There are indicators, concerning unemployment, inflation, non-performing financial assets, debt, public health, and inequality, that would illuminate the true state of the Chinese economy, and to some extent its societal well-being. These specific indicators are chosen for their nature and their salience. They are quantifiable in nature, requiring less judgment and suffering from less bias. They are numbers the PRC itself presents, though inaccurately, because they lie at the core of Chinese prosperity and economic and political stability. And they are often used as constitutive elements in outside assessments of China, or simply repeated as the only data available.
The easy conclusion when examining these indicators is the party is attempting to hide areas of considerable economic vulnerability. Information about this vulnerability may offer the U.S. government leverage on both economic and political issues, a topic which others can explore. What can be demonstrated now is that the continuation of China’s positive role in the global economy requires far greater transparency, closer to that of the Organisation for Economic Co-operation and Development (OECD) economies. The PRC’s transparency failures are a considerable problem, for both itself and its partners.
In response, the U.S. government should encourage the PRC to be more transparent. More important, it should initiate its own programs and support existing private efforts to gather better data on key Chinese indicators. An element of the U.S. government action should be strict limitations on U.S. taxpayer support—direct or indirect—for projects in China and ventures with Chinese entities.
There is a worldwide obsession with Chinese gross domestic product (GDP). GDP is a poor measure of national wealth and economic performance. This is especially true in China where so many transactions are “empty”: China’s official benchmark of fixed asset investment for 2012, for instance, was about $1.75 trillion higher than the State Statistical Bureau’s (SSB) number for gross fixed capital formation, the standard international measure. Land or used machinery changes hands but creates no additional value. Funds are said to be spent, with no identified benefit. Fixed asset investment is dutifully reported every month, while gross fixed capital formation appears only once a year.
What the party cares about in economic terms is not GDP or fixed investment, but inflation and unemployment. The former led to massive protests for democratic reform, and ultimately violence, from 1987 to 1989. Fear of the latter has driven Chinese economic policy for 15 years, in particular the panicked response to the global financial crisis that ensured the current economic stagnation.
Unemployment. The crucial nature of unemployment is straightforward: The jobless are more prone to mass protest. High unemployment is a threat to political stability in the PRC, as it is everywhere else. This is why the only regularly published unemployment rate is “urban registered unemployed” (read: whom the Ministry of Human Resources and Social Security is willing to count). These are exclusively urban workers in the jurisdiction where they are officially registered, and who have worked for certain periods for surveyed employers (most of which are state entities).
This definition accounts for the trend over time. When the global financial crisis struck, China faced the possibility of mass unemployment and responded with unprecedented bank lending. Yet official employment actually rose sharply, because workers fled a shrinking private sector for the state sector. This also helps explain the perception that the state sector has advanced at the expense of the private sector. Because the Ministry of Human Resources counts as it likes, the unemployment rate never exceeds 5 percent, with the number of urban jobless presently between 9 million and 10 million.
At the other end of the spectrum in terms of the jobs challenge is a September 2010 government white paper on human resources that puts the total labor force at 1.07 billion, and the number of employed at 780 million. The 290 million who are not reported as employed are mostly registered in rural areas. Many are farmers and therefore self-employed (and perhaps also underemployed).
Between this and registered urban unemployed are a host of unofficial estimates. One recently developed estimation technique is to compare the number of job seekers to urban jobs available, using data from government job centers. Unlike the official measure, this technique revealed a surge in joblessness when the global financial crisis struck. At present, however, the number of job seekers used is not even as large as the ministry’s partial figure for annual urban labor-market entrants. It thus gives a wildly optimistic picture of overall unemployment.
It is hardly just China where published unemployment rates are misleading; even much richer economies struggle. But no other country offers an ostensible range of 10 million to 300 million idle or partly idle laborers. If, say, 175 million people are unhappy because they cannot find adequate work, the PRC is extremely vulnerable to events that threaten employment.
Consumer Purchasing Power. Casual observations about how much richer the PRC has become, in terms of GDP per capita or foreign reserves, neglect that the economy consists of people. What matters is their wealth. This wealth has to be controlled for inflation, and official inflation estimates are inadequate.
The GDP deflator is the price change implied by the difference between the on-year nominal increase in GDP and announced “real” GDP growth. When the Chinese economy is expanding rapidly, the deflator rises far faster than the consumer price index (CPI), making growth look slower. The main reason for this is that the deflator includes housing. (Unlike the CPI, it also includes producer goods, which see sharper price shifts in both directions.) A separate index of housing prices ceased publication at the end of 2010, because reported inflation hit double figures in 2009 and 2010, and even that was low compared to the values implied by space sold and revenue. While none of the indicators is anywhere close to ideal, implications of changes in the GDP deflator are often neglected. Closer examination and accounting for its makeup offers a different perspective on some of the reported numbers.
The other side of purchasing power, of course, is income. In rural areas, Chinese personal income previously lagged GDP growth, as more gains accrue to state enterprises and their employees than everyone else. In urban areas, weaker income growth and soaring housing prices have recently cut into gains in purchasing power, even while GDP growth remained solid. To correctly measure purchasing power requires adjusting personal income by a proper measure of prices.
Using the GDP deflator to represent prices, instead of the various deflators the statistics authority purports to use, real rural income growth averaged 4 percent annually for a decade (1999–2008) before improving the past few years. On the flip side, real urban income growth has averaged barely 4 percent from 2008 to 2012. These are substantial gains but they are far from spectacular. Large portions of the population are not as happy with China’s economic performance as top-line figures suggest, not because of high aspirations but because they have not seen particularly strong gains in the first place.
In both its foreign and domestic policies, the party demonstrates concern about China’s territorial integrity. The concerns are primarily political, such as the ethnic violence in the west, but there is also an economic challenge. The PRC faces clear and very large development gaps between its solid middle-income east coast and its still largely lower-income interior.
The nature and extent of these gaps is obscured by Chinese and foreign data. Because the east coast is economically larger, richer, and more integrated, it is far more important to foreign partners, both corporate and national, than the rest of the country. Corporate headquarters, research houses, and visiting official delegations are therefore heavily concentrated in Beijing and Shanghai. The information gathered by most foreign entities is about the China that matters most to them, not necessarily the China that matters most to the party.
The party may not have much better information. It is by now well known that provincial GDP series do not match national series. What is less well known is that problems are even worse with other data. The SSB now collects national data independently of the provinces; the provinces generate their own data. The latter are essentially useless.
The party did not choose economic reform for the interior, it chose state-directed spending. As a result, inland provinces claim rapid GDP growth based on even more rapid investment growth. Reporting has become absurd: There are now multiple provinces whose fixed investment is larger than their GDP—which would be impossible if fixed asset investment was anything close to a legitimate measure. GDP, and thus GDP per capita, is being heavily exaggerated, so that the gaps with the coast are understated. Fabrication is even worse in foreign investment statistics; here, provincial totals can exceed the reported national figure by 50 percent.
This undercuts the common view that inland provinces have been catching up to the coast. They may have, but only temporarily, on the basis of increasingly useless state spending. (Or they may have only in the form of imaginary numbers.) The party is certainly aware that the public statistics are false and likely has a good sense of which regions are potential sources of unrest. Political assignments are made accordingly and key economic programs, such as permitting labor movement, may be shaped by awareness of regional disparities. To better evaluate the calculations behind Chinese policy decisions, far better provincial-level data are needed.
GDP and inflation statistics are issued and pored over every quarter. A long-term economic crisis would most likely be due to unemployment. But what wins attention on a weekly basis is Chinese finance. Whenever signs of stress are perceived, most recently the June 2013 interest-rate spike, speculation begins on whether a domestic financial crisis is imminent. In principle, a short-term crisis could occur due to a default by a bank, major firm, or local government arm.
However, a mistake continually made by foreign observers is to treat the PRC’s financial system as more or less equivalent to America’s financial system. Ninety-seven percent of Chinese banks’ assets are held by state-owned institutions. (Fewer than 2 percent are held by foreign-owned banks, fewer than 1 percent by domestic private banks. Even the much-discussed non-bank finance—“shadow banking”—stems largely from state banks taking assets and liabilities off their books, plus the investment activities of state-owned insurers.
So there is far less counterparty risk than in the U.S., and little meaningful competition. Benchmark interest rates are irrelevant both to troubled state firms, which enjoy costless borrowing through endless loan rollovers, and private firms, which pay far more. Understanding Chinese finance requires data, not severely strained comparisons to Lehman Brothers.
Bank Debt. Non-performing bank assets are the repository of economic failure. An unwise loan funds an overly optimistic investment. The ensuing increase in production is unwanted by the market and an economic imbalance is created. Closing the loop, the banks’ probability of repayment is lower. So a rising amount of distressed assets signifies a failing economic model. And a high level of distressed assets implies a systemic threat.
Small wonder that the party treats the system-wide level of non-performing loans as a state secret. Estimating the total amount of bad loans used to be a cottage industry in international finance. Then, the government decided that as many state banks as possible should seek multibillion-dollar initial public offerings (IPOs), and independent assessments of asset quality were harshly suppressed. Bad loans were offloaded to other entities prior to IPOs, and massive amounts of cash were continuously injected by government financial arm Central Huijin, implying that distressed assets steadily accumulated over time. All the while, official data on bad loans have bordered on the absurd. Despite well over $1 trillion in new loans in 2009 in an acknowledged downturn, bad loans were said to fall. Nor did they rise later on.
The trend for bad assets is easy to identify, in principle: If investment is rising clearly faster than domestic and overseas sales, bad loans will eventually rise no matter how strong demand is and no matter what Beijing claims. On this view, pressure on loan quality began to accumulate in 2006, though slowly enough that improvements in practices may have protected bank portfolios. That was not true in 2009, when loan quality plummeted. A 2010 recovery was followed by a mediocre 2011 and poor 2012. The quality of official investment and sales figures is an obvious problem but non-performing assets are almost surely far larger in 2013 than 2006.
An exact figure is harder to come by. There are likely closely held estimates, including within the Chinese government. It may be useful for the U.S. intelligence community to seek them out and make them publicly available. These should be combined with assessments of the thresholds where a non-commercial banking system is progressively impaired.
Corporate Debt. The obvious counterpart to bank debt is corporate debt. Chinese corporate accounting has long been a farce. In 2000, the national audit office accused two-thirds of almost 1,300 state enterprises of cooking the books. Chinese guidelines at the time were so minimal as to be useless by international standards, yet state firms still could not meet them. Since then, domestic reports of accounting problems have become politicized, but American regulators have identified fraud at Chinese companies and their foreign accountants. This fraud has affected U.S.–China commercial relations, reason enough for the U.S. government to gather better information.
Another reason is to undercut the “Beijing consensus.” Though the PRC has never officially embraced the concept, the Beijing consensus is the claim that state-led development is superior to market-led development—the “Washington consensus.” The crux of the evidence cited is the PRC’s impressive GDP growth, presumably a result of its mix of planning and market implementation of government plans, and the dominance of its very large state-owned enterprises (SOEs).
It is therefore important economically and diplomatically to analyze SOEs beyond their size and the foreign currency provided to them by the government. Not coincidentally, such analysis is inhibited not only by bad accounting practices but by protection of the corporate information of large SOEs as state secrets, with severe associated penalties for disclosure.
While the evidence is limited, the size and expansion of SOEs could mask debts that would be unsustainable in a competitive system, and require transfers from the rest of society. Chinese firms are indeed large, with the second most appearances on the Fortune 500 list (after U.S. firms). But these firms show far more leveraging than their American counterparts. Indeed, a state think tank indicated Chinese firms had the worst debt-asset ratios in the major economies, at over 100 percent. Further investigation would almost surely find more, hidden weakness, discrediting the Beijing consensus and reducing the appeal of working with Chinese state investors.
Local Government Debt. The third main component of financial worries is local government borrowing. Direct accumulation of debt by local governments is formally limited, but most long ago set up investment vehicles to circumvent the restrictions. Local government debt is a component of the evaluation of the Chinese economy in terms of policy trends, aggregate economic vulnerability, and comparative regional performance.
After encouraging local governments to spend in response to the 2008 financial shock, Beijing began to fret and ordered an audit of local borrowing. The result was reminiscent of that for firms: dozens of cities and counties with debt-to-asset ratios over 100 percent and total debt of $1.61 trillion in 2010. The total figure has certainly risen, the number of distressed local governments probably has, too, and there have been a series of official statements to the effect that the problem has worsened. But there has been no official update yet.
This may be due to fear of the future. Most foreign observers focus on the possibility of an urban housing market collapse, which would harm employment and bank assets and ultimately the wealth of ordinary people. A larger problem, at least regarding the amount of money involved, is the value of land. In addition to soaring real estate taxes, revenue from land sales stood at a total of 5.3 trillion yuan from 1999 to 2008. In 2010 and 2011 alone, it was almost 5.9 trillion yuan. This rate of increase cannot possibly last and, indeed, there was a mild decline in 2012.
More declines are coming, so local government ability to service debt will also decline. A complete picture of the financial system, including true local government debt and the likely trajectory of land sales revenue, would answer vital questions. How far will the central government be constrained by the need to support local outlays? Is expanded public spending even possible on a net basis? Will some local governments be forced to shrink outright, perhaps in poorer counties and provinces where this would provoke discontent?
Economic data are published regularly; the problems with them stem from internal inconsistencies that leave analysts endorsing one official Chinese figure over another. Figures with more obvious sociopolitical implications, such as those concerning income distribution or mortality, are typically suppressed.
The party believes that the top threat to its rule is internal corruption. Individual cases of corruption have proven manageable, but evidence of increasing wealth concentration correlated with party membership and rank might not be manageable. Given state dominance of the economy, income inequality is a proxy for perception of corruption. Perhaps even more inflammatory than inequality of income is inequality of health, both in terms of how long people live and their causes of death. This is the kind of information that can trigger political change.
Income Inequality. The party has acknowledged, and begun to address, urban–rural income disparities. The SSB’s income statistics show urban income 2.48 times larger than rural income in 1997, with the absolute gap at a bit over RMB 3,000 ($365). By 2009, the ratio was 3.33:1 and the absolute gap was RMB 12,000 ($1,750). Either policy steps, statistical falsification, or both, partly stemmed the tide, and the 2012 ratio was 3.10:1. However, the absolute annual income gap still passed RMB 16,000 (over $2,500).
Rural areas remain somewhat isolated. What promotes dissatisfaction among hundreds of millions of urban residents is seeing huge wealth disparities right in front of them, most prominently expressed in housing. After years of surprisingly focused social complaints, the SSB published an overarching inequality measurement, in this case 10 years of the gini coefficient. From 2003 to 2012, the term of the Hu Jintao government, the reported gini never fell below 0.47, where 0.4 starts to indicate considerable inequality.
The numbers were released because the 2012 result was said to fall below the 2008 peak, and even the 2003 figure. But it is highly doubtful that the general population accepts anything like this. In spring 2007, it was alleged that nearly all of the wealthiest were family members of high-ranking party cadres. As the term of the Hu government neared an end in 2012, a set of reports in the Western media documented the extreme concentration of wealth at the top of the party leadership. The responsible outlets saw retaliation from Chinese censors but the stories all corresponded with what ordinary urban Chinese could see for themselves.
The percentage of national wealth held by the top 1 percent or 5 percent can be incendiary in any country, but much more so in the PRC. There, the wealth of the top 5 percent is almost all due to the party’s control of the economy, and heavily influenced by systemic corruption. Figures on how much of the Chinese “miracle” has not been shared will change the perception of that miracle both outside and inside China.
Public Health and Environment. Public health is reported on constantly, but reliable numbers are again conspicuously lacking. The World Bank has done a series of reports over the past 20 years documenting the economic costs of environmental degradation. Initially suppressed, these have been accepted, even repeated, by the party because they always paled against reported economic performance. The pollution pattern is similar. China accepts reporting about bad air and water pollution when it can no longer be avoided, and quickly promises massive clean-up efforts.
While such issues cause local protests and general disgruntlement, they are not directly life and death issues. But birth defects and cancer rates are, and domestic reporting has been suppressed in these areas. Reliable national data on the trend in cancer rates and birth defects, especially if broken down geographically, would be a critical indicator of the true level of “social stability.”
Life expectancy combines these health and environmental factors. It is possibly the single most important indicator of societal welfare and strongly correlated with economic expansion. Declining life expectancy is tied to the collapse of Soviet Communism, an event which the PRC continues to evaluate. China reports increasing life expectancy. This was certainly credible at the outset of reform and for some years after, but it is not clear that recent figures should be accepted as reliable.
One main reason they might be inaccurate: The way China exploits its coal resources is known to be bad for public health. The PRC has long had lax regulation of mining, production, and thermal power generation. It now also accounts for half the world’s coal output—on less than 7 percent of the world’s land and fresh water. Coal mining is land-intensive and even more water-intensive. This combinations of factors has the obvious effect on life expectancy at the local level—sharp reductions. Even if the national average life expectancy has managed to continue to increase, it can only have done so with widening regional gaps. A large and expanding difference in life expectancy is perhaps the starkest inequality imaginable. Detailed, trustworthy data on life expectancy would reveal the extent of the PRC’s social and, ultimately, political cohesion.
Arable Land. A final issue combines the macroeconomic and social dimensions. For the sake of revenue, land can be seized by the government without due process, to be sold to infrastructure projects or property developers. It can be lost to pollution. Loss of land means unemployment for farmers, it means food-inflation pressure, it adds to income inequality, it threatens public health through food quality, and it ultimately undermines local government finances.
The problem here is not false Chinese figures; arable land can be evaluated by satellite. The problem is failure by the PRC and independent observers to fully evaluate the multiple implications of land loss.
Urbanization is at the heart of current development plans. At the micro level, not just farmers but urban poor are harmed disproportionately by land loss, the former due to loss of livelihood and the latter due to the harsher impact of (correctly calculated) food inflation. At the macro level, urbanization impinge upon protecting arable land, forcing even more resources to be diverted to protect food supply. The party’s long-standing fear of dependence on imported food is already frayed by $30 billion in soybean imports annually. Without far better protection of arable land, more large-scale food imports should be expected.
Recommendations for the U.S.
Recommendations that the U.S. government, the private sector, international institutions, and China itself improve the quality of the data provided are old hat. Of course, if they had been heeded 10, or even five, years ago, American policymaking would have been much improved.
A fresh reason for urgency in gathering better information is greater awareness of the PRC’s economic difficulties. There is increasing likelihood of financial losses from current and previous China-related transactions, losses that could drive speculative attacks on the stocks of the companies involved and even be transmitted to American taxpayers in various forms. Private entities should not be inhibited in any way by the U.S. government but should proceed entirely at their own risk.
Conclusion: Hard Thing, Worth Doing
Claims that Americans have adequate information on the Chinese economy are false. The same line has been used for years: Old numbers were faulty but current numbers are satisfactory. This was said in 2004 about data from 1994, it is said now about 2004 data, and it will be said a decade from now about today’s data.
It is certainly true that the SSB’s methods have improved over time, for example, by relying less on provincial reporting, and further improvement is possible. It is equally true that the Communist Party still controls and alters the flow of information, and some important indicators, such as for unemployment and investment, have actually become more misleading over time.
Whether the PRC’s economy rises, falls, or stagnates, it is big enough to be important to know why ordinary people, local cadres, and the top leadership are behaving the way they are and how the U.S. can better exert global influence. To gather better numbers on any one of the indicators listed here would be valuable, but would still offer an incomplete picture. To gather better numbers on all of them will likely require sustained U.S. government assistance over time, and be well worth it. Until then, American taxpayers should not have to support commercial activities in a low-transparency environment.—Derek Scissor, PhD, is Senior Research Fellow in Asia Economic Policy in the Asian Studies Center at The Heritage Foundation.