Pre-Christmas Thoughts on China’s New Economic Plan

Tip: don't take Chinese announcements at face value

Christopher Balding , December 22, 2015 10:38am

So I haven’t been writing that much the past two weeks primarily because of a minor wrist surgery two weeks ago.  In addition to some forced time off, forced me to play a lot of catch up to my existing commitments.  Drove me nuts, because there are so many interesting things going on in the Chinese economy right now that I really wanted to write a lot more.  So for the moment, you’ll be stuck with a grab bag of thoughts.

First, China released its 2016 economic plan yesterday and while I’ve only read the news reports at this point, it sounds pretty well reasoned, like they read this blog (definitely joking but also probably somewhat true), but things mentioned in it are very unlikely to actually occur. One thing I always tell people trying to understand the Chinese economy is that you absolutely should not take press releases as fact.  If they announce a GDP figure of X, only believe it after you have verified it.  Same thing goes for the economic plan.  From everything I have read, it actually looks rather sensible.  However, I believe the likelihood of it happening is quite low.

Secondly, I don’t say this for pure skeptical reasons but a variety of reasons, not least of which is just pure mathematics. Let me give you one example.  The plan notes the importance of deleveraging. However, they simply cannot deleverage and maintain GDP growth of anywhere close to 6.5 percent.  Let me give you a slightly oversimplified model that will explain why.  (I should re-emphasize this model is using easy ratios in an oversimplified model but it will clearly convey the idea).  Let’s assume that that GDP growth is 6 percent and credit is growing at 12 percent.  If they only want to slow leverage build up, not even deleverage, and cut credit growth to 8 percent, then in our simplified scenario that would cut GDP growth to 4 percent.  Now let’s add in another wrinkle: one recent report had (again using a nice round number) 50 percent of credit being used to pay off old debts.  Let’s now assume that 6 percent of credit growth goes to GDP growth and 6 percent to paying off old debts.  If they cut credit growth to 8 percent (leaving 4 percent to fall on the 6 percent/6 percent division), and if the entire 4 percent reduction fell on credit growth to pay off old debts, then that could easily trigger a wave of defaults.  Conversely, if the brunt of that credit cut fell on GDP expansion and new capacity expansion (already problematic), that could easily torpedo any growth targets for 2016.  Remember, this still assumes total leverage is rising, just slower than before.

Third, this is the key point: I see absolutely no evidence that the Chinese government is prepared to either accept or even recognize that those types of trade-offs are necessary. Beijing wants to believe that markets move in one direction and do exactly what you want them to do and that just isn’t reality.  One of the most fundamental laws of economics is that man has unlimited wants and limited means.  There is a very small number of people, firms, or governments to whom this does not apply in the course of human events.  Tradeoffs have to be made and at this point, I see no evidence that Beijing is prepared to recognize that trade-offs need to be made and then make difficult decisions to make them.

Fourth, I have a profound belief that when the government of China wants something to happen, they will make it happen. This is not universally true, but mostly true.  If they really aren’t interested, they will nod and agree and ignore.  As the saying in China goes: in China there are a thousand ways to say no, including many where people say yes.  Don’t watch the press releases but look at the results.  That is the only way to judge what is going on.

Beijing is going to face some battles on implementing these plans like deleveraging for a few reasons. First, I truly believe they don’t really know what is going on throughout the country.  Even banks don’t know what is going on in their branches throughout the country sitting at the home office in Beijing.  News reports of major GDP fraud in the northeast is the tip of the iceberg.  Imagine how bad the data is at lower levels that receive less public or major official attention.  Also, Beijing has not fundamentally changed the promotion incentives so officials have an incentive to focus on the old line metrics.  Before I get a bunch of nasty emails saying otherwise, ask yourself if a city official would get credit for improving environmental welfare by shutting down a polluting low capacity coal plant and putting people out of work and restructuring the assets and recognizing some bad loans? Are you kidding?  Consequently, even if Beijing really wanted this (which I don’t think it does), it would face real problems pushing this plan.

I don’t like to say told you so but this is one time I will say it: I told you so. A week or two ago, Beijing released details of how badly inflated the northeast Chinese provincial GDP was. There are a couple of things to note about this situation.  First, if you believe this is limited to the northeast provinces, please get stronger meds.  Second, China, which has been a serial adjuster of GDP upwards, hasn’t made any indication it plans to revise the problematic GDP downwards.  That would be unharmonious.  Third, faced with overwhelming, even self-admitted, evidence, the new defense of Chinese cherry red kool-aid GDP drinkers is that, “this was at the provincial level not at the national level. National level data is still good.”  There are two separate and enormous problems with this argument.  First, this assumes that government statisticians in Beijing are as pure as the driven snow, as ethical and honest as Mother Theresa, and have the conscience of St. Augustine worrying over the proverbial pear tree.  I just have to ask: who are you kidding?  A friend of mine who used to teach in China told me a story about a Chinese class he taught where Chinese high school students believed the same thing about government officials (stop and ponder smart people holding the same opinion as indoctrinated Chinese high schoolers for a minute). When he pointed out that central government officials came from provincial appointments, the students would argue that they were promoted because they were so pure and untainted, at which point he would stop arguing.  Again, if you believe that central government statisticians are pure as the driven snow….get help.

Second, and potentially more problematic, this assumes that even if central government statisticians are pure as the driven snow they can calculate what the true level of GDP or other statistic should be.  In other words, if you are an honest Beijing statistician, how to do you adjust data you believe to be faulty to what it’s true number is?  This is harder than it sounds for many reasons.  A Chinese auditing report earlier this year found state owned (at the central and provincial level) falsified financial records, no surprise so far.  What was surprising was that some falsified them to look more positive and some to make them look worse.  They did this depending on whether they were trying to hide money or get money.  In short, just assigning a 3-5 percent downward adjustment, as a simple example, wouldn’t work.  Furthermore, if Beijing suspects that the data they are receiving is false but then the submitter would know that Beijing would know that, so they clearly wouldn’t submit false data.  In short, there is a lot more randomness and one would have to assume super natural power of clairvoyance if official data is accurately corrected.  That also for many more reasons, is an enormous stretch.

If I can’t write again before Christmas… Merry Christmas to everyone.

Christopher Balding

Associate professor at the HSBC Business School of Peking University Graduate School.