Tuesday, September 1, 2015

How Worried Should We Be About China?

Outside of macroeconomics classes, the common worry about China is that their economy is big, and growing fast, and will soon be taking over the world … or something like that ;)

Macroeconomists are worried about something different though: how far off from reality are the official numbers announced by China. And, as a corollary, how bad is it?

We also worry about something called the middle income trap. This is the idea that while some countries grow from undeveloped to developed relatively smoothly (think South Korea), others seem to stall once they climb that ladder a ways (think Brazil). Macroeconomists are worried that China’s economy might stall before they become the biggest economy in the world. We really don’t know why economies stall, but a majority of them seem to.

So how does China look to a macroeconomist? The answer is: not great. China has certainly grown extraordinarily over the last 35 years. But the growth is uneven, both regionally and across industries. And there are a lot of warning signs.

As I write this (over several days in July 2015), the Chinese stock market has spent most of the last couple of months crashing. That’s kind of a big deal — more on this towards the end.

I’m not a China expert, but here’s some quotes from someone who is. This is from a post entitled “Considering the Veracity of Chinese GDP” from Balding’s World.

After China released above consensus GDP numbers showing 7% growth, many asked questions about the accuracy of Chinese GDP growth data.  Articles were written by The Economist and Financial Times, by both publications and journalists I respect, essentially arriving at the conclusion that the numbers are good faith estimates, aren’t perfect, can be considered generally accurate, and have the trend right.  I understand this line of thinking but I think this view point fails to grasp the depth of data manipulation that is being thrust upon the world in the world. 

The author then spends several paragraphs getting into the specifics of his own research showing that official Chinese estimates of home price inflation seem to be ridiculously low (I’m not too concerned that you digest all of that). Anyway, 10% inflation in the price of housing, in total, over 15 years, seems ridiculous just about anywhere.

But, recall that real GDP is not measured directly. It’s measured by counting up nominal GDP first, and then removing the effects of inflation. Remove too little inflation, and you’re left with real GDP growth rate estimates that are too high.

… China experienced some of the highest levels of money growth excluding high inflation states; while numerous countries had comparable or higher nominal GDP, China reports inflation levels over the 2000 to 2011 time period less than the United States and among the lowest of even all developed countries.  All of the Chinese real GDP story is dependent on low inflation data.

… To anyone who has spent anytime in China in recent history the question is simple: do you believe the price of renting an apartment has risen in urban areas by less than 10% since 2000?

It cannot be emphasized enough that this is not a rounding error or an accident …

However, it would be a mistake to think this type of behavior has disappeared.  Just this past February a major statistical change was made to GDP numbers that was only uncovered by researchers at McKinsey after numerous people, myself included, expressed surprise at the rapid increase in Q4 2014 consumption.  The NBSC went so far as to note that consumption data in 2014 was not comparable to previous years and this change was found only after inquiries were made by people questioning the data. 

The NBSC is the agency of the Chinese government that compiles macroeconomic data.

Revisions to macroeconomic data are common. The thing is, in other countries, no one does a revision unless it can be compared to previous years.

Throughout the years, China has been a serial GDP reviser with a non-exhaustive list of changes in 2004, 2008, and 2014 though it is quite possible there are others that are either public or non-public with all revisions making significant upward changes.  Furthermore, the NBSC has admitted that it has not standardized the data so almost any year to year comparison over more than a couple years is worthless.  In fact, even when back to back years are non-comparable due to methodological changes, there is no mention of this anywhere on the NBSC website.

This next bit is huge, but you have to put on your statistics hat for a bit:

There is also indirect evidence that Chinese data is less than accurate.  Let me give you two examples.  First, Chinese economic data has virtually no variance

I start out in principles of macroeconomics by pointing out that routine variation in U.S. real GDP growth rates is much broader than most people recognize, with a standard deviation that’s roughly 2%. That’s not 2% of the growth rate, that’s 2%, so that a plus or minus 2 standard deviation range (approximating a 95% confidence interval) is 8% wide. Normal U.S. real GDP growth runs from –1% to +7%.

Second, China is probably the fastest country in the world to release quarterly and annual GDP. … A mere 15 days after the quarter, China has such efficient statisticians that they have collected a sampling of data and crunched the numbers?  Makes you wonder why companies can’t release quarterly numbers in a few hours.

So what’s the truth?

When studying the Chinese economy, it isn’t enough to say we believe GDP or other data is wrong as we need to have comparable data that allows us to say with confidence what a better figure is.  … common sense should tell us that Chinese GDP growth is much weaker than advertised.

… Producing 7% more as a country and consuming only 1% more electricity would require a monumental shift in production techniques or industrial restructuring for a country of 1.3 billion people in one year.  …

… Look at trade partners where exports to China have absolutely collapsed across a range of products from consumer to industrial inputs and commodities.  Official trade data with imports declining 15.5% …

… absent the stock market boom, Chinese firms saw no profit growth.

Finally, I am always puzzled when I hear people talk about the “weak” Chinese economy when they turn around and talk about 7% growth.  The official growth estimate for 2015 has declined from only 7.1% to 7.0% but somehow this 0.1% has sent commodity prices plummeting, close trading partners like Singapore into recession, cause electricity consumption to flatten, and cars sales to evaporate.  …

Here’s what’s really scary:

Li Keqiang [the number 2 guy in China’s government] made his now famous remarks about GDP growth in the context that the data he received as a provincial leader was unreliable so he focused on measures that were more difficult to manipulate.  The risk here is that Chinese leaders and other interested parties are receiving manipulated data.  … If Chinese leaders are telling the world how poor the statistical agencies in China are, imagine the reality.

N.B. There’s a little bit of statistical jargon in Chinese economic data. The acronym YOY means “year over year”. It’s basically a growth rate for the last 12 calendar months, not this year’s 12 calendar months.


Now, what about that stock market boom and then crash? There’s a lot of evidence piling up that that the boom is coming about from lending money to buy stocks (you know … that whole 1929 thingie). Oh, and BTW, this article also notes that Li Kequaing forecast 7% real GDP growth this quarter, and lo and behold, the NBSC says the economy hit it exactly (you know … that whole no variance thingie).

And, the source is wonkie, but the Chinese government tried to rein in that borrowing and lending ( a lot of which is being funded by provincial governments), and failed. The scope of the problem was too large for the solution, so they are now implementing a bigger but more focused second plan that seems to be working better.

And China seems to have triple bubbles. Remember 2007-8 in the U.S., where we had one bubble in primary residential real estate? China has one of those, and it measures out at 3 times the relative size. Oh … and they have the stock market bubble (that seems to be deflating), and the credit market bubble (that the government seems to be trying its hardest to prick).

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