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Recalculate China’s GDP before rebalancing
Nov 28, 2013 12:03pm by guest writer
By Ken Peng of Citi Private Bank
China must rebalance! Yes, everyone from President Barack Obama to your average Beijing taxi driver knows that. Around 48 per cent of China’s GDP is investment, just 36 per cent is household consumption, with government spending a bloated 13 per cent and net exports, 2 per cent. Whether through timely and painful reforms now or delayed reforms and disaster later, investment growth is expected to falter and consumption to be unable to pick up the slack.
But what if these basic assumptions are wrong?
It is increasingly accepted that China’s consumption is underestimated, while its investment is overestimated. Two studies, among others, have shed light on the subject. One is on unreported ‘grey’ income by Professor Wang Xiaolu of the National Economic Research Institute; the other is on consumption underestimation by Professors Zhang Jun of Fudan University and Zhu Tian of the China-Europe Business School. Many have heard of these studies, but most believe that the difference is insignificant.
By combining the results of the two studies, however, my conclusions show very significant changes to China’s GDP composition. The corrections would raise household consumption by 11 per cent of GDP, while reducing the shares of investment and government spending by 8 per cent and 3 per cent of GDP, respectively.
Even that only brings consumption from 36 per cent to 47 per cent, still a long way away from desirable. But the implication is profound: it would mean that China need not be so aggressive in slowing investment and that it has less scope than previously believed to stimulate consumption. Correctly identifying the starting point of rebalancing would go a long way to determining just how fast the process needs to take place.
The quality of China’s statistics is under constant challenge. Three big problems are explored here.
First, household income is underestimated due to massive unreported ‘grey income’, particularly at the high end. By extension, ‘grey consumption’ is also left out. Wang finds that grey income amounted to Rmb6.2tn ($1tn) in 2011. He also estimates that GDP is underestimated by Rmb3.7tn. This implies that government and enterprise incomes are overestimated by Rmb2.5tn, which would curb their spending and investment. In other words, the Rmb3.7tn of additional GDP should be entirely classified as consumption.
Second, the value of housing use is underestimated. The GDP data put the value added of both owner- and tenant-occupied housing at an average of just Rmb1,868 a year or Rmb156 a month per household (both rural and urban). If we assume Rmb500 a month, which is still on the low end, then the extra rental value would be about Rmb1.7tn, which would be additional service consumption within GDP. By contrast, US GDP data assumes about $1,200 a month per household.
Third, a large amount of household consumption is disguised as business costs, government spending and investment. Vehicle use, gifts, vacations, meals, even groceries can be counted as business costs, so long as tax receipts can be procured. This is hard to quantify, but the Wang study provided a clue. As mentioned above, Rmb2.5tn is subtracted from government and enterprise incomes, which can be split roughly evenly according to their respective shares of national income. Assuming that the government saves 30 per cent as reported, then government spending (G) would be reduced by Rmb856bn. Since gross capital formation (I) amounted to 128 per cent of enterprise disposable incomes, the Rmb1.3tn reduced income would mean Rmb1.6tn reduction in gross capital formation. The sum of reductions in G and I is about Rmb2.5tn, matching what is implied in Wang’s study.
Source: Citi | Click to enlarge
The other side of this correction is that China saves less than officially reported. China’s households are often blamed for over-saving and the official data puts 2011 household savings rate at an outlandish 40.9 per cent of disposable income. But after my adjustments, that ratio is 28.8 per cent – still not too shabby. Put in government and enterprise savings, and the adjusted data show a national savings rate of 42.3 per cent, considerably lower than the official 50.6 per cent. This is, undoubtedly, still a high rate but it is in agreement with our previous calculation that investment was overstated by 8 per cent of GDP.
2011 Savings Rate Reported Adjusted
National 50.6% 42.3%
Households 40.9% 28.8%
So what do all these numbers mean? To put it simply, China still has time to rebalance. Reforms should focus on improving equity and efficiency, rather than slowing down GDP or investment growth. The above findings can help to answer several mysteries.
But the key point is this: with a less severe degree of imbalance, China’s future growth does not necessarily have to falter. The IMF’s projection of average 6 per cent real GDP growth from now to 2030 is not only possible, but likely.
Ken Peng is Asia strategist with Citi Private Bank, and previously served as China economist for Citi and BNP Paribas
Guest post: recalculate China’s GDP before rebalancing | beyondbrics
Nov 28, 2013 12:03pm by guest writer
By Ken Peng of Citi Private Bank
China must rebalance! Yes, everyone from President Barack Obama to your average Beijing taxi driver knows that. Around 48 per cent of China’s GDP is investment, just 36 per cent is household consumption, with government spending a bloated 13 per cent and net exports, 2 per cent. Whether through timely and painful reforms now or delayed reforms and disaster later, investment growth is expected to falter and consumption to be unable to pick up the slack.
But what if these basic assumptions are wrong?
It is increasingly accepted that China’s consumption is underestimated, while its investment is overestimated. Two studies, among others, have shed light on the subject. One is on unreported ‘grey’ income by Professor Wang Xiaolu of the National Economic Research Institute; the other is on consumption underestimation by Professors Zhang Jun of Fudan University and Zhu Tian of the China-Europe Business School. Many have heard of these studies, but most believe that the difference is insignificant.
By combining the results of the two studies, however, my conclusions show very significant changes to China’s GDP composition. The corrections would raise household consumption by 11 per cent of GDP, while reducing the shares of investment and government spending by 8 per cent and 3 per cent of GDP, respectively.
Even that only brings consumption from 36 per cent to 47 per cent, still a long way away from desirable. But the implication is profound: it would mean that China need not be so aggressive in slowing investment and that it has less scope than previously believed to stimulate consumption. Correctly identifying the starting point of rebalancing would go a long way to determining just how fast the process needs to take place.
The quality of China’s statistics is under constant challenge. Three big problems are explored here.
First, household income is underestimated due to massive unreported ‘grey income’, particularly at the high end. By extension, ‘grey consumption’ is also left out. Wang finds that grey income amounted to Rmb6.2tn ($1tn) in 2011. He also estimates that GDP is underestimated by Rmb3.7tn. This implies that government and enterprise incomes are overestimated by Rmb2.5tn, which would curb their spending and investment. In other words, the Rmb3.7tn of additional GDP should be entirely classified as consumption.
Second, the value of housing use is underestimated. The GDP data put the value added of both owner- and tenant-occupied housing at an average of just Rmb1,868 a year or Rmb156 a month per household (both rural and urban). If we assume Rmb500 a month, which is still on the low end, then the extra rental value would be about Rmb1.7tn, which would be additional service consumption within GDP. By contrast, US GDP data assumes about $1,200 a month per household.
Third, a large amount of household consumption is disguised as business costs, government spending and investment. Vehicle use, gifts, vacations, meals, even groceries can be counted as business costs, so long as tax receipts can be procured. This is hard to quantify, but the Wang study provided a clue. As mentioned above, Rmb2.5tn is subtracted from government and enterprise incomes, which can be split roughly evenly according to their respective shares of national income. Assuming that the government saves 30 per cent as reported, then government spending (G) would be reduced by Rmb856bn. Since gross capital formation (I) amounted to 128 per cent of enterprise disposable incomes, the Rmb1.3tn reduced income would mean Rmb1.6tn reduction in gross capital formation. The sum of reductions in G and I is about Rmb2.5tn, matching what is implied in Wang’s study.
Source: Citi | Click to enlarge
The other side of this correction is that China saves less than officially reported. China’s households are often blamed for over-saving and the official data puts 2011 household savings rate at an outlandish 40.9 per cent of disposable income. But after my adjustments, that ratio is 28.8 per cent – still not too shabby. Put in government and enterprise savings, and the adjusted data show a national savings rate of 42.3 per cent, considerably lower than the official 50.6 per cent. This is, undoubtedly, still a high rate but it is in agreement with our previous calculation that investment was overstated by 8 per cent of GDP.
2011 Savings Rate Reported Adjusted
National 50.6% 42.3%
Households 40.9% 28.8%
So what do all these numbers mean? To put it simply, China still has time to rebalance. Reforms should focus on improving equity and efficiency, rather than slowing down GDP or investment growth. The above findings can help to answer several mysteries.
- How high can investment growth sustain while rebalancing? If the aim is to make household consumption take up half of GDP by 2020, the official data would simply make it impossible because it would require faster consumption growth and a sharp decline in investment growth, which simply cannot take place together. After adjustments, however, consumption needs to grow 11 per cent annually, a tad slower than the 12.7 per cent 2012 pace, while investment can still grow at 9.3 per cent annually, not far below the 10.7 per cent in 2012.
- Where has the borrowed money gone? Since the 2008 financial crisis, China’s debt-to-GDP ratio has ballooned, leaving many analysts wondering what the borrowed money had bought. A lot of that debt paid for disguised consumption (8 per cent of GDP, or 20 per cent of capital formation). But if this is consumption debt, then it should be repaid by those who consumed, which needs to be addressed by government and fiscal reform.
- How can China grow with constrained credit? China now takes 6.7 units of credit to create 1 unit of investment, which is about double the global average, and of China’s own pre-2008 experience. This indicates deepening problems of corruption and inefficiency. But at the same time, it implies that a lot of funding did not go into real investment projects in recent years. So, if corruption and efficiency can improve with recent reform efforts, then it would take less credit per unit of GDP.
But the key point is this: with a less severe degree of imbalance, China’s future growth does not necessarily have to falter. The IMF’s projection of average 6 per cent real GDP growth from now to 2030 is not only possible, but likely.
Ken Peng is Asia strategist with Citi Private Bank, and previously served as China economist for Citi and BNP Paribas
Guest post: recalculate China’s GDP before rebalancing | beyondbrics