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Everyone knows that China’s economy is slowing. But is it still growing? That depends on what you measure. In this episode of the podcast, we’re talking with three experts, each with a different take on assessing the Chinese economy. Featuring interviews with recent authors Salvatore Babones, Eduardo Campanella, and Pankaj Ghemawat.
To learn more on the subject, check out these related links:
How Weak Is China? By Salvatore Babones
Misreading China’s Economy By Edoardo Campanella
Can China’s Companies Conquer the World? By Pankaj Ghemawat and Thomas Hout
This podcast has been edited and condensed. A rush transcript is below. Music credit: FreeMusicArchive.org / The Stealing Orchestra & Rafael Dionisio, Podington Bear
ALLAWALA: Everyone knows that China’s economy is slowing. But is it still growing? That depends on what you measure. Today on the podcast, we’re talking with three experts, each with a different take on assessing the Chinese economy. Some are more optimistic than others. But, however you slice it, it is clear that we’ve been looking at China all wrong.
BABONES: The Chinese government sets targets for itself every five years, and we've just started in the 13th five year plan, which will cover 2016 through 2020. When the Chinese government sets targets, it meets targets, [chuckle] that's part of its ethic…
ALLAWALA: That’s Salvatore Babones, an Associate Professor of Sociology and Social Policy at the University of Sydney. Because China is so keen to meet its targets, he says, they become festishized.
BABONES: So the targets become, well, fetishized, they become something everybody has to meet, or else. And that means that numbers are very often massaged to hit the targets. And we know the numbers are massaged, because the overall targeted numbers don't match the underlying statistics that make up the target.
ALLAWALA: Over the next five years, China expects its GDP per capital to grow at 6.5 to 7 percent each year. The country claims that the growth rate for 2015 was 6.9 percent, which most analysts have found unlikely.
BABONES: The problem with a 6.9% number for 2015 is that none of the components of GDP are growing at 6.9%, none of them. And not only that, most of the components of GDP aren't growing at all. So if the components of GDP aren't growing, it's very difficult to come up with a figure that says GDP is growing.
ALLAWALA: As Babones writes in a recent article for Foreign Affairs, there are two compnets of GDP that are growing: retail sales and government spending.
BABONES: Retail sales growth is pegged by the government at slightly over 10% for 2015, but it's hard to reconcile retail sales growth of more than 10% when production is down, and imports are down. Where is all this stuff coming from that's being sold?
ALLAWALA: Beijing’s spending rose at an officially acknowledged rate of 15.8 percent in 2015, bringing the government's official budget deficit up to 2.3 percent of GDP. Spending growth was even higher toward the end of 2015, reaching 36 percent year-on-year in October 2015. China’s State Council—the country’s chief administrative authority—has stated that “experts believe” that China will run a fiscal deficit of “three percent or higher” in 2016.
Even so, Babones writes, the 12th five-year plan didn’t include any plans for massive deficit spending. In fact, the first high-profile announcement wasn’t until the end of December.
BABONES: The first high-profile government announcement, wasn't until the end of December. Between Christmas and New Years, the government announced that its deficit spending for 2015 had risen much higher than planned, and that it was planning to continue deficit spending into 2016.
ALLAWALA: Babones argues that it is anyone’s guess how long China can continue spending like this.
BABONES: This is a big open question. The United States, of course, ran fiscal deficits more than 10% of GDP during the 2008-2009 financial crisis, but the United States has massive fiscal capacity, massive capacity to borrow, massive capacity to convince lenders that it will ultimately repay. The United States borrows entirely in its own currency, the US dollar, so there's very little risk of any kind of default.
China does borrow primarily in its own currency, so it would be borrowing in Renminbi, which means in theory, the Peoples Bank of China could print as much money as it wants. But, nobody really knows what China will do. China is insisting that it wants to adhere to contemporary principles of fiscal prudence, it doesn't want to see runaway hyper-inflation, or runaway government spending.
ALLAWALA: In fact, spending might not be the problem at all.
BABONES: China's levels of spending are way below Western norms for levels of government spending. The problem is that China's tax system is typical of developing countries. China relies, almost entirely, on value-added and sales taxes, so they raise tax revenue indirectly from people who don't feel the pain, so to speak, of paying taxes. And they have very little income generated by the national income tax in China.
ALLAWALA: Value-added tax is a tax on the amount of value added to an item at each stage of production, when inputs are transformed into outputs of higher value.
BABONES: Value-added taxes thus represent, in theory, all value added in the economy, or in other words, GDP. There are only two major categories that are exempt from value-added tax, government spending, and exports. Well, we know that government spending is up, we know that exports are down in China. But for the rest of the economy, for the broad swath of the domestic economy that's just people producing and buying inside the country, according to China's own figures, the value-added tax revenue is up less then 1%, that implies that the value-added is up than less then 1%.
ALLAWALA: Facing facts like these, Babones thinks that the only source of growth in China today is almost certainly government deficit spending—and that should make Beijing nervous.
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ALLAWALA: Our next guest prefers to approach the question of Chinese economic health from a different angle.
EDUARDO CAMPANELLA: Hi, I'm Eduardo Campanella, Junior Fellow at the Aspen Institute Italia.
ALLAWALA: He’s also author of the recent Foreign Affairs article, “Misreading China’s Economy,” in which he makes the case that the traditional economic indicators that we use to measure growth no longer make much sense for a changing Chinese economy.
CAMPANELLA: Yes. So the Chinese economy is transitioning from a investment-led expert-driven economy to a consumption-driven economy. So everybody knows that, but still, most of -- most of the figure that we look at are related to the old economy. The old economy is actually slowing down. It has been slowing down for four or five years now, and yes, we are having another (ph) economy, a service-based economy that is emerging and striving.
ALLAWALA: In fact, in 2013, services overtook the industrial sector in both total size and pace of growth, and they now account for almost 50 percent of China’s GDP.
CAMPANELLA: The figures we should look at are, for instance, the years related to the online economy to the retail sector or to average leisure activities in general. And unfortunately, there is a lack of attention on that and the reason being the fact that we don't have high-quality data on these -- for these kind of activities. In general, we should not be surprised that the quality of macroeconomic figures that come out from China are of low quality because China is still a developing economy that lacks both the expertise and the resources to collect high-quality data. So we have seen that problem even in advanced economies, so we should not be surprised that China is struggling to produce reliable figures. And that's why usually investors look at proxy. One proxy that is commonly -- commonly used is the so-called Li Keqiang Index that is made up of three indicators: electricity consumption, cargo transport and credit drop.
ALLAWALA: This index combines data about credit growth, energy consumption, and freight transport volumes—all indicators that are more sensitive to shocks in the industrial and commodity sectors than to changes in aggregate economic activity. The Index approach is crude, Campanella explains, but it was acceptable a decade ago when the industrial sector represented more than 60 percent of China’s economic activity when measured as gross value added (or production minus capital). But now, he says, this GDP proxy misses most of the economic picture.
ALLAWALA: For example, consider the role of two indicators: the monthly growth in train cargo and in train passengers. Cargo growth serves as a proxy for the performance of the old industry-based economyPassenger growth is a proxy of domestic tourism, a sector that is expected to expand as more and more people reach the middle class. Freight traffic has contracted for several quarters, and it is now shrinking by 15 percent on an annual basis. This indicates a softening in industrial growth that has indeed slowed from 15 percent in the first quarter of 2010 to the current 6.1 percent, Campanella says, at least according to the official numbers provided by Beijing. But since mid-2012 passenger traffic has continued to grow at around 10 percent annually.
ALLAWALA: Campanella suggests a few other things to measure as well.
CAMPANELLA: I think we should pay more attention to the digital economy. I think -- and I can (inaudible) few kind of activity, like online banking, mobile travel booking, online payments. these are all activities that have been expanding into double digits over the last few quarters.
We should look also at the figures coming from the educational sector, from healthcare, from leisure activities, because what we want to see is whether Chinese consumers are empowered (ph) and whether they can afford to pay to -- whether they can afford more sophisticated consumption habits.
ALLAWALA: With the new indicators, Campanella says that Chinese GDP growth looks to be more in the 6.5 percent range—close to what the government projects. All in all, he says, analysts should be trying harder to get China right.
CAMPANELLA: I think, first of all, the -- the Chinese authorities should work hard to improve the quality of the macroeconomic indicators they -- they produce, and to do so, they should work ideally with international organizations like the IMF or the World Bank in order to be supported (ph).
And second, I think also, financial investors should make an effort to try to understand how China is changing. They should, in a way, be (inaudible) collect new data. And something that I didn't mention in my article but I think it's extremely important, especially in developing economy, is to rely on local intelligence.
ALLAWALA: That was Eduardo Campanella discussing China’s new economy. Whether it is growing slowly, stagnating, or declining, many economists and analysts argue that China remains on course to overtake the United States and become the world’s leading economic power someday soon. Indeed, this has become a mainstream view on both sides of the Pacific. But proponents of this position, our next guest says, often neglect to take into account an important truth: economic power is closely related to business power, an area in which China still lags far behind the United States. Foreign Affairs’ Gideon Rose sits down with Pankaj Ghemawat to learn more.
PANKAJ GHEMAWAT: We're used to using undifferentiated measures of economic power or things like GDP etcetera, which have got their own limitations.
ALLAWALA: That’s Ghemawat.
GHEMAWAT: But in a situation where multinational corporations account for typically 75%, 80% of a nation's trade, foreign direct investment, and then revenue terms a comparable share of GDP, it seems that it's a little bit hard to make aggregate conclusions without actually looking at these big players.
ROSE: So how does looking at firms shift your perspective from looking at aggregate national figures?
GHEMAWAT: We did a study published in the Harvard Business Review about seven or eight years ago where we looked at, okay, within China, which sectors do Chinese companies lead in, which sectors do foreign companies lead in. We re-did the analysis for the current Foreign Affairs article and we were frankly very surprised by the results.
ROSE: Why? What was so surprising?
GHEMAWAT: Because we'd expected to see much, much more movement over a seven, eight year period.
ROSE: Movement in the sense of Chinese companies becoming more dynamic, global companies?
GHEMAWAT: Exactly. So, if one sort of assumed an equivalence or parallel movements between national economic indicators and company level indicators, you would've expected to see since 2006 or 2007 some significant improvements in the competitiveness of Chinese companies relative to foreign multinationals at home. And in fact, with the exception of one or two sectors, there were very few areas in which market share leadership shifted either from Chinese companies to multinationals, or more interestingly in the present context for multinationals to Chinese companies.
ROSE: So let's push this a little bit. Chinese companies, you're saying, tend to be essentially followers rather than leaders? Is that basically a way of putting it?
GHEMAWAT: By and large, they're followers and not just in terms of technology, which is the first thing that people think about, but we've known for a long time that multinationals tend to exist in industries where marketing and brands are important or where technology is important. In both those categories, most Chinese companies with a few salient exceptions like Lenovo, tend to lag significantly.
ROSE: One of the things that I was intrigued by with the article and this analysis is, that it helps reinforce how we know less than we think we do about what's going on in the economy. Our own or other's countries because we tend to ratify conventional statistics, particularly aggregate ones and say, "Well, that's the story." But if you read your piece you come away thinking, "Well, there's lots of stuff going on that we need to look at that may not be reflected in the gross aggregate statistics that we think about." Is that something that is, is it an appropriate take away? And when you're judging let's say the Chinese economy, how does the fact that we just don't know which metrics to use actually play into the game?
GHEMAWAT: Well, so, lots of people look at say the Chinese stock market, specially given the huge run up and then the meltdown that's happened over the last year-and-a-half. Now, what's interesting is that between 1990 and 2013, Chinese stock prices were essentially flat while the country was growing rapidly. So this is a little bit of a reminder that we still have very different economic systems, and that stock prices are way less informative in countries like China, where pretty much all stocks tend to move up or down on a given day, than they tend to be in countries with well functioning capital markets, like the United States.
ALLAWALA: In other words, Ghemawat says, confidence in the inevitability of Chinese economic dominance is unfounded. China is gaining strength but it faces a long climb. The outcome of the U.S.-Chinese contest, he argues, depends at least as much on how well Western multinationals and governments exploit their existing advantages as on China’s ability to up its own game.
That’s all for this week. We’ll be back in two weeks with another episode. Until then, please reach out to [email protected] with questions and comments, and leave a review on iTunes.