These guys think China's economy is much larger

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As the world awaits China's third-quarter gross domestic product (GDP) figures on Monday, the accuracy of mainland data is once again up for debate.

A growing section of financial market participants and journalists has speculated that recent numbers might be painting a more flattering picture of the world's second largest economy than is the reality.

But according to research, China's economy is likely much bigger than official data suggest.

In a report published by research institution Center for Strategic and International Studies (CSIS) last month, Daniel Rosen and Beibei Bao showed that 2008 GDP was actually 13-16 percent larger than official figures, while 2013 GDP stood at $10.5 trillion rather than the official $9.5 trillion.

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What might explain this mismatch? The authors think the difference could be explained by how China calculates, or does not calculate, economic activity.

China currently measures GDP using the United Nations System of National Accounts standards set in 1993, which has a narrower coverage of services sector, while the bulk of developed nations use the latest standards set in 2008.

"At the broadest sector level, the hard to count services cluster is in greatest need of upward revision: 22.2 percent in our estimate," Rosen and Bao said. Services actually surpassed the industrial sector in terms of biggest contribution to GDP in 2009, not 2012 as official data now suggest, they added.

Perhaps most noteworthy was the fact that property—often labeled as one of China's top risks—led the service sector's upward revisions. The real estate sector was around 133 percent larger in 2008, "suggesting that GDP growth has been even more dependent on a property boom than previously understood."

The authors also pointed out key elements that aren't covered in China's official GDP, such as the capitalization of research and development (R&D) investment. "China does not publish value-added data for R&D, but according to our calculations, officials are underestimating R&D value-added by $6.5 to $154 billion a year."

So, what do these new calculations mean? China isn't doing as badly as recent headlines suggest.

The debt to GDP picture is less dire, gross output per worker is slightly higher, indicating better labor productivity and the energy intensity of GDP is lower than previously observed, Rosen and Bao explain.

So, is China going to upgrade?

At 2013's Third Plenum, Beijing did announce it would upgrade the national accounting methodology, scheduled to occur between late 2014 and early 2015, but the transition has yet be completed.

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"Notwithstanding the technical challenges of adopting a broader methodology, there may be other factors contributing to the delay, including the political importance of China's annual growth target," warned National Australia Bank economist Gerard Burg in a Thursday note.

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Upgrading to the current international methodology would increase the overall scale of China's economy, but it would also result in a slower rate of growth since additional economic activity would be coming off a larger base, Burg explained.

Indeed, CSIS flagged only a minimal boost to headline GDP if China transitions, stating that it will be harder to wring higher growth out of today's larger economy.

With global market sentiment already spooked by a surprise yuan devaluation and months of stock market volatility, Chinese policymakers are using every tool possible to reassure the world of the mainland's economic health so the revisions seems unlikely in the near-term.

"Given that an upgrade to China's growth accounting methodology could result in weaker growth, the upgrade may have to wait until after China abandons its growth target," Burg said.

But in the long run, an upgrade could pay off.

Embracing the latest methodology will bring about longer-term advantages, such as increased investment into previously undercounted sectors like R&D, according to CSIS. It could also boost international sentiment towards China. Upgrading to the latest standards will show Beijing's delicate economic rebalancing has progressed further than previously believed, Burg noted.