Brusca: China's 'Truth' and Consequences
Is China’s real GDP really growing by 7.6 percent in the second quarter? How would we know? In every country we take the word of the domestic statistical agency. Yet some skepticism attaches to China’s word these days.
It is not as though China is being singled out. US energy giant Enron cooked its books. Greece, got help playing hide and seek from the facts using Goldman Sachs’ advice, and hid a pile of its debt to join the European Monetary Union. Bankers have long come to mistrust official data when they make lending decisions in the international realm. But how do they pick and choose who to believe?
China is an interesting case simply because it is so darn big. Also China is a country that has not built its economy up on trust and openness. It mistrusts its own people. It uses repression. It suppresses information. It harbors counterfeiting. It does not protect international copyrights. And yet some American economists have treated Chinese data as though it were a gold standard along with Chinese policymaking. Curious…
"They know what they are doing," one well-known US economist said as though we in the West do not. China’s job in trying to understand its economy is huge. To begin with it has no accounting framework since China is a communist country and left to its own devices there is no need for western style "for profit" accounting. Much of the economy is directed—certainly the banking sector. Of course as China has "opened up," more firms have migrated over toward less antiquated standards. But China’s growth is huge; its breadth is huge, why would anyone think it has a good handle on all this? We hear complaining each month in the US about the birth-death model in the Labor Department’s payroll survey. Well, firms die and are born. In an economy like China’s it must be a vast problem. Yet, in the US the attempt to model this behavior of firms that are so new the data collectors don’t know about them and others that used to report then fall strangely silent has become an issue of mistrust. In reality it must be 100 times worse in China…where the skeptics are silent.
But, what began to really incite widespread skepticism was China’s reporting of strong GDP growth along-side data on plunging electricity use. Provincial Chinese GDP numbers sum up to more than the total for national GDP. The head of the national bureau of statistics has admitted to some double counting of industrial production. Clearly, China has issues. But does it have technical issues or are its figures purposely distorted?
At the end of August (2012) the NY Times published an article saying that China had mounds of goods piled up in inventories that were not being reported.
The Times claims that:
The severity of China’s inventory overhang has been carefully masked by the blocking or adjusting of economic data by the Chinese government — all part of an effort to prop up confidence in the economy among business managers and investors.
There is no easy way to confirm any of these claims. But we can use a simple tool: logic. China’s economy has been boosted by the growth in external demand. In the data that the OECD saw fit to print (up to only 2006!) private consumption’s share of GDP was at 46% and some say it is now under 40%; compare that to 71% for the US, 58% for EMU, and 60% for Japan. What it tells you is that China’s growth depends on growth overseas. Industrial output in the West was growing at 3% to 4% before the global recession; it is now closer to 1%. GDP growth in China’s main markets is down to under 1.5% after being close to 4% in the US, EMU and Japan before the financial crisis. Yet, China’s data still have GDP sailing along at 7.6%. Believable?
What is unbelievable about that is that US had been pressuring China for years to let its currency appreciate and to nurture domestic demand. China has refused. China has been running vast trade surpluses. China did not want to shift to a model of domestic-led growth. Instead, by 2006 the share of investment in China’s GDP ramped up to over 56%. China was doubling down on its growth model and investing even more in export-led growth. Then the financial crisis hit. China has invested for the wrong world environment; that investment will now not pay dividends and will become a dead-weight loss of bad debt.
In the aftermath of this crisis the world has changed to China’s detriment-yet it continues to post strong growth figures. It’s illogical. It continues to report ‘solid’ GDP numbers as target markets’ growth has dried up (US, EMU and Japan). It is no longer able to ram exports out in defiance of US or European official protests because US and European consumers are too indebted and too unemployed to continue to absorb these exports. It is no longer a matter of policy conflict. Real world, economic conditions bite. And now after delaying and protesting it cannot switch its export model on a dime.
What China must do is to develop domestic consumption. To do that it must pay workers more so they can consume. To do that it must let its competitiveness fade. This process has only barely begun. So how has China kept its growth up? The Times article suggests that China is still really cranking out the output on its old model- it’s just not selling it anymore…and that is frightening enough. In a capitalist economy rising inventories would signal factories to slow output. But this is crony-communism. Firms have targets and continuing economic growth is the way to keep the cauldron of unrest from bubbling over.
So you can believe what you want. I am very skeptical about China. It has a lot of work to do. As it is we have enough data inconsistencies, enough reports of improprieties and China has enough of a legacy of distrust to warrant being very wary of what its official data say. Unofficially China is in a deep funk and faces some severe problems that could mushroom in the coming years. Its renewed bellicosity with Japan over the disputed chain of islands may well be a foreign policy maneuver to deflect attention from its economic failures. And that is even more chilling because there is more to come.
—Robert Brusca Ph.D. has been an economist on Wall Street since 1977. He is now Chief Economist for FAO-Economics in New York City.