China’s crazy numbers

The Big Picture is right.  China's growth numbers are not to be trusted.   China's growth almost certainly slowed more than the government acknowledged in say 1998 and 1999, after the Asian crisis.  And China probably grew faster than the government acknowledged in 2003 - and perhaps is growing faster than the headline numbers say now. 

Lots of numbers just don't add up.

But one thing is certainly true - despite the title of this New York Times article ("Consumer demand at home keeps China's factories humming ... "), consumption growth has not been driving the Chinese economy this year.

Sure, consumer spending is up.  

Retail sales rose at a robust pace of 12.7 percent in September after August's 12.5 percent. And M2, a broad measure of the money supply, grew 17.9 percent in September and has been accelerating since spring.

But consumer spending is not up as much as investment.  Urban investment was up 30% y/y in the third quarter.  Year to date, fixed investment is up 26%. 

As Morgan Stanley notes, investment now makes up 54% of China's GDP - up from 48% in the first three quarters of last year.  National accounts gurus know that 54% investment plus a 6% current account surplus implies national savings of ... close to 60% of GDP.  That is nuts.

Exports are also growing faster than retail sales.  They were up 26% in September, down from 33% in August.  But for the first three quarters, they are up over 30%. 

Of course, all three are increasing either as fast as GDP (retail sales) or faster than GDP (exports and investment), which does pose a few logical problems.  Nominal GDP is up 12.8% y/y.  Real GDP is up 9.4%  

The World Bank Quarterly (see especially the box on p. 4) can help us sift through some of these data puzzles.  They have developed a few rules of thumb to help translate the commonly reported headline consumer growth and investment numbers into the national income accounts.

It turns out that the retail sales growth number typically is higher than overall consumption growth, since retail sales data leaves out both the sales of service and public consumption, both of which have grown more slowly than retail "goods" sales.

And the fixed investment data focuses on urban investment, and includes land purchases.  Overall investment numbers in the national accounts, according to the World Bank, are typically are about 6-8% higher than urban fixed investment numbers.

That does not change the basic story though.   

China's growth continues to be led by investment and exports.  It actually became more dependent on exports in 2005 as a result of the government's efforts in 2004 to clamp down on certain types of investment.   So long as consumption is growing more slowly than the economy, consumption will fall as a share of GDP and savings will rise as share of GDP.  And right now, both investment and exports are still rising as a share of GDP.

In other words, an unbalanced Chinese economy got more unbalanced over the course of 2005.

But the Keith Bradsher New York Times story does capture one important truth: it certainly seem that China has taken some policy steps to stimulate its domestic economy recently. 

A year and a half after the Chinese government imposed strict bank lending controls and other measures to cool an overheating economy, the authorities in Beijing have begun easing up in other areas and are starting to let the good times roll. They have cut taxes for farmers and hinted at broader tax cuts, except for fuel, which could further stimulate the economy.

"Recent data suggest that domestic demand in China is on the mend," wrote Liang Hong, a Goldman Sachs analyst, in a recent research report, "supported by a quiet easing of monetary policy and other more domestic-demand-friendly policy changes."

We will see what impact these steps have on the composition of China's 2006 growth.  It certainly seems likely that domestic demand growth will pick up somewhat.  The recent revival of import growth in China and export growth elsewhere in Asia (See Stephen Roach) suggest that China's 2006 growth will not be driven so strongly by net exports.  

But make no mistake: exports and investment remained the drivers of China's 2005 growth. 

And with investment such a large share of GDP, a sharp investment slowdown remains a huge risk to China's expansion.   Investment booms have been known to turn into investment busts.  And remember, even if investment slows in the future, the capacity created by China's current investment boom will still be coming on line - indeed, the scenario that worries me most is a correlated slowdown in consumption demand in the US and investment demand in China.   That would make China more dependent on exports even as the United States' capacity to shift workers out of the tradables sector and into residential construction slows and its capacity to support consumption by borrowing against rising home prices falls (check out this Big Picture/ Barron's graph).  Treasury Under Secretary Tim Adams really will have his hands full then.