level of confidence in my assumption though: as I pointed out earlier, it is hard to find any sector of the Chinese economy that is behaving the way you’d expect a country growing at more than 6.5 percent to behave. Furthermore, especially in recent years, it has been hard to reconcile other economic proxies with the GDP numbers. (See, for example, this article by Johns Hopkins University economists Bob Barbera and Yinghao Hu, which itself refers to a satellite imaging study.)
What is more, people whose work I greatly respect, like Anne Stevenson-Yang of J Capital, seem very much to doubt the data and argue that China’s actual growth rate is much lower than the posted numbers, largely because the data is falsified at some level of the collection process. But whatever the case may be, if there is indeed a substantial discrepancy between what the statisticians actually measure and what they are claiming to measure, it is very hard to make predictions about how long the overstatement will continue and how much of an adjustment it will eventually undergo.
IS GDP MEASURED AS AN OUTPUT OR AN INPUT?
The third set of problems with GDP occurs in a very limited number of cases globally (today, China is the main example). But the implications are much greater. This has to do with whether GDP is even being used as a proxy for economic activity. In China, reported GDP does not tell observers about the economy’s performance; rather, it tells people how rapidly Beijing thinks it can impose the necessary adjustments on the Chinese economy. This is because GDP means something different in China than it does in most other major economies.
In any economic system, GDP is supposed to be a measure of output, and in most countries that is exactly what it measures, however messily. The economy does what it does, in other words, and at the end of a given time period, statisticians measure the things economists agree to include in the relevant calculations, and they express the change over time as the scale of GDP growth for that period.
This is not what happens in China, where GDP is actually an input determined annually as the country’s GDP growth target. The growth target of a given time period is decided well ahead of time, and to achieve it, various entities, including local governments, engage in the requisite amount of activity, usually funded by debt. As long as China has debt capacity, and as long as it can postpone the writing down of nonproductive assets, Beijing can achieve any growth target it desires.
But this arrangement changes the meaning of GDP. Reported GDP in China is no longer a measure of economic growth, but rather a measure of political intention. As any systems theorist knows, input data reveals nothing about the performance of a system. So when analysts discuss what reported GDP indicates about the health of the Chinese economy, such thinking involves a very basic mistake in systems theory—a systems input can only offer insights about the goals of the operators, never about the performance of the system itself.
In practical terms, this means that once Beijing sets a GDP growth target, local governments are expected to generate enough economic activity to reach that target, and they are able to borrow as much as they need to do so. If this activity were productive, there wouldn’t be a problem, although it would be an amazing coincidence (or a truly incredible feat of prognostication) for the amount of productive activity truly to equal the growth target. What would be more likely in that case is that GDP growth would consistently exceed the target, which is indeed what happened until about a decade or so ago.
But if the economic activity isn’t productive, there are two requirements that allow China to set GDP growth as a systems input in a way other countries are unable to do. First, there must be no hard budget constraints, so as to allow economic entities to persist in value-destroying behavior year after year. Second, the resulting bad debt cannot be written down. Once these two conditions are met—and they are in China’s case—Beijing can set any growth target it likes and, as long as it has the necessary debt capacity, it can achieve that target.
But notice that achieving the target reveals nothing about the country’s real economic growth, for which GDP is supposed to be (however imperfectly) a proxy. Once GDP growth becomes a systems input, rather than an output, it does not indicate anything about the economy’s health or performance.
There is likely to be no end this year to the discussions about China’s economic growth rate and its relationship to GDP. By now, observers widely agree that China’s economy is not as strong as the GDP data suggests. And I suspect that only a handful of the least imaginative resolutely-mainstream economists (and, weirdly enough, this is more likely to be true of foreign than Chinese ones) still believe that China’s economy is as healthy and brisk as would be expected from a country whose GDP is growing at 6.5 percent and is expected to grow next year by more than 6 percent.
The problems facing the Chinese economy, and the worries expressed by Chinese leaders, are so deep that it no longer requires much imagination to figure out that reported GDP in China simply does not represent what we think it represents elsewhere. Yet some economists have not always understood the implications, and they often seem to refuse to adjust their methodologies to take into account the aforementioned problems with China’s reported GDP data. Yesterday, for example, I read a report written by an economist that discussed the implications of China’s PPP-adjusted GDP being the biggest in the world.
But any observers that are at all skeptical about the relationship between the Chinese economy and its reported GDP must dismiss the PPP-adjustment as almost complete nonsense. (I don’t mean that the PPP-adjusted data is less accurate for China than it is for other countries: I mean, quite literally, that it is almost complete nonsense). Any ratio based on reported GDP figures can only be comparably meaningful for China to the extent that China’s reported GDP numbers have the same relationship to the underlying economy—or to whatever GDP is thought to mean—as corresponding numbers in other countries do. But surely few observers still believe that.
The point is that if there has been a divergence between China’s reported GDP figures and the country’s underlying economy, there are at least three completely different ways that this discrepancy can manifest itself. Observers too often confuse the three, however. For example, I have said many times that I believe that if China’s GDP were to be expressed in a way that is comparable with that of other countries, it would be growing at less than half the current reported growth rate.
A lot of people interpret this to mean that I think Beijing is falsifying the data, but I don’t mean that at all. In my mind, the biggest problem is that China’s reported GDP is an input into the economic system, not a measured output. To make China’s GDP figures comparable to those of other countries, the input numbers would have to be adjusted with some relevant output, such as the amount of bad debt that should be (but isn’t) written down in a given time period. If this amount were subtracted from China’s nominal GDP growth rate, the resulting adjusted growth rate probably would be a lot closer to what economists think of as GDP than the country’s actual reported GDP data is.
Aside from this blog I write a monthly newsletter that covers some of the same topics covered on this blog. Those who are interested in receiving the newsletter should write to me at chinfinpettis[at]yahoo[dot]com, stating affiliation.
Correction: The original version of this article included the sentence, “In addition, not all measured activity actually creates value: building , for example, would create exactly the same increase in GDP as building a much-needed bridge.” The phrase “building a bridge to nowhere” was accidentally lost during the process of posting the piece to the website and has been put back in.