Do you believe growth figures in China? What about the US, Canada, or Germany?
Actually, there is no reason to believe any GDP numbers. A recent email from Michael Pettis at China Financial Markets explains.
From Pettis ….
Last year China’s official growth rate was 7.8%, above the 7.5% target but the lowest number in many years and far lower than the more than 10% growth rates China had generated for the past two decades.
But even with the lower growth numbers throughout the year economists were puzzled by evidence that the economy was in fact growing more slowly than the official numbers suggested. Energy consumption in China, for example, usually grows more quickly than GDP, but surprisingly, in 2012 energy usage grew by only 5.5%, well below the official growth rate of 7.8%. Other indicators also indicated that growth may have been lower than the official numbers suggested.
While some of the sell-side economists still insist that China’s growth remained high and healthy enough, in fact among independent economists who specialize in the Chinese economy, both among Chinese and foreign economists there has been growing skepticism. A consensus is developing that China grew by less that 7.8% in 2012. For example Stephen Green at Standard Chartered, one of my favorites of the sell-side economists, refigured his numbers and guesses that instead of 9.3% for 2011 and 7.8% for 2012 (the official numbers), actual growth might have been 7.2% for 2011 and 5.5% for 2012. Other economists are suggesting even lower numbers, closer to zero.
I don’t have my own estimates because it seems to me that all of these attempts to measure economic growth are actually measuring economic activity, which may itself overstate growth. If you spend $100 million each on two separate bridges, one of which is actively used and the other rarely used, the official measures will have them contributing the same amount to GDP, even though the former creates real value and the latter does not. In either case if you then adjust the overall GDP numbers downwards by examining electricity usage, cement consumption, and so on, as the likes of Stephen Green do, you may end up with a more accurate estimate of economic activity, but you still treat the two bridges as contributing the same amount.
It isn’t until you write down the debt associated with the second bridge that you end up with a more meaningful measure of GDP. Of course this makes the whole process very confusing and it is hard to compare different estimates. It isn’t always clear how these estimates are reached, but as far as I can tell nearly all, if not all, of the downward revisions provided by various skeptical economists are still measures of economic activity, and do not include estimates for debt write-down associated with unnecessary investment.
We Know What To Do
There have been so many articles in the Chinese and foreign press about problems in the banking system that I won’t bother going through the topic much more except to note that Beijing cannot tolerate rapid credit growth and it cannot tolerate slow GDP growth. The problem is that it can only choose both or neither. There are no other options.
As credit concerns continue to rise, expect Beijing eventually to bite the bullet and stamp down on debt, in which case expect GDP growth rates to drop much, much more, in fact to well below anything we saw in 2012. The question is not whether this will happen, but when. Once Beijing is confident enough about its grip over vested interests and the consensus has developed within the leadership, growth rates will drop very sharply.
So this is probably why former Premier Wen is warning about the difficulty China faces in reforming the economy – a warning that he and Premier Li have made many times before but never more shrilly.
I have said often enough that we will be able to judge how resolute Beijing is and how capable of overcoming vested interests by how quickly credit growth is constrained and, with it, GPD growth. I expect to see high GDP growth (close to 8%) in the first half of the year but, if Beijing is able to move quickly, I expect growth to slow significantly in the second half.
If GDP growth does not slow, I will be worried about how long it takes the new leadership to get their arms around the problem that they clearly recognize (although perhaps still underestimate). The signals so far are good. Growth may be slowing even quicker than I had originally anticipated.
Does Cyprus matter?
I can’t really finish this newsletter without noting the astonishing events in Cyprus, especially since everyone in the world has already mentioned them. The concern most commentators have expressed is that by going after depositors the EU may have paved the way for bank runs in the rest of peripheral Europe. Quite a few analysts warned that we will begin to see this happen fairly soon.
I agree, but see it a little differently. The Cyprus proposal will probably have little impact on deposits now, but it will have an impact on memory. Depositors in the peripheral countries will remember what happened in Cyprus and it will affect their future confidence in the credibility of deposit guarantees.
We can imagine the “Cyprus effect” as a point on the credibility curve at which there is a sudden discontinuous or non-linear jump. As a country’s credibility declines, the deterioration in credibility was never likely to be smooth and linear because the process is self-reinforcing, but now we have added a sharp discontinuity. At some point of lower credibility, depositors, remembering Cyprus, will suddenly and sharply speed up their deposit withdrawal. And even if the original Cyprus plan is modified to protect small depositors, it probably won’t matter. The cat has already been let out of the bag.
Instead of embedding countercyclical mechanisms we have just embedded a big, fat, highly pro-cyclical pump into the credibility curve. It won’t matter so much now, but as things deteriorate, it will matter at some point, and of course always at the worst possible time.
Problem In The Definition
I italicized the key point. By definition, government spending contributes to GDP. No products have to be produced. Economic benefits are unnecessary.
Pettis used an example of governments building worthless bridges. Previously I have noted that if the government hired people to spit at the moon it would add to GDP. And that is an inherent problem with the definition.
In France, government spending accounts to 56% of GDP. How much of that spending is wasteful? How much government spending in the US is wasted?
Consider how Davis-Bacon and prevailing wage laws affect the answer. In the case of roads repairs, if the private market could do as good a repair job for 1/3 less, then the answer is 33.3%. But what about projects that should not be done at all?
Spending can even be net-negative as is the case in bombing countries for no reason. What did the US accomplish in Vietnam or Iraq? Even bridges to nowhere have more economic benefit.
While everyone is ready and willing to consider that China overstates its GDP, too few point the same finger at the US for the same reason.
Mike “Mish” Shedlock