China

GDP in the Red?

A new article in The Economist reveals a startling discovery: when China’s GDP was recalculated using Purchasing Power Parity, China’s GDP fell by 40%. Is there cause for concern, or is this just more statistic slinging by economists?

Purchasing Power Parity is the measure of the nominal exchange rate between two countries obtained by comparing the price differential between goods in the two countries. For example, if a Big Mac costs $1 in the U.S. and ¥10 in Japan, then the exchange rate should be ¥10 to $1. But the ratio of prices between two countries based on only one good may not be an accurate estimate—there could be a myriad of other factors that impact price, like the availability of beef, for example. Thus, studies must use the prices of goods across a wide variety of sectors. The 2005 study of PPP used the prices of 1,000 goods and services.

Interestingly, a 1999 paper published by Chen Kai at the World Bank comes to the completely opposite conclusion from the Economist—that by using PPP, China’s GDP should be much higher than listed. However, this paper addresses China’s GDP from the period of 1980-1991, different from the 2005 calculation reported in The Economist.

Is it possible for China’s GDP to be grossly underestimated by using the PPP approach in 1991, and then be radically overstated 15 years later? One explanation might be the stratification of China’s economy. China’s growing wealth gap could very well be reflected in the prices of goods and services. China’s urban class is growing in wealth while the rural poor, the majority of China’s population, remains impoverished. Prices in shops and restaurants around Beijing vary wildly in price, based on location and intended audience (34 RMB for a Venti Frappucino in Zhongguancun; 2.5 RMB for half a dozen baozi in Dahongmen). The goal of selecting 1,000 different goods to compare is so that such disparities even out. But with China’s much more bipolar economy, how effective is it to compare price differentials?

Some might question the role of income disparity and point out that the China’s Gini coefficient is similar to America’s. Thus, differences in economic price structures shouldn’t matter since both countries have similar income gaps. But the Gini coefficient is a measure of the inequality of wealth distribution, a measure in which the size of a country’s GDP doesn’t matter.

In addition, the Gini coefficient does not measure income derived from wealth. The booming stock market in China amounts to very significant gains in wealth for the small fraction of Chinese who can afford to invest, thus significantly increasing the wealth gap. Stock ownership in China in 2006 was estimated to be less than 10% of the population, compared to about half of the U.S. population in 2004. Further, the Chinese middle class is estimated to be only 13% of the population, while in the United States it’s closer to 45%-50%.

Even the economic measurements in a country with very open information, such as the United States, have a margin of error. With much data about the Chinese economy is left opaque—such as the inner management of state-owned enterprises and sovereign wealth funds—the margin of error for measurements is much greater. It’s not out of the question that GDP is grossly overstated.

© 2008 The Hypermodern.