Streetwise Professor

A couple of interesting articles questioning the reality of Chinese growth.  One, from Forbes, homes in on something I’ve been saying: there is an extreme disconnect between China’s official growth statistics and another independent measure of economic activity, electricity generation:

China watchers have been dubious about the quality of Chinese economic data for some time. And a recent spate of seemingly conflicting data has fuelled that criticism.

One particular quibble involves the relationship between electricity usage and industrial value added — another measure of output. The worry is that failings in the way official data are compiled may be generating results that are giving investors misconceptions about the health of  China’s economy.

During the first half of this year, industrial value-added rose a robust 7 percent, while total electricity usage fell 2.24 percent. This seemingly implies that output is growing and contracting simultaneously. The divergence has attracted attention, not least because industry is half of the economy and electricity usage is one of those bits of data that is hard to massage. Even Chinese Premier Wen Jiabao has openly said that electricity usage is the data that he trusts most.

. . . .

China’s National Bureau of Statistics has posted a few articles on its website trying to reconcile the two sets of data. But their explanation — that China’s industries have become less energy dependent during the thick of the financial crisis — just does not stack up. [It sure don’t!]

The article focuses on the fact that Chinese government statistics are biased towards large, and particularly state-owned firms, and overlook small firms that have been major contributors to recent Chinese growth.  Here’s one example:

In a similar vein, the state-compiled Purchasing Manager Index consistently looks more bullish than a similar index compiled by brokerage firm CLSA this year. The two diverged sharply in March, when the official number was 52.4, indicting expansion; while the CLSA figure was only 44.8, which indicates contraction. The official index tracks mainly large state-owned firms while the CLSA index is more weighted towards small, private firms.

A relative in-depth analysis from the American Enterprise Institute reinforces these points, and adds considerable detail:

Make no mistake: China’s 8 percent growth target for 2009 will be achieved, almost by definition. Whether or not that is a healthy outcome depends upon how you look at it and upon understanding just how China’s economy functions and what China’s growth “accomplishment” means. Chinese economic data are constructed very differently from the roughly comparable U.S. statistics, so that looking at Chinese data through a lens conditioned by U.S. data-building and reporting conventions can be misleading.

. . . .

China’s 8 percent output growth target will be met because China’s economic statistics are based on recorded production activity, rather than being a measure of expenditure growth–defined as the sum of consumption, investment, government spending, and net exports–as U.S. data are. The U.S. stimulus package, for example, attempts to boost GDP by undertaking measures that will boost consumption, investment, and government spending. China, however, decrees measures that will generate recorded increases in production spending. Part of the Chinese stimulus package involves large transfers of funds from the central-government planners directly to state-owned enterprises and to fixed-asset investment projects that are aimed at public works spending largely under its control.

Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken.

The same convention, counting production and shipments as de facto outlays by end-users, is employed with respect to retail sales data in China. Shipments to retailers are counted as retail sales on the apparent assumption that ultimately all goods shipped will be sold at some point in the future. China’s nominal retail sales have been rising at a rate of about 15 percent year-over-year during the first half of 2009 because that is the rate at which shipments to retailers have been occurring. There is very little direct data available to measure actual sales by recipients of the retail shipments to ultimate consumers.

In other words, there is some stuff being produced, but no reliable evidence on whether it’s being consumed.  Moreover, some stuff is being counted as produced merely because the money to pay for it has been shoved out the door.  Hardly what one would consider high quality growth.  Or maybe not even growth at all.

John Makin’s AEI piece recommends looking at credit creation for an indication of how the economy is really doing.  In his view, the more credit the government is pumping into the economy, the more pessimistic they are about its true prospects and performance:

It is possible, however, to make inferences about the pace of demand growth relative to production or supply growth in the Chinese economy by watching the behavior of the central bank and its control over the growth of money and credit. If policymakers observe that demand growth and progress on infrastructure projects is lagging behind announced production-side GDP data, they can attempt to boost demand growth by increasing the growth of money and credit. Such growth has accelerated sharply during the second quarter in China, indicating that while the measured pace of China’s increase in production is rising, the public works projects and actual spending already recorded are falling behind schedule.

. . . .

It is the intensification of efforts to use rapid money expansion that serves as evidence that private consumption and private investment have remained weak even though they are difficult to measure since little data are available on such demand-side components of GDP. Meanwhile, as already noted, China’s export growth remains weak, with exports dropping at a year-over-year rate around 20 percent during the first half of 2009, after growth rates of 17 percent in 2008 and 25 percent in 2007. Having announced a stimulus package that will boost domestic demand in order to compensate for the loss of export growth on overall economic growth, China’s planners are not about to risk any cessation of the intense monetary stimulus currently underway. That said, there are signs that problems are emerging from China’s growth policies that amount to assuming that supply creates its own demand with the help of adequate monetary stimulus.

Those problems that Makin mentions in the last sentence include surging bubbles in real estate and stock prices.  These bubbles are being fed not just by domestic credit creation, but by substantial flows of hot foreign money into the Chinese market.  Makin notes that since February–a mere 6 months ago–housing prices in 13 Chinese cities have risen 13 percent, a 26+ percent annual rate.  This is a very rapid pace, even by the standards of the dizzying rates of appreciation in overheated US real estate markets in the mid-noughties.  The stock market has also risen by more than 70 percent.  Looks bubblier than champagne to me.

My takeaways?

First, reported Chinese growth is a chimera. Chinese government statistics appear no more reliable than Soviet figures. The disconnect between electricity generation changes and reported growth is highly suspicious, especially for a manufacturing-intensive economy noted for its energy-intensity as well. The focus on big state firms that don’t produce what people want, and the slighting of small firms that do, in the collection and reporting of statistics also raises red flags (and not of the Red Flag of Revolution! variety).

Second, Chinese growth reporting is eerily like 90s-style earnings management. There’s a target, and the numbers WILL be massaged in whatever way necessary to hit the target. Indeed, some of the tactics bring sordid episodes like Enron and WorldCom to mind.

Third, it seems that the Chinese are betting on a recovery in the West, and hence a concomitant recovery in exports, and are determined to keep up the earnings management and the credit stimulus until that happens. That is a highly risky strategy. If the desired recovery doesn’t happen before the bubbles collapse, China will face both a domestic demand and a foreign demand crunch. Moreover, even if “successful” in the sense that a recovery in exports allows the government to ease up on the stimulus, it will have contributed to a substantial misallocation of capital and created the risk of substantial inflation.

In brief, in my view, like governments around the world, China is taking an extremely short-sighted perspective. It is greatly increasing the risks of large future dislocations in order to palliate current problems. It may work, but the risks of things spinning out of control are appreciable.