Brief Follow Up to GDP as Misleading Indicator

I want to do a brief follow up to my piece for Bloomberg Views on why GDP misleading indicator when looking at the Chinese economy.  As usual, start there and come back here for additional detail.

I know that there is a vigorous debate about whether Chinese data is legitimate or not and if you are reading this, you’re probably very well aware of my opinion.  To this day, I do not understand how anyone can look at the headline data and say it is a good faith accurate representation of statistical reality.  Even most people who defend Chinese data anymore set a much lower bar of something like “well the directionality is accurate.”  Talk about an absurdly low threshold.

However, one of the things that has generally escaped notice is that even if GDP is perfectly scientifically accurate, it is a stunningly poor indicator of how we our understanding of the Chinese economy.  In other words, let’s assume for our purposes right here that it is accurate.  If it is accurate, do we understand and frame the Chinese economy well?  The answer is a resounding no.

The fundamental reason is that GDP is a non-existent measurement for quantifying the ability to pay for things.  Whether it is consumer spending or debt coverage, no one can pay for anything in GDPs.  I would encourage you to walk into a bank sometime, apply for a loan, and when they ask you for repayment ability tell them your cash flow is weak but your GDP output is high.  Seriously, try it sometime.

We assume that GDP measures are correlated with measures of economic activity and cash flow but in China for a number of reasons, this assumption, while not necessarily wrong is much much weaker.

For one reason, corporate China, where most of the debt is, has been dealing with long term deflation.  Consequently, while liabilities have been increasing moderately to rapidly their total revenue and revenue per unit have been flat to declining.  In other words, even if GDP is completely accurate, the weak cash flow growth of firms is even worse than the GDP growth making firms ability to service their debt even worse than the GDP numbers make it appear.  This is the problem with deflation but that is what is happening.

We even see this mismatch when looking at per capita GDP which is sued for a variety of individual focused measures not match the cash flow people have to spend.  Household income is on average 45% of per capita GDP and in some major cities like Tianjin, significantly lower than that.  If they pay in GDP’s, then many consumer measures look maybe stretched or excessive but not wildly crazy.  However, if we change to measures of income, the measures look decidedly excessive.

Again, my purpose here is not to revisit whether or not to trust Chinese GDP, but much more fundamental how do we use GDP, even if it is perfectly accurate, to frame issues like risk and consumption.  I would say, not very well.



2 thoughts on “Brief Follow Up to GDP as Misleading Indicator

  1. Professor Balding,

    First of all, thank you, as always, for this blog and for your dedication to both it and, implicitly, to your readers.

    As a high school economics teacher in Tianjin, I was interested to read the following:

    “Household income is on average 45% of per capita GDP and in some major cities like Tianjin, significantly lower than that.”

    Interested because:

    i) It’s always nice to see my poor little Tianjin – however disparagingly – get a mention once in a while in “China commentary” rather than “groovier” hot-spots such as yours.

    ii) Secondly, and more seriously, you note (quite correctly) the difference between “hard” and “soft” numbers.Take “income” as an example of a hard number.

    If we then take China’s GDP as the soft number – a statistic under a cloud and, furthermore, one even cloudier and murkier through (presumably and for a number of reasons, all of which are well-known to both you and to your readers) cumulative overstatement – then does it make sense, in principle, to state a hard number (income) as a percentage of a nebulous one (China’s GDP)?

    In other words, is any China-specific statement along the lines of “income as a percentage of GDP” a meaningless one (i.e., a percentage of what exactly?)?

    • Sorry for not getting back to you sooner, I’ve been playing catch up.

      1. My primary intent in highlighting this difference between per capita GDP and income. In many countries, per capita GDP is a good representation (not perfect) of how much money the average worker has to spend. However, in China it isn’t.
      2. By hard vs. soft I mean things that are easy to count. To take a non-economic example, a hospital can count how sick people are and how many dead peope there are. Quantifying how sick its patients are involves lots of subjective and difficult issues where as we know if someone is dead. Same thing with economic data. Now whether it makes any sense, fundamentally I would say no but pragmatically and realistically we typically need some type of framework or anchor. I would focus on hard numbers like cash flows but I do understand the instinct to base X as a percentage of GDP.

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