I am about to tell you something which you probably don’t know.
The reason I say this is because I, myself, and most people I know didn’t know this basic fact, despite reading a lot about politics and economics.
The man below is called Michael Pettis
He is a professor of finance, working at Guanghua School of Management at Peking University (Beijing).
He alleges that China’s growth is less than half of what is reported:
So far, so “mainstream”. Many others have made this point. What is fascinating about his analysis is that he isn’t alleging that China is “faking” the numbers.
He is merely stating something he says is a fact – the way China calculates GDP is different from the rest of the world.
GDP isn’t a standardized thing. Even France and the UK calculate GDP in a slightly different way. China just calculates it in a very different way.
You could argue, perhaps legitimately, that every country has a right to calculate GDP in the way it sees fit.
That may be true, but we also, therefore, have to see how these different definitions might affect the overall picture.
As the old saying goes, “lies, damn lies and statistics”!.
To quote him directly “the Chinese economy operates under soft budget constraints. A hard budget constraint means “you’ve got to have the money to spend it,” whereas a soft budget constraint means there’s no limit to one’s spending and losses can in principle be rolled over indefinitely.
Local governments in China operate under soft budget constraints, in contrast to the hard budget constraints of other major Western economies, and because they comprise a significant share of economic activity, China’s GDP numbers are fundamentally different in nature and as such, incomparable.
He illustrates this point by two hypothetical, identical Chinas—with the only difference being one has hard budget constraints and the other has soft budget constraints.
In the first China, a construction firm spends $100 digging a hole, then $100 filling it up. “In a hard budget constraint economy or in a normal accounting, you have an expense of $200 and nothing to show for it,” said Pettis.
In the second China, a construction firm similarly spends $100 digging a hole, then $100 filling it up. “But in [this] China, you don’t expense it,” he explained. “You call it an asset.
You say, I have now built an asset worth $200.” This, Pettis noted, is how GDP accounting works in the China that we all know. What this means is that China’s official GDP figures as currently reported are significantly inflated relative to actual economic conditions, and are also impossible to compare with the GDP figures of other nations.
You can see the full article here:What China means when it says it wants “high quality” GDP growthBeijing wants to focus on quality over quantity of GDP growth, but that’s much easier said than done.https://qz.com/2119395/what-china-means-by-high-quality-economic-growth/
To give a simple example to his point, let’s say one province in China has a GDP of 600billion and the target is 6% growth (so 630 billion is needed).
Now let’s say there is so real growth of 3%. However, it is fairly easy, with the soft budget constraints for the local government to engage in unproductive (or low-yielding at least) investments to achieve the other 3%, which wouldn’t be counted in a hard constraint economy.
That is one reason there are so many ghost cities and excessive infrastructure projects in China, such as second and third airports in cities that don’t need them.
So, China grew by 5.95% in 2019 versus 2%-3% for the US, using both country’s accepted GDP growth measurements.
However, if you were to standardize the measurements, China and the US would have grown by a similar amount.
What is interesting is that he also appears regularly on the Chinese state, so his findings aren’t seen as embarrassing by the regime, and China itself is now focusing on “high-quality growth” because they recognize the problem.
I have yet to find somebody who has actually refuted his central claim that there is not necessarily any lying or manipulation going on, but the different use of statistics is distorting the total figures.
This should be interesting for investors thinking about investing in Mainland Chinese private companies.
I don’t think it makes any difference to those looking to invest in Chinese stocks because GDP growth and stock market performance often aren’t linked.
So, we can’t say that weaker GDP growth will mean lower valuations for Chinese stocks, especially as they look very cheap compared to some markets.
The Chinese Communist Party has always relied on deception to wrong-foot rivals and attain the advantage in negotiations. Deng Xiaoping famously counseled, “Hide your strength, bide your time.” But Xi Jinping prefers to exaggerate China’s economic strengths and conceal its vulnerabilities.
Mr. Xi’s brazen approach conditions other countries to believe that Beijing enjoys a superior hand, that China’s rise and dominance are inevitable. These erroneous beliefs weaken the will of injured parties, including Western nations, to resist predatory Chinese behavior.
President Trump and Mr. Xi confirmed a “phase 1” trade agreement Friday. Both need the deal for domestic political and economic reasons. But in every negotiation, pressure is relative, and the U.S. has more political and economic leverage than China. This insight will help the U.S. during the more difficult second phase of negotiations.
Consider why China engages in predatory, illegal economic behavior. It needs to grow rapidly to maintain fiscal stability, manage its debt and advance its strategic and military ambitions. China can’t become the dominant power in the Indo-Pacific without sustained growth. The only reliable way Beijing has of maintaining adequate growth is to support its companies with cheap credit. The rise in Chinese corporate debt since the 2008-09 financial crisis has been one of the largest and most rapid—in relative and absolute terms—for any 10-year period in peacetime economic history.
China cannot significantly deleverage without drastic changes to its political economy. The model involves offering state-owned enterprises and national champions such as Huawei cheap finance and privileged domestic-market access at the expense of an independent private sector. China showers state businesses with subsidies and stolen intellectual property, and shields them from foreign competition.
The Chinese domestic economy is slowing because of chronic overinvestment. This provides the economic rationale behind plans such as the Belt and Road Initiative and Made in China 2025. The former is a scheme to export excess capacity and lock in new regional markets for Chinese firms, especially in infrastructure. The latter is a new export-oriented approach based on dominating increasingly important advanced and high-technology sectors in global markets. Both attempt to create external commercial opportunities for protected, unreformed Chinese firms without the need to reform the country’s main economic and political institutions.
That brings us to the question of negotiating leverage.
The current Chinese model is self-defeating. Less-deserving companies continue to receive the bulk of finance and opportunity. The staggering misallocation of capital is worsening, which makes the mushrooming debt even harder to manage. And allocation of opportunity is political. This means that the private sector, and therefore household income, will continue to remain artificially suppressed—putting even more pressure on Beijing to stimulate growth through further credit expansion.
The U.S. has a far more adaptive and diverse economy than China. China’s economy is inefficient, bloated, dysfunctional—plagued by institutions and policies that are not fit for their purposes. If the tariff war resumes, it will continue to prove much more disruptive to China than to the U.S.
Moreover, by calling attention to the seriousness of Chinese trade violations, Mr. Trump is properly recasting China as the main threat to a fair and sustainable global economic system. Multinational companies are gradually assessing the commercial risk that sovereign risk poses to them—the possibility that China will arbitrarily alter laws or regulations or fail to honor government bonds when they mature.
In recent years, Mr. Xi has been openly accused by former senior officials and influential journalists and academics of mismanaging the relationship with America, decisively abandoning any market-based reforms that would make the Chinese economy more resilient and agile, and overreaching with his aggressive promotion of Belt and Road and Made in China 2025. Leaks about the abhorrent treatment of Uighurs in Xinjiang seem designed to undermine him, while continued protests in Hong Kong are a stark rejection of his authoritarianism.
Mr. Xi’s purging of more than 1.5 million officials, including top generals and party members, will come back to bite him. In addition to holding a weaker economic hand, Mr. Xi is far more vulnerable to internal rebellion, and therefore more desperate for economic pain relief, than the American president.
Mr. Trump has threatened to walk away if any agreement—including the final details of the phase 1 deal—is not to his liking. He indicated in “The Art of the Deal” that his style is to aim high and keep pushing and pushing until he gets what he wants. Let’s hope he follows through. The national interest depends on it.