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"On my part, I remain committed to the process of dialogue. It is my firm belief that dialogue and a willingness to look with honesty and clarity at the reality of Tibet can lead us to a viable solution."

How China Cooks Its Books

September 9, 2009

It's an open secret that China has doctored its economic and financial
statistics since the time of Mao. But could it all go south now?

BY JORDAN CALINOFF
Foreign Policy - SEPTEMBER 3, 2009

In February, local Chinese Labor Ministry officials came to "help" with
massive layoffs at an electronics factory in Guangdong province, China.

The owner of the factory felt nervous having government officials there, but
kept his mouth shut. Who was he to complain that the officials were breaking
the law by interfering with the firings, he added. They were the law! And
they ordered him to offer his workers what seemed like a pretty good deal:
Accept the layoff and receive the legal severance package, or "resign" and
get an even larger upfront payment.

"I would estimate around 70 percent of workers took the resignation deal.
This is happening all over Guangdong," the factory owner said. "I help the
Department of Labor, and they'll help me later on down the line."

Such open-secret programs, writ large, help China manipulate its
unemployment rate, because workers who "resign" don't count toward that
number. The government estimates that roughly 20 million migrant factory
workers have lost their jobs since the downturn started. But, with
"resignations" included, the number is likely closer to 40 million or 50
million, according to estimates made by Yiping Huang, chief Asia economist
for Citigroup. That is the same size as Germany's entire work force. China
similarly distorts everything from its GDP to retail sales figures to
production activity. This sort of number-padding isn't just unethical, it's
also dangerous: The push to develop rosy economic data could actually lead
China's economy over the cliff.

Western media outlets often portray Chinese book-cooking as part and parcel
of a monolithic central government and omnipotent Beijing bureaucrats. But
the problem is manifold, a product of centralized government as well as
decentralized officials.

Pressure to distort or fudge statistics likely comes from up high -- and
it's intense. "China announces its annual objective of GDP growth rate each
year. In Chinese culture, the government has to reach the objective;
otherwise, they will 'lose face,'" said Gary Liu, deputy director of the
China Europe International Business School's Lujiazui International
Financial Research Center. "For instance, the government announced that it
wanted to ensure a GDP growth rate of 8 percent in 2009, and it has become
the priority for government officials to meet that objective."

But local and provincial governmental officials are the ones who actually
fiddle with the numbers. They retain considerable autonomy and power, and
have a self-interested reason to manipulate economic statistics. When they
reach or exceed the central government's economic goals, they get rewarded
with better jobs or more money. "The higher [their] GDP [figures], the
higher the chance will be for local officials to get promoted," explained
Liu.

Such statistical creativity is nothing new in China. In 1958, Chairman Mao
proclaimed that China would surpass Britain in steel production within 15
years. He mobilized villages throughout China to establish backyard steel
furnaces, where in a futile attempt to reach outrageous production goals,
villagers could melt down pots and pans and even burn their own furniture
for furnace fuel. This effort produced worthless pig iron and diverted
enough labor away from agriculture to be a main driver in the devastating
famine of the Great Leap Forward.

Last October, Vice Premier Li Keqiang said in a speech after inspecting
China's Statistics Bureau, "China's foundation for statistics is still very
weak, and the quality of statistics is to be further improved" -- a brutally
harsh assessment coming from a top state official.

Indeed, China has predicated its very claim of being the healthiest large
economy in the world on faulty statistics. The government insists that even
though China's all-important export sector has been devastated
-- contracting about 25 percent in the past year -- a massive uptick in
domestic consumption has kept factories producing and growth churning along.
A close examination of retail sales and GDP growth, however, tells a
different story. China's domestic retail sales have risen about 15 percent
year on year, but that does not really translate into Chinese consumers
purchasing 15 percent more televisions and T-shirts. The country tabulates
sales when a factory ships units to a retailer, meaning China includes
unused or warehoused inventory in its consumption data. There is ample
evidence that state-owned enterprises buy goods from one another, simply
shifting products back and forth, and that those transactions count as
retail sales in national statistics.

China's retail statistics seem implausible for other reasons, too. They
would imply an increase in salaries among Chinese people, allowing them to
purchase that extra 15 percent. To be sure, the Statistics Bureau reported
salaries had increased 12.9 percent in the first half of 2009.

But Chinese netizens complained such numbers were hard to believe -- as did
the bureau's chief.

A look at GDP growth also raises serious questions. China's economy grew at
an annualized 6.1 percent rate in the first quarter, and 7.9 percent in the
second. Yet electricity usage, a key indicator in industrial growth and a
harder metric to manipulate, declined 2.2 percent in the first six months of
the year. How could an economy largely dependent on manufacturing grow while
its industrial sector shrank?

It couldn't; the numbers don't add up. China announced a $600 billion
stimulus package (equal to about 14 percent of GDP) last fall. At that
point, local governments started counting the dedicated stimulus funds in
GDP statistics -- before finding projects to use the funds, and therefore
far before the trillions of yuan started trickling into the economy. Local
governments keen to raise their growth and production numbers said they
spent stimulus money while still deciding on what to spend it, one economist
explained. Thus, China's provincial GDP tabulations add up to far more than
the countrywide estimate.

Alternative macroeconomic metrics, such as the purchasing managers' index
(PMI), which measures output, offer a no more accurate reflection.

One private brokerage house, CLSA, compiles its own PMI, suggesting a sharp
contraction in industrial output between December 2008 and March 2009.
Beijing's PMI data, on the other hand, indicated that industrial output was
expanding during that period.

Unfortunately, such obfuscation means China's real economic health is
difficult to assess. Most indicators that would help an intrepid economist
correct the government numbers -- progress on infrastructure projects,
end-user purchases, and the number of "resigned" workers --
are not public.

Still, it is possible to infer the severity of the gap between economic
reality and China-on-paper by looking closely at monetary policy.

China's state-owned banks dramatically increased lending in the first half
of 2009 -- by 34.5 percent year on year, to more than $1 trillion.

This move seems intended to keep growth artificially high until exports
bounce back. Most analysts agree that it is leading to large bubbles in the
stock, real estate, and commodity markets. And the Chinese government
recently announced plans to raise capital requirements -- an apparent sign
it sees the need to reign in the expansion.

For the long term, China is banking on its main export markets -- in the
United States, Europe, and Japan -- recovering and starting to consume
again. The hope is that in the meantime, rosy economic figures will placate
the masses and stop unrest. But, if the rest of the world does not rebound,
China risks the bursting of asset bubbles in property and stocks, declining
domestic consumption, and rising unemployment.

That's when the Wile E. Coyote moment could happen. Once Chinese citizens no
longer believe that the economy is doing well, social unrest and more
widespread worker riots -- already increasing in scope and severity -- are
likely. That's something that China will have a harder time hiding. And then
we'll know whether China's statistical manipulation was a smart move or a
disastrous mistake.
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