A few weeks ago, the WSJ announced that in the third quarter the growth rate of China’s economy had declined to 6.9% — the lowest rate since the financial crisis. Perhaps predictably, economist naysayers immediately piled on, questioning the accuracy of Chinese GDP estimates.
This recent skepticism is nothing new. In the 90s, the World Bank questioned Chinese economic figures, and since then, there has been a steady drumbeat in the press questioning the reliability of key Chinese statistics. So the conventional wisdom is that the Chinese numbers are bunk. Is this a great story or is this truly evidence-based conventional wisdom?
But what does the evidence say?
In a recent paper, “Broken Abacus? A More Accurate Gauge of China’s Economy,” Daniel H. Rosen and Beibei Bao attempt to independently measure the nominal size of China’s GDP. The authors make a strong case that perennial claims that Chinese data are fabricated are simply misguided.
Over the years, the Chinese have made great strides in bringing their accounting practices up to modern international standards. And while the role of political interests and a lack of transparency have created the perception that Chinese GDP is overstated, the reality may be just the opposite.
The authors reviewed data from 2008, and conclude that true Chinese GDP was between 13%-16% larger than state-sponsored statistics indicated at the time. Extrapolating these results, they suggest that China’s 2013 GDP was $10.5 trillion – ~$1 trillion more than official statistics indicate.
Where are the biggest discrepancies?
The authors find significant undercounting in the Real Estate sector for 2008, where they estimate official GDP understated Real Estate by a staggering ~2 tn RMB, accounting for 38% of the total GDP adjustment. The authors find that an underestimation in the value-added calculation, combined with a growing spread between construction costs and market values, have driven a downward bias for real estate’s share of the economy. It seems that China may be more dependent on its real estate markets than is generally believed.
The authors also find the contribution of Industry to GDP appears to be understated by ~1 tn RMB, accounting for 21% of the total GDP adjustment. This is driven by nuances of data collection and accounting methodologies, especially regarding depreciation data, and is exacerbated by downward revisions by China’s industrial statistical department.
Additionally, the inclusion of value-added from R&D activities, which is not included in official figures, has a significant impact on estimates of actual GDP. When the authors capitalize R&D associated China’s growing knowledge economy – patents, trademarks, knowhow – it represents an incremental ~1 tn RMB for the Chinese economy, or another 21% of the total GDP adjustment.
What are the implications?
There are numerous implications for these findings. Notably, a higher nominal GDP would suggest China’s debt-to-GDP ratio is a less pressing concern than is commonly assumed. A higher GDP also suggest higher productivity of labor, and better energy efficiency. It may be that the service sector in China overtook industry and construction several years earlier than many believe. Also, the impact of technology and innovation, particularly regarding financial services, is not fully reflected in official GDP estimates, although the Chinese are taking steps to remedy this.
Overall, China could be world’s largest economy sooner than is generally recognized, and the authors estimate that date could move forward a few years given a more accurate picture of GDP.
Back in September, the WSJ ran a piece in their Real Time Economics Blog, with the title, “What Do U.S. Economics Think of Official China Statistics? ‘Only a Fool Would Believe Them.’” The post consisted of a number of quotes from various U.S. economists.
In response to the question, “Do you think that China’s GDP statistics accurately reflect the state of the Chinese economy?” Allen Sinai, of Decision Economics, offered up this quote, “Overstate GDP by about 2 to 3 percentage points.”
How are we to reconcile this view with the work of Rosen and Bao, who suggest the opposite is true? They can’t both be right.
In 2013, China represented ~12.6% of the world economy. Clearly, China is an ever larger player on the international stage, and as a transitional economy it poses unique risks that are difficult to anticipate. When we are too quick to dismiss the possibility that China is larger than many think, we do so at our collective peril.
David Foulke is an operations manager at Tradingfront, Inc., a provider of automated digital wealth management solutions. Previously, he was at Alpha Architect, where he focused on business development, firm operations, and blogging on quantitative investing and finance topics. Prior to Alpha Architect, he was involved in investing and strategy at Pardee Resources Company, a manager of natural resource and renewable assets. Prior to Pardee, he worked in investment banking and capital markets roles at several firms in the financial services industry, including Houlihan Lokey, GE Capital and Burnham Financial. He also founded two internet companies, E-lingo, and Stonelocator. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.