How to understand China’s economy

Earlier this year, a report by Wei Chen, of the Chinese University of Hong Kong, and others claimed the country’s nominal growth figure for 2018 had been inflated by almost 2 percentage points. 

" A key issue with China’s GDP figure is its comparability with that of other developed economies, especially because of its lack of volatility.”

These studies were likely prompted by the well-known inconsistencies between China’s industrial output statistics and industrial GDP prior to 2007.

For a more thorough review, ANZ Research attempted to replicate the study conducted by Chen in order to obtain an estimate of China’s GDP figure. We note they used the growth in total tax revenues (which include VAT, income tax, and so on) assuming tax exemption or related supportive measures should increase corporate profits and hence income tax.

On average, during the 2011-17 period, the official GDP figures were 0.2 per cent higher than that implied by the total tax growth, suggesting the discrepancy was not systemic.

Given the structural changes that have been made over the past decade, such a discrepancy does not provide conclusive evidence of over-reporting of China’s nominal GDP.

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Different economies

A key issue with China’s GDP figure is its comparability with that of other developed economies, especially because of its lack of volatility.

China measures its GDP growth estimates using the production approach and in year-on-year terms. However the headline GDP figures of the US and Japan are annualised sequential rates.

Supply-side data are usually not satisfying because the short-term fluctuations mainly arise from the demand side, corresponding to the expenditure approach. Inventory adjustment, a key component of the business cycle, is missing in China’s GDP calculations.

Using the production approach also entails dealing with thousands of intermediate inputs.

Nonetheless, ANZ Research’s analysis suggests the level of fluctuation is still acceptable.

For example, the World Bank found greater openness to trade may expose an economy to more external shocks but make it less vulnerable to internally generated shocks.

China’s growth volatility, converted to the standard score, is still within the same range of other economies with similar levels of openness, as measured by trade as a percentage of GDP.

From this perspective, ANZ Research also sees no strong case that China’s GDP figure has been inflated.

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However, there are still issues related to transparency and disclosure.

China’s National Bureau of Statistics’ (NBS) seasonally adjusted factors and the quarterly GDP values after seasonal adjustment are not released to the public. Only the seasonally adjusted quarter-on-quarter growth rates are announced. The NBS has not published any detailed manual or technical note about China’s national accounts on its website (unlike its international peers).

More importantly, in contrast to the statistical authorities in other countries, NBS officials often go beyond the professional mandate of statisticians. For instance, the NBS spokesperson, during the announcement of China’s first quarter GDP figure, reiterated progress made in trade talks with the US. The impression given is the NBS is propagating the official message irrespective of the statistical truth.

Another well-known issue is that of discrepancies between provincial and national GDP growth figures. Gross regional product (GRP) estimates form part of the national accounts but are conducted by statistical bureaus within local provincial governments.

The methodology of GRP is similar to GDP but the identification of local economic activity is rather challenging.

Due to competition among local governments, there is an incentive to misreport the economic activities of large corporates in the various provinces. As a result, GRPs are usually double-counted and exaggerated. To rectify this issue, the NBS will take over the accounting of provincial GDP figures and produce GRPs on a consolidated basis from 2019.

Deflator concern

At the national level, ANZ Research’s concern is the real GDP growth rate.

It is obtained by deflating the gross value added of different activities by different price indices. For example, the industrial value added can be deflated by the producer price index (PPI). Fixed-asset investment price index and sub-indices of consumer price index (CPI) will be applied to construction and other activities such as catering or healthcare. However, price indices are not available for some of the services sector.

As substitutes, the sub-indices of CPI are employed as deflators. In addition, the real growth of some activities is deducted from volume extrapolation with appropriate volume indicators.

However, what matters is the real value added of service activities.

There are significant differences between the CPI and GDP deflator of the services sector. On average, the GDP deflator is 2.5 per cent higher than CPI before Q3 2017; subsequently, it is 0.4 per cent lower than CPI.

The inconsistent price information casts doubt on the recent strong growth in China’s services sector.

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More accurate

China’s headline GDP growth is not a preferred measure of growth momentum.

For instance, the headline GDP growth figures of the US and Japan are based on the expenditure approach while China uses the industry-based method. In the latter approach, applying the relevant price information for deflating is difficult, especially for the services sector, which is why many economies prefer to use the expenditure approach to calculate headline GDP.

All in all, ANZ Research believes China’s nominal GDP is relatively reliable. In fact, many indicators have a good correlation with nominal GDP growth.

Excavator sales, which are closely linked to infrastructure and property investments in China, have been included in the assessment of China’s business cycle from 2003, when the real estate sector started to increase in prominence. In spite of their seasonality, excavator sales correlate with nominal GDP growth.

A slight pick-up of excavator sales occurred in February 2019, suggesting a recovery in China’s infrastructure investment.

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As ANZ Research has mentioned in previous insights, the main threat faced by the Chinese economy is the risk of deflation which can easily drag the economy into a liquidity trap, similar to what Japan experienced in the 1990s.

This is especially relevant to China as it faces rising debt levels in recent years, requiring higher GDP growth to sustain its debt servicing ability.

Because of this, China’s nominal GDP growth figure is the preferred gauge of its overall economic health. In fact, many countries are considering switching to nominal GDP growth targets.

ANZ Research believes the nominal GDP figure will be more relevant than the real GDP growth figure in assessing China’s future policy reactions.

Zhaopeng Xing is a Markets Economist and Raymond Yeung is Chief Economist, Greater China at ANZ