As I have covered here many times, the entire claim that the Chinese economy is growing at 7% and of a remotely successful rebalancing depends on the argument that the Chinese service sector is expanding rapidly enough to offset the widely recognized decline in manufacturing and industry. However, when people discuss the services sector, most especially with regards to China don’t understand one important service sector component and the implication of one component that is recognized as a service sector component. I should note I plan to do a much longer post on this with lots of data for comparison but for the moment just give a short sample.

The first mistake people in discussing the “service” sector is not realizing that real estate is included in the so called service sector. In must be emphasized that this is standard the world over and not in any way unique to China but many people do not realize that when they talk about the growth in the “service sector” they are including very hard production and the upstream industries in this classification.

The second mistake is in how we understand an industry that while recognized and appropriately classified as a service industry has a very large caveat due to “Chinese characteristics”. Financial services are widely recognized as a service but there are two important factors which imply we should at least recognize the unique nature of arguing for a healthy economy due to service sector expansion. First, financial services still derive the vast majority of employment, assets, and revenue from the major SOE commercial banks. Second, these banks give out the large majority of their loans, by some measures almost 90%, to old industry firms that are facing large declines in revenue. In other words, the financial services industry growth has come from the credit boom of traditional banks channeling money to old industry firms.

As the Financial Times EM Squared team notes, if we strip out financial services from the tertiary sector, services have actually declined since 2000 and relatively significantly by probably at least 5% of GDP. Even if we look at other services, service sector contribution to GDP excluding finance is near all time lows. In other words, any rebalancing has come from the service sector feeding capital to old industry declining firms not from the growth of new firms or organic growth in services.

The numbers bear this out. While listed A-share operating revenue for financial services and real estate has grown 17% and 31% annually for the last three years, wholesale and retail operating revenue grew at a mediocre 4% annually over the same time period. That is the complete opposite of rebalancing.

I want to strongly re-emphasize that there is nothing here out of the ordinary in how things are classified officially. What does need to be recognized are what exactly is considered a service sector industry and their dependence on old declining industries. If we account for that, the picture looks decidedly different.

Perma-pandas have pretty much abandoned making the argument that the product economy is growing any where near 7%. Even in a relatively data hungry economy like China, there is simply way too much data indicating that product output is essentially flat. From consumer to manufacturing or commodities, domestic product output is essentially flat in China and imports are collapsing. This is based upon a variety of granular level indicators that I have covered here and elsewhere.

Never discouraged in their quest for the mythical 7%, perma-pandas now argue that service sector growth is driving total GDP growth in China. There are numerous problems with this argument from the factual to the theoretical. First, the perma-panda argument is relying exclusively on top line official data that the service sector. Top line official data is very questionable and especially the supposed shift in GDP structure in recent history. As noted recently here, a wide variety of service sector industries were averaging revenue growth in the low to mid-single digits that began at the latest in 2014, despite official data showing a shift to the service economy. Oddly, even the perma-panda data fails to indicate an increased share of services in the GDP basket despite their argument for its importance.

Second, if we exclude top line official National Bureau of Statistics data, there is simply no evidence of rapid service or consumption growth in the Chinese economy. I want to be clear on this point that service growth does not appear as weak as product output, however, most evidence indicates it is only growing in the low to mid-single digits. I have already addressed certain areas like transportation and telecoms which using year over year year to date growth, are experiencing weak growth. Telecom services appear to be suffering small declines with provider revenue mirroring this change. Transportation and freight appear to be essentially flat, though due to methodological changes in data counting, which have never been explained publicly, passenger numbers between 2013 and 2014 dropped significantly. Consequently, while we cannot extrapolate further than one year, the year over year and year to date passenger numbers are flat and are comparable.

Most recently, I have downloaded data on data related to medical and health services. If the supposed boom in services is happening, it certainly isn’t happening in Chinese health care. Visits to medical institutions, hospital visits, and primary medical facilities are growing at 2.98%, 5.40%, and 1.56% respectively. If Chinese consumers are going to consumer a higher level of health services or consume health products, it is an absolute pre-requisite that their visits to health institutions increase. Furthermore, while I did not test for this econometrically, given the continued aging of the Chinese population, a small increase in visits to health care providers is expected.

Medicine output, both western and Chinese tells a similar story, with a caveat. Traditional Chinese medicine year to date total monthly output is down 15.1%, though this decline is due largely to slowing production in July and August. Through June traditional Chinese medicine output was essentially flat registering a miniscule 0.59% increase. While the year to date number for raw chemical medicine output at the end of August was a distinctly more robust 17.5%, this number comes with a significant caveat. For some reason, this number goes through large intra-year swings. If I reported the number as of June, it would come in at a much more moderate 3.8%. Looking back over the past few years of this category, it is prone to large intra year swings that will move between significant YTD increases and then back to small declines. It is likely that the 17.5% growth will not continue for the rest of the year.

If health services consumption is going to rise we should see higher levels of hospitals, medical institutions, and primary medical facilities. It defies logic that health care service utilization would rise but visits and basic medicine use would grow slowly or fall. Correlated with that, we would expect to see increased primary and Chinese medicine consumption. While neither visit or basic medicine growth is negative, neither are they robust even in the mid to high single digit range, with the noted caveat about the August spike in raw chemical medicine. Low to mid single digit growth in specific health services that would be a comprehensive indicator and consumption that would be strongly correlated with higher health service usage, simple do not indicate the growth necessary to rebalance the economy.

Third, perma-pandas are confronting the laws of mathematics in attempting to defend the increasingly elusive 7%. Let’s take a slightly stylized version of the Chinese economy. Assume they have a 50/50 split between production and services, which isn’t exact but close enough for our purposes. Now let’s assume that production is growing at 2%. It is hard to find any output growing that fast, much less all output, but let’s assume that for the moment. For the remaining 50% of the economy to push total GDP growth to 7%, that would require the service sector in aggregate to grow at, in our somewhat simplified version of the Chinese economy, a total of 12%. So far, if we exclude top line NBSC data, I haven’t been able to find any service sector growing at double digits much less the entire service sector using key metrics. I am not the brightest guy around but I struggle to see how health service provision and consumption can increase in double digits when visits and medicines are growing so much slower. I fail to see how telecom services can positively contribute to service sector growth when virtually all its components are negative. Service and consumption need to grow significantly faster than 7% to push the entire economy up to 7% given the acknowledged slowdown in output and it simply is not merely a flesh wound.

I want to note on specific caveat about the data I am producing as I go through various sectors of the Chinese economy focusing on consumption and services. The metrics I am using, such as hospital room and primary health care institution visits, are imperfect metrics in the sense that are not perfect substitutes for their respective components of GDP in health care service provision. However, they absolutely should be closely correlated with the respective components of GDP. Telecom service provider revenue is again an imperfect measure of telecom services GDP, but when the official statistics claim 23% growth and service providers are declaring flat revenue, this raises serious questions.

I will continue to search for data in various service industries however, having covered transportation, hotel and catering, telecommunications, and now health care services, the granular industry level data simply does not support the story of rapid service sector growth in China. Despite repeating it over and over, there is simply no underlying evidence that service sector growth is rapid enough to make up the difference in flat production output to turn China into a 7% GDP growth country.

Note: Data from the post cited can be downloaded here.

1. There is an argument being advanced that the Fed being concerned about emerging markets (read China) opted to hold off on raising interest rates. I actually disagree with this interpretation of events but understand the logic and reasonableness of the argument. I believe instead that the Federal Reserve Board looked at inflation and potential background pressures and opted to leave rates unchanged. While I personally would have voted for at least a 0.25% increase, even the most devoted inflation hawks have a tough time making the case that inflation is rising or the background factors are mounting to spur significantly higher inflation. In short, I believe the Fed looked at the US and doubted the size, strength, and speed of potential inflationary pressures existed to necessitate a rate hike. I mention all this because I want to pass on a market rumor I heard from a couple of unrelated people. The rumor as was told to me was that the August 11 devaluation was a warning shot to the Fed to keep rates unchanged or else the PBOC would let the RMB drop a lot more. I am not ready to believe it but at the same time, it isn’t easy to discard. Here is why. First, if China was hoping to use RMB devaluation to increase exports, 3% is not nearly enough to offset domestic and international currency pressures needed to make Chinese exports competitive. Second, despite China saying this was a move to introduce market pricing, virtually every day since August 11 has seen market pressures on pricing ignored. This was not about market pricing. Third, as I have noted numerous times, the biggest change was the introduction of fear into the RMB/$ peg. In short, as many people noted early on, any economic rationale for the PBOC action was weak at best leaving watchers with a puzzle to try and explain the movement. Again, this is just a market rumor that was passed on to me by a few people and I am passing it on to you.
2. I know one thing that is difficult for many to grasp, especially those who do not delve into the bowels of Chinese data, is why I am so skeptical of Chinese data. The simple answer is that the data is so obviously inconsistent because it does not reconcile to itself by a large margin. However, even trained China data watchers, especially those who believe the only thing wrong with China data is a lack of transparency, make this mistake. As a simple example, China data day dream believers will acknowledge questions about GDP data and then use other topline official data to demonstrate their point as if the NBSC will have any trouble massaging those data points. Even this data is obviously problematic. Let me give you an example I just discovered the other day that cuts directly to the heart of the argument that services are rebalancing the Chinese economy. In the monthly data at the National Bureau of Statistics China under the Postal and Telecommunications Services section, the Telecommunications Services is credited with year over year growth of 27% and accumulated year to date YOY growth of 23.2% supporting the shift to services argument. Pretty solid numbers. However, looking beneath the surface at the components of telecom services growth the numbers tell a radically different story. The YTD YOY growth in telecom component services reads as follows according to the NBSC: local calls volume fixed line including IP -12.6%, length of long distance calls of fixed line including IP -7.6%, length of call mobile telephone -1.9%, number of fixed line subscribers -6.5%, urban fixed line subscribers -2.7%, rural fixed line subscribers -15.1%, mobile telephone subscribers 2.6%, 3G mobile phone subscribers -4.7%, SMS services -4.7%, and broadband subscribers 4.6%. All these components produce an unweighted average growth of -4.9%. The underlying component results closely match the revenue results from China Mobile reporting 0.5% telecom services revenue growth (PDF) and China Unicom revenue growth which actually declined slightly 1H 2015 on a YOY basis. There are a few final points. First, I have absolutely no idea how the NBSC arrives at 23.2% YTD YOY growth when all the components are huddled around 0 with a few witness low to mid-single digit growth. I am not even going to guess. Second, this undercuts the argument that China is shifting to a services based economy. Third, firms do not live off of manmade GDP but on the revenue from selling those services and it is clear that firms are not witnessing the supposed rebalancing or GDP growth in services the NBSC and perma-pandas believe exists.
3. Many perma-pandas that argue GDP data is accurate have also tried to argue that services are an increasingly important part of GDP growth. However, their own writings contradict this positive assessment. Nicholas Lardy at the Peterson Institute writes a blog post entitled “Retail Sales Numbers are Not a Reliable Indicator for Consumption Expenditure” discussing China retail sales and data. What makes this post so unique is that Lardy supposedly believes that consumption is one of the additive components of GDP, believes that consumption data is inaccurate, but also believes that GDP data is accurate. I’m not going to even try and explain that contradictory logic but instead focus on what his data says about services. In his post on retail sales data and services in China, according to Lardy figure 1 and figure 2, services as a percentage of urban household consumption expenditure is virtually unchanged since 2005. Rural household service as a percentage or household consumption has increased from the mid-range estimate only slightly by approximately 1-2% since 2005. That is not the great rebalancing of the Chinese economy perma-pandas are arguing for, that is the balancing of the Chinese economy. Just to recap what Lardy is arguing: consumption data is inaccurate and can’t be believed but GDP should be believed and that services is rebalancing the Chinese economy when his own data shows the opposite. Perma-pandas keep making arguments with a complete lack of data, data that shows the opposite, or official headline data with underlying component data that shows the opposite.
4. The China Beige Book report on the Chinese economy is getting some good play but the headline being used is “pessimism is divorced from the facts”. The actual report which I have read is distinctly more nuanced than that. For instance, they write that “those touting China’s sudden fragility are either exaggerating current problems or have entirely missed the slowdown of the past several years.” They go on to note that while growth is slowing “no collapse is nigh.” They note that revenue gains in the service sector has been modest. I would say in general this is a reasonable assessment of the Chinese economy, as most of the data I have been covering indicates very low levels of growth and that there is no collapse. However, even the Beige Book analysis does not indicate a rebalancing. A rebalancing necessitates that service and consumption outpace other sectors of the economy. Right now all evidence, excluding topline official data, indicates that the consumption and services are growing at best slow to moderately and definitely not enough to shift the structure of the Chinese economy. Even the Beige Book is not arguing for a rosy economy picture.

1. So the Fed has opted to leave rates unchanged and one of the primary, if unspoken, reasons is the global slowdown brought by China. The global slowdown has China at the epicenter through a variety of channels such as reduced demand and prices for commodities which results in lower growth primarily in other emerging markets and downward price pressures. China should be sending Janet Yellen a fruit basket this morning because any raise, would have placed even more pressure on the RMB/$ peg. There is an important distinction here that needs to be made. While the Fed keeping interest rates unchanged does not raise the pressure on the RMB, it certainly does not lessen it. Despite the PBOC assurances, capital continues to flood out of China and show no signs of falling. Just yesterday there was a story that outbound investment from China was on pace to hit $1 trillion USD for the year. I generally view internationalization as a positive. Just keeping up this pace will place enormous pressure on the RMB as foreign investment in China definitely isn’t keeping that pace, with many categories falling, and the trade surplus is not enough to offset the difference. In other words, the RMB will remain under pressure and the Fed should be receiving fruit baskets from the PBOC for not turning up the pressure.

2. There is a question I’ve seen arise in both explicit and implicit ways that I believe needs some exploration. Many have noted that capital outflows are not related to economic growth. That is generally true but the truth is more complicated and indirectly untrue in keyways. Let me explain. First, Chinese investors are telling you what they think of the Chinese economy. There is a dearth of good investment opportunities in China. Falling credit quality, deflation in producer prices, surplus capacity in a range of sectors, coupled with an awful investment climate do not inspire confidence in even Chinese investors despite calls for unity and national pride. Second, capital outflows are placing downward pressure on the RMB. That is going to require an implied tightening to maintain the RMB/$ peg which would require secondary loosening. If a devaluation would take place, this would reduce consumption and have minimal impact on exports unless the devaluation was sizeable. Third, an enormously under appreciated part of the China growth story for the past decade or longer was how the money supply simply exploded whether through sterilization of trade surpluses or credit. Chinese M2 growth lags only serial inflators like Russia, Turkey, and Argentina in the past decade despite reporting some of the lowest inflation among all major emerging and developed countries in the world. Reducing the money supply will have an enormous impact on Chinese growth. Fourth, capital outflows will place enormous stress on Chinese financial institutions. Any drying up of liquidity, will place significant stress on institutions with high levels of short term loans that they need to roll over. In other words, while yes capital outflows have no direct impact on GDP growth, the reality is decidedly more nuanced and does have significant indirect impact.

3. What is interesting in the debate over the quality of Chinese data and attempting to ascertain the true state of the economy is to watch people hear what they want to hear and disregard the rest. Bloomberg has released a short paper on its opinion of the quality of Chinese data and economy writing that “naive suspicion of China’s growth rate based on a limited set of industry-related indicators is misplaced.” They note that the “default” position of many market participants now is to doubt official data using electricity consumption as an indicator of Chinese GDP growth. They go on to cite perma-panda Nicholas Lardy that consumption and services is holding up well because, movie box-office revenue is up strongly this year. So apparently, replacing electricity growth with box-office revenue is not narrow but an acceptable use of data analysis. The bigger problem with this analysis is it is willfully overlooking enormous amounts of data that has been produced about the Chinese economy. Whether it is retail sales or output data, including consumer products and significant amount of services, Bloomberg is simply choosing to ignore quality work that has been done by a variety of people demonstrating weakness in the Chinese economy and the major discrepancies between top line official data in the granular data underneath it. There are three final points worth noting. First, Bloomberg is flat out wrong on one specific point of fact according to the data I downloaded from Wind. They write that “gains in passenger volumes are robust.” Based upon the data I downloaded from Wind on passenger volumes and distances traveled, this is simply false. Second, Bloomberg and Nicholas Lardy not only provide virtually no evidence to support their rosy scenarios, they fall prey to one of the class blunders in economics: the lip stick fallacy. Lardy and Bloomberg cite rising movie box office sales as proof that consumption and services are strong. However, economists have long noted the relationship between the increase in “affordable luxuries” during economic downturns. It is frequently referred to as the lipstick effect as consumers increase their purchases of affordable luxuries compared to bigger spending items. Think lipstick compared to a new purse. Third, Bloomberg and Lardy rely completely on official NBSC data to support the argument that consumption and services have risen as a percentage of GDP. Given the enormous discrepancies we know exist between underlying data and headline in these areas in the past few years, this is not an assumption to take lightly. To claim that critics of Chinese data are overly obsessed with electricity consumption to track the overall economy is an incredibly poor read of the work that has been done in the market. The market and myself are looking at a wide range of data and finding that the data simply doesn’ fit the 7% growth story and the data discrepancies are much larger and systematic than Bloomber recognizes. There is a reason the new market default position is skepticism.

Note: Here is the output data referenced that was used in the FT Alphaville piece.

The book that most influenced my thinking about how to approach the Chinese economy is Capitalism with Chinese Characteristics by Yasheng Huang of MIT. More than the factual information, which is great by itself, he imparted a simple lesson: more than probably any other economy, details matter when studying the Chinese economy.

Prof. Huang uses two simple examples from his book to illustrate his point. First, though economists with Chinese encouragement classify private companies based upon their legal classification, this overlooks the importance of government shareholdings. As Chinese banks can attest to today, just being a listed company does not make you a private enterprise. According to his calculations, if we account for these types of distinctions, as much as 80% of the Chinese economy is still managed by the state. Second, many “Chinese” companies that most people have heard of such as Lenovo and Alibaba are not actually Chinese companies. They are registered elsewhere for good reason.

There are many other examples in the book and many others I could provide about the importance of paying attention to the details of the Chinese economy. I by no means claim to have mastered this art but I am continually asking how can we dig beneath the surface of a flashy number or statistic to make sure I am understanding and taking prudent precaution to verify a specific issue. The problem is so frequently, when you dig beneath the surface of Chinese data, you uncover a bunch of dead bodies.

Yesterday, the National Bureau of Statistics China announced that retail sales China clocked in at a solid 10.8% growth. There are however significant reasons to doubt this number. As I have already written elsewhere, output of consumer products in China is flat or falling. However, just because China isn’t producing consumer products doesn’t rule out the possibility that retail sales are going up.

To examine this closer, I downloaded data from the report covering the 50 and 100 largest retail enterprises in China with sales broken out by category. Looking at the 50 largest retail enterprises in a year over year basis, except for jewelry, all other categories are negative. Looking at the 100 largest, jewelry is still the largest gainer at 8.7% with food registering a 4.9% gain. Total retail sales among the largest 100 registered a total gain of 1.5% year over year. Most interestingly about the top 100 year over year retail sales, there is not one category that reaches the 10.8% claimed by the NBSC.

If we look at the year to date YOY sales of the top 50 retail enterprises, total retail sales grows by 0.9%. In fact, only one category grows by more than 3%, jewelry which grew at only 4.2%. The short version is that looking at the major retailers of China, there is no evidence to support the official statistics that consumer retail spending is a robust 10.8%. While it is possible that major retailers are registering flat and declining numbers depending on specific category, while China nationally sees such robust growth of 11% is highly unlikely. Furthermore, the retail sales of major retailers matches closely what we know about the flat output of consumer products in China. It is very difficult to reconcile falling consumer output and flat major retailer sales with the official story of 11% growth.

There is however an even more important point that needs to be made. Headline official data of 7% GDP growth and 11% retail sales growth are in most ways irrelevant to a firm. Businesses rely on cash flow to pay for workers, machines, and space. If we look at retail related cash flow for 2014, as it is not yet available for 2015, there is an enormous discrepancy between the official data of 12% retail sales growth and the cash flow associated with retail businesses.

Looking at the “Comprehensive Retail” financials, sales growth for 2014 was only 3.8% with profit growth of 4.4%. Food saw the largest sales growth at 5.7% in a year when China was touting national retail sales growth of 12%. Even if we assume that GDP growth is actually 7% and that retail sales are proving robust at 11-12%, firms are not enjoying the cash flow benefits. A high point of sectoral cash flow of 5.7% is no indicative of firms enjoying robust growth. The slow cash flow growth would indicate that the retail slowdown has been going on much longer than initially believed.

There are a few points of economic analysis worth mentioning. First, we pay close attention to GDP and retail sales because we expect them to be good proxies of economic health and activity. However, firms pay with money not official GDP figures. Consequently, even if we stretch credibility and accept official GDP and retail sales numbers as perfectly accurate, firms are not seeing the related cash flow. Second, it appears that the retail slowdown has been much more prolonged than people realize. I present data here that covers revenue growth for the retail industry for all of 2014 showing sales growth of 3.8%. Again, if we believe the official retail sales growth number of 12%, firms live on cash flows and the slow down appears to have begun no later than 2014. Third, this data directly contradicts the entire economic rebalancing story in China. According to the data consumption is simply not outpacing growth in the traditional drivers of Chinese growth such as fixed asset investment. Fourth, this data comes much closer to matching most other data points we have such as consumer output, electricity, freight, and related data. If we ignore the topline official data, none of the underlying and independent data supports a 7% growth story.

Despite what people may choose to believe or disregard, it is incredibly difficult to reconcile official national statistics with more granular industry data on retail sales. Furthermore, when we also consider the consumer product output data coupled with large retailer sales data, it is difficult to accept official data. The most worrying part is that even if official GDP and retail sales data is accurate, the cash flow required to support the debt and return numbers indicate significant stress at the firm level.

The more we pay attention to the details of the Chinese economy, the more difficult it becomes to reconcile with official data and the more worrying the picture becomes.

Note: You can find all the data here cited in this blog. I apologize you need to download the data, I am having trouble inserting figures into the blog.

A couple of articles have been written attempting to defend Chinese GDP data. I have received questions about them and think it will be helpful to address these articles. It is interesting to me that articles defending Chinese GDP data spend so little time studying official Chinese GDP data or claim that it is true because it is equal to itself.

1. One writer chalks this concern up to a bunch of “conspiracy theor(ies)”. This type of thinking reveals nothing more than a complete ignorance of the issue and overall facts. No less than the second in command of China, the Premier Li Keqiang, has stated that Chinese GDP data is unreliable and “man-made”. To put this in perspective, the current Premier of China, second in command for the entire country, leading economic policy formulation, a Phd in economics, having spent essentially all his career inside public administration in various posts throughout China advises you not to trust GDP figures or the economics professor in the United States who has never lived in China and has no specific expertise in China. It stands near the pinnacle of hubris for a professor correct someone with this depth of knowledge. Astoundingly, other measures of economic activity such as electricity production and freight traffic are criticized as proxy measures. While both are undoubtedly imperfect measures but do provide evidence of broad economic activity, this overlooks why these measures are used. Li Keqiang cited them as measures he used to judge economic activity as they are harder to fake because (wait for it), he believed GDP figures were so artificially manipulated. As a final note, I fail to grasp how concerns over Chinese GDP qualify as a conspiracy given that we are being told this is a problem.
2. One writer makes the straw man argument that China has grown substantially over the years, so Chinese GDP data has to be “broadly accurate”. There are numerous problems with this specific argument. No one who points to serious technical issues in GDP accounting has ever said China has not grown rapidly over a sustained period. It is pure sophistry to create the illusion of disagreement hoping to overlook the real point for which they provide no defense. China has grown rapidly over a sustained period, but that say absolutely nothing about the veracity of GDP data they are showing the world. Furthermore, “broadly accurate” so vague for something that should be focused on detail and accuracy as to be irrelevant. This is like me saying it is “broadly accurate” to say it is hot and there is snow in China. They are both true and broadly accurate but provides me no usable information about when, how much, or to what degree. The is still no serious defense of official Chinese GDP data.
3. Another point made by one of the Chinese GDP defenders is that if GDP data is manipulated, this would require fiddling with underlying data. There is only one problem with this point: we know that underlying data category after underlying data category is manipulated. For more than a decade, Chinese unemployment spent most of its time bouncing between 4-4.2%. Chinese economists became skeptical of the number and conducted a study estimating urban unemployment during their sample period reached 10.9%. Inflation data in China is understated by about 1% annually between 2000 and 2011 studying only one specific line item which overstates real GDP. Others focus on a miscalculation of the GDP deflator with regards to how imports and exports impact national accounting. Chinese exports have been overstated by upwards of 30%, though in all fairness this is due primarily to Chinese form of transfer pricing even if the government looks the other way. Additionally, the enormous discrepancy between underlying provincial GDP and national GDP is well noted, with only a few provinces reporting growth beneath the national average a statistical impossibility. More recently, there are significant discrepancies between output of consumer products and retail sales to name but a few industry level statistical anomalies. If commentators want to point out that manipulating GDP data would require manipulating underlying data, there are these and a variety of others to choose from. One final point here. We know that Chinese bureaucracy controls, manipulates, and hides all nature of information throughout the entire government apparatus. Just this past week, China declared itself, and no I am not making this up, the world’s largest democracy. It strains credibility to believe that the Chinese government acts throughout the state the way it does to manipulate data while simultaneously behaving like well meaning, earnest choir boys when the subject is economic data.
4. One other argument that has been made is that China is transitioning to a consumption and service sector economy. I have covered this point in greater detail at FT Alphaville where, in short, covering significant amounts of retail, consumer, and services sectors, I find no empirical evidence that growth in the sectors is growing anywhere close to what some people claim. There simply is no empirical evidence that Chinese consumers and services are rapidly growing to transition the economy. What is amazing is the proponents of this theory admit they have no actual data to support what they are saying. One proponent in trying to argue to China is transition to a consumption led model actually writes “China’s transition to consumption-led growth is that there are no high frequency data to support the analysis.” Yet conversely somehow, the lack of data can conversely be used to argue in favor of a transition to consumption based economy? If critics have it wrong and there is no data that we can use to estimate service and consumption growth, then the same is absolutely true for those who argue the opposite
5. The last major flaw by proponents of Chinese GDP data is that they use official Chinese GDP and national accounting data to support their argument that official Chinese GDP and national accounting data is accurate. This is the peak in intellectual circular logic. If the data or data producer is in question, you need to produce other data that supports your argument. For instance, the service sector and consumption data cited comes from the same people who bring you the GDP data in question. This is similar to arguing Enron’s profitability is accurate based upon their revenue.
6. The fundamental problem faced by defenders of Chinese GDP data is that they do not dig into official data and look at some of the enormous glaring problems. One defender relies heavily on World Bank data while another cites official topline Chinese data defend official topline data. Neither take the time to examine up close the glaring discrepancies. According to official data urban housing CPI from 2000 to 2011 was 6% total. Mind you that is not 6% annually but 6% total over 12 years during a period when GDP growth was averaging 9%+ and inflation significantly higher. If you update this the number becomes about 12% in total from 2000 to 2013. Official data is essentially implying housing fell as relative to income, wages, GDP, and pretty much everything. Anyone with any knowledge of Chinese housing prices, not just real estate asset prices, knows that this number is pure fantasy. However, not only is the explicit data clearly manipulated data but the underlying data is manipulated. To produce total national housing CPI, the National Bureau of Statistics China (NBSC) created a weight between urban and rural areas. According to the NBSC, urban areas received an implied weighting of 80% to benefit from the already once manipulated CPI data that would produce a better national number. Now China is likely at least 20 years away from being an 80% urban country much less in 2000. The key issue here is that this was not a rounding error, miscalculation, or poor methodology, this was pure and simple fraudulent manipulation of statistics. Some defenders have in a point of concession acknowledged there might be some statistical methodology issues but nothing else. To anyone who believes this, if you publically declare that China was 80% urban in 2000 and every year since and that urban housing inflation has been approximately 10% since 2000, we can discuss anything you want.
7. China has undoubtedly grown significantly over the long run and this is unquestionably good for China and the world. However, that is not the question. The question is how reliable are Chinese GDP figures. I believe as a baseline case from my own research alone, real Chinese GDP would need to revised downward by a minimum of 10% or approximately $1 trillion USD. Add in other known problems and I believe the number could go as high as a downward revision of 30% of real GDP. Think of it using a simple scenario, let’s assume every year since 2000 China has overstated GDP by 1%. In other words, 10% is in reality 9%. That would imply that today, China needs to revise current real GDP downwards by approximately 16%. This would still mean that China has grown significantly but also, as a mountain of clear evidence indicates, Chinese GDP growth has been overstated. Finally, it is important to note that lots of little numbers are clearly off but all these little numbers add up to big changes especially when added up over time. Chinese GDP data is broadly accurate in that the Chinese economy has grown significantly over time. However, accounting for the very real holes in the Chinese national accounting would appear to require downward revision of at least 10% and quite probably significantly higher.
8. I look forward to attending the meeting where American economists living in the United States sit down with the Premier of China and explain to him what is wrong with his views of Chinese GDP data. That should be fun.

A lingering question about the Chinese economy is the reliability of GDP data but a less studied question the quality of Chinese GDP. Let’s begin with questions about the accuracy of Chinese GDP data. Last week the Peterson Institute of International Economics and Nicholas Lardy wrote a blog post criticizing anyone casting a critical eye at Chinese GDP data. Lardy make three main points. First, why did China wait so long before devaluing the RMB? Second, China is transitioning its economic growth. Third, a lack of high frequency data.

While I think highly of Nicholas Lardy and PIIE, these are straw man arguments that do nothing to build up the accuracy of Chinese data and only weakly make the case against critics. To briefly rebut the Lardy points. First, China has been unveiling a wide range of economic and financial support measures the entire year. The RMB policy is merely one intended to support growth. Second, transitioning economies do not throw basic mathematics aside. If the data does not support the headline number, the data does not support the headline number. Third, there is large amounts of high frequency data whether it is from official or quasi official agencies through to better recording of unofficial data. This is why people work so hard to compare a mountain of data to official Chinese GDP and are so concerned when they simply do not reconcile.

The bigger problem with the Lardy argument is that there is no evidence that he has clearly considered or even attempted to rebut the clear and convincing data compiled by a variety of people demonstrating the problems with NBSC data. I will draw from my own research on the topic as I know it best, though there are a variety of others from consulting firms, investment banks, and academics that have raised a variety of very specific and technical concerns about data manipulation in Chinese GDP that are ignored by Lardy.

In compiling inflation data, the National Bureau of Statistics China (NBSC) has clearly manipulated the data. According to official inflation data compiled by the NBSC, urban housing CPI rose from 2000-2011 by 6%. Let me emphasize, that is 6% TOTAL over 12 years, not 6% annually. Even extending that through the latest available data year brings the total to only around 10%. That number is so patently absurd that no one believes it. Rather than using third party and independent data to convince you how absurd that number is, which I could do, I am rather going to show you how the NBSC manipulated the data so badly that cannot even reconcile its own data.

To arrive at a low national housing CPI number from 2000-2011, the NBSC utilized an 80/20 urban/rural housing CPI weighting. The NBSC was assuming in 2000 that China was already an 80% urban country. It did this because according to their data, rural housing prices were rising much faster than urban housing prices. Only by using an 80/20 urban/rural weighting can the NBSC arrive such amazing final numbers. Now elsewhere, the NBSC is reporting that that China was only approximately 35% urban in 2000. In other words, the NBSC inflation data did not match their own nationwide population data.

I could write at length about how obviously manipulated Chinese economic data is but I feel this ground is well covered and want to move on to other issues but I will leave this topic with a few brief points. First, if you want to criticize people that are skeptics or critics of Chinese GDP data, then at least examine the very high quality work that has been done on the topic and be prepared to rebut it. Second, read the numerous and varied work on Chinese statistics. This isn’t a case of sour grapes or uneducated speculation. Third, given the enormity and obviousness in one major line item, it is extremely unlikely that this is not happening throughout a variety of other areas of national statistics. Fourth, the size of the discrepancies here are not minor or rounding errors. These are nothing less than clear and blatant examples of statistical manipulation. Fifth, this specific line item matters because if plausible adjustments are made to inflation factoring in reasonable housing inflation, this would reduce total real Chinese GDP by a little more than 10% or one trillion USD. Sixth, whoever wants to defend Chinese GDP statistics needs to begin by agreeing with 6% urban housing CPI in China in 12 years and an 80/20 urban/rural weighting beginning in 2000. After that I will gladly discuss or debate anything the author wishes including but not limited to unicorns, a Beatles reunion tour, and whether Donald Trump is too withdrawn and wonkish to be considered a viable presidential candidate.

I think a factor that received decidedly less attention is the quality of GDP. The old simple example of what I mean by quality of GDP is this: two guys make up a country decide that they are going to drive up GDP. One guy decides to pay the other guy to dig him a hole. The other guy decides to pay the first gentleman to fill up the hole for him. This process repeats itself infinitely and GDP rises rapidly. Now very little has been accomplished but GDP goes up. Now before proceeding, it must be emphasized that this is a very simple example.

While not fitting this exact pattern, there is significant evidence that the quality of Chinese GDP has been quite low. There are multiple ways to consider the quality of GDP. First, there is capacity and pricing data. The Chinese economy remains heavily dependent on the steering of the Chinese government. Though many companies are by lax accounting standards “private”, an issue covered in , large amounts of economic activity and investment direction remain steered by the government. We see this quality of GDP showing up in lower pricing, surplus capacity, and failing government debt. By official accounts, approximately 30% of the 2008-2009 debt fueled fiscal stimulus was wasted and local governments just received a 3.6 trillion debt restructuring that kept them out of default. Especially in commodities like steel and other metals which had been targeted for expansion by Beijing, surplus capacity is enormous causing deflationary pressure on global markets. Most airports in China are losing money and there are examples of vast sums of money being spent on airports that see few travelers. Even in real estate, there is nearly three years of unsold inventory waiting for buyers. While this binge may push up GDP in the short term, this is difficult to maintain over the long run and is low quality GDP.

Second, while there is no specific data on this, there is evidence that a Chinese variation on hole digging and refilling is occurring. As an anecdote, the Shenzhen airport where I live is was recently unveiled and it is beautiful. The problem is this. The Shenzhen airport that was closed was only approximately 20 years old and having travelled through it frequently was a fine airport, definitely nicer than Los Angeles International. Though straining at capacity, the decision was made to shutter the old airport rather than upgrade it even though it was in fine working order. This is nearly the airport version of redigging the hole even though the other hole just needed to be bigger. Having lived in China for six years, one witnesses this type of replication work constantly. While new capital is being created, there are also enormous capital losses regularly. People have paid great attention to the new infrastructure, but there is little attention paid to whether it is being used and how quickly it is being replaced. The capital losses associated with both are simple staggering. Though I know of no explicit study on the issue, I would wager significant money that depreciation and capital losses are much higher as a percentage of GDP than other countries, whether measured against developer or emerging market.

The reason this matters is that most talk of economic health are both dependent on maintaining high growth rates and high quality growth rates. I have serious doubts about both in China and I believe that all non-official data supports this position.