China’s Incredible Shrinking Economy

How big is the Chinese economy? Beijing’s National Bureau of Statistics reported that the country’s gross domestic product totaled $8.28 trillion last year.

Perhaps. Christopher Balding, an associate professor at the HSBC Business School at Peking University, thinks it’s more than a trillion dollars smaller. GDP numbers are supposed to show changes in a country’s output without regard to inflation or deflation. In an August 14th paper, Balding persuasively argues that the NBS grossly understates and underweights housing costs in adjusting nominal GDP for inflation to arrive at real GDP.

Balding builds on the work of Standard Chartered Bank’s Stephen Green, who was among the first to advance the notion that China inadequately adjusts its GDP for inflation. Green believes the country’s economy expanded only 5.5 percent last year—not the claimed 7.8 percent—once properly adjusted for inflation. “If there was an index for suspicion about China’s official statistics, it would be off the charts, or to use the technical American term, ‘crazy bad,’” the widely followed economist has written. Even Li Keqiang, before he became China’s economic czar this March, confided to American officials that his country’s statistics were unreliable, or “man-made” as he put it.

What are the consequences of the large downward adjustment in Beijing’s numbers? China’s official statisticians must be at least slightly embarrassed because Balding’s paper is devastating, exposing the obvious manipulation. Yet apart from the loss of their “face,” not much would seem to be at stake. After all, even with Balding’s correction, China retains its distinction of having the world’s second-largest economy, comfortably ahead of third-place Japan.

Yet the Green-Balding argument reveals China’s critical weakness.  When assessing a country’s economic condition, one of the leading indicators is its debt-to-GDP ratio, which measures a country’s ability to manage its indebtedness. With regard to China, there is wide disagreement as to the amount of debt that exists. Furthermore, there are questions as to what debt should be counted for this purpose. Yet putting these disagreements aside for the moment, China’s ratio, and its economic stability, appears substantially weaker when its GDP is adjusted downward.

This adjustment is important because the Chinese central government has been essentially buying economic output—in other words, creating GDP—with massive amounts of state spending. Premier Li has been trying to convince the global financial community that Beijing is no longer engaged in this practice, but this month he has, without announcement, begun implementing an “unofficial economic stimulus” by forcing state banks to lend to provincial governments.

China can continue creating growth in this manner as long as it is able to service the debt that is incurring, but concern is growing that the country’s “hidden obligations” threaten to overwhelm the country’s economy and trigger a crisis.

Beijing says its debt-to-GDP ratio at the end of 2012 was about 40 percent. That is considered manageable, but the real number is undoubtedly higher because Beijing excludes substantial obligations—and because it is inflating its GDP by understating inflation. Some believe the ratio, properly calculated, is actually north of 200 percent (America’s, by comparison, was a scary 102.9 percent at the end of last year). If Balding is correct, then the ratio is worse, and China is on the edge of a monumental debt crisis.

Clearly, China’s inadequate adjustment of GDP for inflation produces artificially inflated numbers, but there are undoubtedly other problems that result in the overstatement of GDP, such as the exaggeration of industrial production. If we knew what China’s economic output really was, we would better understand that the country is headed into a debt crisis from which it may not recover this decade.


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