I want to do a brief follow up to my piece for Bloomberg Views on why GDP is a 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 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.