This column originally appeared in Forbes
Debate continues about whether China can continue to pull the world out of its economic slump. Famous short-seller Jim Chanos continues to argue on Bloomberg TV and CNBC's Squawk Box that China's economic growth is illusory, a bubble ready to blow up a thousand times worse than Dubai's. He believes China's economic numbers are all fudged, the way the Soviet Union's were under Josef Stalin, to conceal true weakness. I wrote in
Debate continues about whether China can continue to pull the world out of its economic slump. Famous short-seller Jim Chanos continues to argue on Bloomberg TV and CNBC's Squawk Box that China's economic growth is illusory, a bubble ready to blow up a thousand times worse than Dubai's. He believes China's economic numbers are all fudged, the way the Soviet Union's were under Josef Stalin, to conceal true weakness. I wrote in"Why Jim Chanos Is Wrong: There Is No China Bubble" that such thinking underestimates how much the Chinese government has done to slow down the real estate market. Here's another reason Chanos is all wrong: The official economic growth numbers are not too high at all. They're too low.
Why? Because China's underground economy is far bigger than the 10% to 20% of the total economy that most economists estimate when they do their calculations. Politically the government can't admit that. A decade ago the U.S. Treasury estimated that 50% of Russia's economy stayed underground, evading onerous taxes. China's underground economy as a portion of the overall economy is at least as large as Russia's. Many company executives keep three sets of accounting records: one for official purposes, one for investors and one for themselves.
You cannot rely on the official numbers or those published by Wall Street analysts. Look at how China's National Bureau of Statistics revised China's 2007 gross domestic product growth from 11.9% to 13% in early 2009. Within days, all the big investment banks, such as Goldman Sachs, had revised their estimates upward too. Huh? How could all the analysts be wrong for more than a year and then suddenly within several days get new data showing that China's growth had increased that much? I take most numbers coming out of China and the investment banks with a grain of salt.
The reality is that China's economic growth is very real. After all, companies like McDonald's (NYSE:MCD), Intel (NASDAQ:INTC), Hewlett-Packard (NYSE:HPQ) and General Motors (GM( are reporting record sales there and investing billions more. They certainly are not fudging numbers for China's leadership. My firm, the China Market Research Group, estimates that GDP has been growing at 10% to 14% a year over the last decade, rather than the 8% to 10% most economists put forward.
That's why China felt so cold in the first half of 2009, when growth rates were in the 5% to 6% range. That's also why we believe most economists underestimate domestic consumption's role in the economy and inflate the role of exports, which account for closer to 20% of the economy than the 40% that many economists continue to use. (See my article "Three Myths About Business in China.")
It would be a mistake to bet against China's growth in the next five years, thinking its economy is weaker than it really is. There will certainly be ups and downs and corrections--notably in commercial real estate, where there is a glut of supply and the reliance on government investments needs to be reduced in favor of domestic consumption--but overall China will continue to grow. A look at how data and taxes are collected shows why many of the numbers analysts use for China are incorrect.
China's National Bureau of Statistics has some very intelligent people analyzing data. Many I know are world-class statisticians with graduate degrees from Harvard and other Ivy League universities. The problem isn't them, and it isn't undue central government interference (though there may be some of that at times). It's the data they work with and how it's collected.
Much of the National Bureau of Statistics' data collection is done by people who lost their previous jobs in the last decade's wave of privatizations. They go around to companies asking them to help fill out their forms, entering information on revenues, profits, number of employees, etc. They are not statisticians, and they are barely trained for a modern economy.
Many companies don't want to reveal to these people how well they're doing. They would rather appear poorer than they really are to avoid getting hit up for favors or outright bribes by local officials. Unlike the tax bureau, the statistics bureau does little enforcement to ensure he data it gets from companies is as reliable and truthful as possible.
The data collectors often make mistakes too. They frequently have to go back to businesses repeatedly because they've made errors filling out the forms or transferring data. If you've seen this numerous times, as I have, you realize that no matter how good the stats bureau people are at the senior level, they are dealing with unreliable numbers gathered by inept collectors from companies that don't want to share their information. I once saw a very pleasant, graying data collector visit the same company six times in three weeks, each time to fill out the same one form, because he kept making mistakes.
Public-sector data is also suspect. Some local government officials inflate their GDP numbers to prove how good they are so they can get promoted. The NBS discounts numbers because of that. But other local government representatives try not to report how much growth they have above GDP targets. Corrupt officials, of whom there are far too many, try to keep what they can for themselves, and many calculate that they'll do best by underreporting their results so they get more funds from central government stimulus packages. That's how you explain the presence of monstrously high skyscrapers rising from rice paddies and housing local officials' offices.
Look also at how tax is collected. That too makes the underground economy appear smaller than it really is. Most restaurants pay a flat monthly tax regardless of how much revenue they have. Obviously not all restaurants of a certain size and location generate the same money. But they all fall within a fairly narrow band in the tax they need to pay. As a result, some unsuccessful restaurants end up overpaying their taxes at least a little, while thriving ones wildly underpay.
Many of China's $36.6 billion e-commerce vendors, who operate largely through websites like Alibaba's Taobao, don't pay any taxes, nor do cash-only retail businesses. (See Robert Olsen's article "China's Migration to E-Commerce.") In real estate, sellers often underreport how much they sell their homes for by 5% to 10%, to reduce their taxes and get the rest paid in cash on the side or in overseas accounts.
Companies can also buy forged and real receipts. Real estate tycoon Zhou Zhengyi, who has been on Forbes' China rich list, was arrested in part for allegedly forging value-added-tax receipts. When you walk down the street, if you see numbers written on the pavement, you're often looking at ads for forged receipts or fake academic credentials.
Clearly revenues and profits are not adequately represented in China's official GDP numbers. It would be politically impossible for the government to say just how large the underground economy is without causing clashes among the responsible ministries. The government is, however, actively cracking down on receipt forging and tax evasion and is implementing new tax and receipt policies that will force cash businesses like restaurants to pay more based on their actual business results.
It is true that certain sectors in China's economy are overheating and that there are structural economic issues that need to be addressed. But predictions of doom and gloom in China by Jim Chanos and his ilk are largely exaggerated. China is no Dubai. The growth is real.