GDP Management, Chinese Style

A couple of interesting articles questioning the reality of Chinese growth. One, from Forbes, homes in on something I’ve been saying: there is an extreme disconnect between China’s official growth statistics and another independent measure of economic activity, electricity generation:

China watchers have been dubious about the quality of Chinese economic data for some time. And a recent spate of seemingly conflicting data has fuelled that criticism.

One particular quibble involves the relationship between electricity usage and industrial value added — another measure of output. The worry is that failings in the way official data are compiled may be generating results that are giving investors misconceptions about the health of China’s economy.

During the first half of this year, industrial value-added rose a robust 7 percent, while total electricity usage fell 2.24 percent. This seemingly implies that output is growing and contracting simultaneously. The divergence has attracted attention, not least because industry is half of the economy and electricity usage is one of those bits of data that is hard to massage. Even Chinese Premier Wen Jiabao has openly said that electricity usage is the data that he trusts most.

. . . .

China’s National Bureau of Statistics has posted a few articles on its website trying to reconcile the two sets of data. But their explanation — that China’s industries have become less energy dependent during the thick of the financial crisis — just does not stack up. [It sure don't!]

The article focuses on the fact that Chinese government statistics are biased towards large, and particularly state-owned firms, and overlook small firms that have been major contributors to recent Chinese growth. Here’s one example:

In a similar vein, the state-compiled Purchasing Manager Index consistently looks more bullish than a similar index compiled by brokerage firm CLSA this year. The two diverged sharply in March, when the official number was 52.4, indicting expansion; while the CLSA figure was only 44.8, which indicates contraction. The official index tracks mainly large state-owned firms while the CLSA index is more weighted towards small, private firms.

A relative in-depth analysis from the American Enterprise Institute reinforces these points, and adds considerable detail:

Make no mistake: China’s 8 percent growth target for 2009 will be achieved, almost by definition. Whether or not that is a healthy outcome depends upon how you look at it and upon understanding just how China’s economy functions and what China’s growth “accomplishment” means. Chinese economic data are constructed very differently from the roughly comparable U.S. statistics, so that looking at Chinese data through a lens conditioned by U.S. data-building and reporting conventions can be misleading.

. . . .

China’s 8 percent output growth target will be met because China’s economic statistics are based on recorded production activity, rather than being a measure of expenditure growth–defined as the sum of consumption, investment, government spending, and net exports–as U.S. data are. The U.S. stimulus package, for example, attempts to boost GDP by undertaking measures that will boost consumption, investment, and government spending. China, however, decrees measures that will generate recorded increases in production spending. Part of the Chinese stimulus package involves large transfers of funds from the central-government planners directly to state-owned enterprises and to fixed-asset investment projects that are aimed at public works spending largely under its control.

Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken.

The same convention, counting production and shipments as de facto outlays by end-users, is employed with respect to retail sales data in China. Shipments to retailers are counted as retail sales on the apparent assumption that ultimately all goods shipped will be sold at some point in the future. China’s nominal retail sales have been rising at a rate of about 15 percent year-over-year during the first half of 2009 because that is the rate at which shipments to retailers have been occurring. There is very little direct data available to measure actual sales by recipients of the retail shipments to ultimate consumers.

In other words, there is some stuff being produced, but no reliable evidence on whether it’s being consumed. Moreover, some stuff is being counted as produced merely because the money to pay for it has been shoved out the door. Hardly what one would consider high quality growth. Or maybe not even growth at all.

John Makin’s AEI piece recommends looking at credit creation for an indication of how the economy is really doing. In his view, the more credit the government is pumping into the economy, the more pessimistic they are about its true prospects and performance:

It is possible, however, to make inferences about the pace of demand growth relative to production or supply growth in the Chinese economy by watching the behavior of the central bank and its control over the growth of money and credit. If policymakers observe that demand growth and progress on infrastructure projects is lagging behind announced production-side GDP data, they can attempt to boost demand growth by increasing the growth of money and credit. Such growth has accelerated sharply during the second quarter in China, indicating that while the measured pace of China’s increase in production is rising, the public works projects and actual spending already recorded are falling behind schedule.

. . . .

It is the intensification of efforts to use rapid money expansion that serves as evidence that private consumption and private investment have remained weak even though they are difficult to measure since little data are available on such demand-side components of GDP. Meanwhile, as already noted, China’s export growth remains weak, with exports dropping at a year-over-year rate around 20 percent during the first half of 2009, after growth rates of 17 percent in 2008 and 25 percent in 2007. Having announced a stimulus package that will boost domestic demand in order to compensate for the loss of export growth on overall economic growth, China’s planners are not about to risk any cessation of the intense monetary stimulus currently underway. That said, there are signs that problems are emerging from China’s growth policies that amount to assuming that supply creates its own demand with the help of adequate monetary stimulus.

Those problems that Makin mentions in the last sentence include surging bubbles in real estate and stock prices. These bubbles are being fed not just by domestic credit creation, but by substantial flows of hot foreign money into the Chinese market. Makin notes that since February–a mere 6 months ago–housing prices in 13 Chinese cities have risen 13 percent, a 26+ percent annual rate. This is a very rapid pace, even by the standards of the dizzying rates of appreciation in overheated US real estate markets in the mid-noughties. The stock market has also risen by more than 70 percent. Looks bubblier than champagne to me.

My takeaways?

First, reported Chinese growth is a chimera. Chinese government statistics appear no more reliable than Soviet figures. The disconnect between electricity generation changes and reported growth is highly suspicious, especially for a manufacturing-intensive economy noted for its energy-intensity as well. The focus on big state firms that don’t produce what people want, and the slighting of small firms that do, in the collection and reporting of statistics also raises red flags (and not of the Red Flag of Revolution! variety).

Second, Chinese growth reporting is eerily like 90s-style earnings management. There’s a target, and the numbers WILL be massaged in whatever way necessary to hit the target. Indeed, some of the tactics bring sordid episodes like Enron and WorldCom to mind.

Third, it seems that the Chinese are betting on a recovery in the West, and hence a concomitant recovery in exports, and are determined to keep up the earnings management and the credit stimulus until that happens. That is a highly risky strategy. If the desired recovery doesn’t happen before the bubbles collapse, China will face both a domestic demand and a foreign demand crunch. Moreover, even if “successful” in the sense that a recovery in exports allows the government to ease up on the stimulus, it will have contributed to a substantial misallocation of capital and created the risk of substantial inflation.

In brief, in my view, like governments around the world, China is taking an extremely short-sighted perspective. It is greatly increasing the risks of large future dislocations in order to palliate current problems. It may work, but the risks of things spinning out of control are appreciable.

Comments

[Ben Gee:]

The Chinese government is keeping an eye on every thing happening. Inflation is one of the most important. China will act swiftly if inflation is coming back. Whether Chinese data are accurate or not is not very important to the average Chinese citizen as long as their lifes are improving. If the bubble burst, things get cheaper, if property price dropped, to the people who want to buy, it may be a very good thing!

Aug 09 08:56 AM

[CautiousInv...:]

Even without these GDP accounting devices which permit illusions of growth, the Chinese would be able to achieve growth targets owing to the structure of their economy.

Approximately 40% of China's economy stems from fixed investment and that is controlled by state spending. With loans up 300% in the first half 2009 compared to the year earlier period, it is calulated 88% of China's growth has resulted from increases in state capital spending.

So, whether its through GDP accounting or the role of state spending, China will achieve its growth targets however illusory.

Aug 09 10:38 AM

[Alphameister:]

I'm no China expert, but I've seen an explanation for the seeming dichotomy between China's reported growth and its electricity usage that seems very plausible. It's no secret that China's electricity-intensive manufacturing/export sectors are experiencing a severe recession, so presumably China's current growth is coming more from sectors that depend less on electricity and more on such raw fuels as oil and natural gas.

Aug 09 11:40 AM

[Tony Daltorio:]

Another article quoting the nutty AEI who thinks America is always right and nothing the rest of the world does is any good.

Hey Craig, why don't you do an article on the phony American economic statistics. There's a treasure-trove of material there.

Aug 09 02:16 PM

[Michael Clark:]

Good article. I really don't think anyone questioning China's honesty in terms of economic propaganda is pro-American and certainly not anti-world. All government's lie when it suits them. But democracies have free press to try to make the governments look bad -- China doesn't have this.

I don't hate China. I don't hate every other nation in the world but America. I KNOW that the American government and business community is lying about many things, including business growth.

I also know (in my gut) that China is lying about their business growth. I'm living in Vietnam with my Vietnamese-American wife...and we are both shocked by the level of corruption in this society, top to bottom, and by the importance in this society of 'keeping face', of looking good, of hiding the truth if it makes oneself look better. The truth is not vital: but 'face' is vital. I'm sure China is similar.

Aug 09 03:56 PM

[dybydx:]

the author has a very valid pt that overall things doesnt seem to match. but someone need to find raw data to back this up from a bottom up approach to arrive at the final GDP figure.

for all we know, the value of USD has been rather unreliable as of late. 8% growth could just arise from translation (not because of RMB vs USD, but because of oil/copper vs USD).

Aug 09 10:07 PM

[expat in China:]

From April some time 2009 not my article!

"Chinese authorities have announced to pilot the way of direct power supply for 15 domestic electrolytic aluminum firms who can buy electricity directly from power plants.

Analysts point out that direct power supply would help electrolytic aluminum enterprises reduce production cost and improve their competitiveness on the international market. However, as the demand from downstream sectors is still weak, the aluminum price may follow the cost to go downward without the government's reserves, the analysts add.

More electrolytic aluminum enterprises will be covered in the new policy since they are large electricity consumers, according to China Non-ferrous Metals Industry Association.

The policy targets the industry's leading companies including five subsidiaries of Chinalco.

An analyst with CBI Co. said that direct electricity supply to electricity consuming enterprises from power plants, instead of via power grids, will help resume some suspended production capacities and therefore exacerbate the glut on the domestic aluminum market. Meanwhile, the drop of average cost may drag down aluminum price and squeeze profit margins of electrolytic aluminum enterprises.

Aug 10 03:27 AM

[Krishnendu ...:]

I read a lot about China & about their data, what do you think about Indian data. A 6.7% growth is not bad. But could the data have the same acceptability problem.
Your comments would be usefull.

Aug 10 08:30 AM

[Chinawatcher:]

I came across a rather interesting article ( bit.ly/info/NvibT ) that cites a reformist Chinese Communist Party official who is effectively blowing the whistle on other officials who fake GDP data - or ramp up the numbers artificially. I get a sense that that leaders in Beijing are aware of GDP manipulation at the regional/ and provincial levels - and are beginning to crack down on it...

Aug 10 08:30 AM

[Mudduckk:]

If it sounds too good to be true? It probably is. If I were to hedge my bets between the US and China on which economy provides more transparent data about its fundamental reality, it's 99% to 1%. I applaud the Chinese for adopting a market economy, but they still have a little problem with centralized control. This story seems to expose how that control contributes to threats within the China asset story.

Just like Japan found in the 90's, that it's closed incestuous Kerietsu culture was a major contributor to its own asset/RE bubble. And, just like the US found in its recent RE debacle, that its closed loop of perverse incentives made asset appraisers beholden to mortgage originators and bond raters beholden to CMO securitizers were prime contributors to our own bubble. Eventually China will have to reconcile itself to a power greater than itself.

This reminds me of a cardinal rule in street hustling; don't smoke the stuff you are selling. Before long you will lose all sense of reality.

Aug 10 09:44 AM

[secroot:]

our current administration stretches the truth about 10 times a day on all kinds of economic data----why are we bashing china----we need less free lunches for the administration and some truthful reporting here before we worry about china----our debt to china concerns me a lot more because i pay taxes

Aug 10 11:16 AM

[jdl51:]

For the past eight years our budget deficits didn't include anything the administration decided it didn't want on there. Iraq, Afghanistan, Katrina, etc. The new administration has put everything on budget to what you see is what you get. The past administration averaged $750 billion a year added to our national debt, yet some still quote the "official" number which is trillions less apparently thinking the people listening aren't that knowledgeable.

Aug 10 11:54 AM

[mna:]

I was looking forward to some concrete evidence of chinese data fudging. This article disappoints. Let me go over the points:
1) Electricity generation figures - this isn't new. However they already know the cause. It's mainly due to lower activities of high energy industries, like Steel makers. Do a little more reading of high quality journals.
2) The bias for large firms, and overlooking the smaller firms - this is even more ridiculous. Think about it. If the GDP figures are overlooking ANY part of the economy, whether big OR small, they're UNDERSTATING the figures.
3) The point of production vs consumption for GDP - this has more merit. However, It just means that the chinese GDP growth is reflected faster than the US figures. Unless you believe the chinese produce stuff to store in warehouses just to add to GDP figures, that stuff's gonna be consumed anyhow. It's a different measure sure, but not any less valid.

So far, no real backed up evidence. I WANT to be more bearish on China, but I need real and intelligent data to back it up.

Aug 10 02:20 PM

[geewow:]

Yes, China is betting on the US continuing to buy $1T in their cheap goods. This is the juggling act Obama/Bernanke/Geithner is having with the Chinese. If the US cannot buy $1T in goods, then they will not continue to buy $1T in Treasuries and other assets. They will begin to dump. Obama is having Bernanke inflate the stock market so consumers believe they can begin spending again. This is a head-fake. Obama is trying to convince China the US is recovering enough for their satisfaction.

China is over produced and over stocked. They don't really care. They hope then that they could sell the stuff domestically. They could sustain such a policy for several years before their economy falters and slows with unemployment and more.

eye-on-washington.blog...

Aug 10 07:23 PM

[george archers:]

Almost everything you touch(manufactured Goods), has a made in China label. On a major water pipe road installation,I found all the cast rings and parts-MADE IN CHINA.Wake-up Crigie,The chinese work for their living--some 7 days/12hrs .They don't depend on USA shoes, pants,shirts.
The biggest problem china has--Americans are bluffing,they ain't going to pay the debt owing-never. Americans have been living on free lunches.the chinese are smart,they have set a trap(just like an animal trap) free bait food. Americans have been caught--not dead yet.Wait until the chinese refuse to sell any goods to Americans--Shoes--$200, Pants $150, Socks $20 ect.
It seems that Craigie is forgetful--If you teach a man to fish,he can feed himself for life. Americans only know how to feed themselves :^/

Aug 10 09:24 PM

[sinolize.com:]

There may well be data quality issues with China's statistics, but drawing a conclusion just based upon the GDP vs electricity consumption is grossly wrong. If you look at the change of composition of China's GDP, it is not difficult to see that energy intensive industries contribute less and less to the GDP, as compared to the service and high tech industries.

Aug 12 10:18 AM