There has been talk lately concerning the possibility that the Chinese may be fudging their economic numbers. Some people refuse to believe that China has been growing at 10% or so a year and they question the veracity of the statistics put out by the Chinese with regard to their Gross Domestic Product (GDP). Other people believe the statistics are correct but they cannot explain some of the numbers they see.
So the question remains: Does China fudge the economic figures, yes or no? The simple answer is both yes and no but the explanation is more complicated than that. To make it easy for me to write this piece and for you to read it, I ask that you imagine a hypothetical case where I shall use round figures to illustrate my points rather than delve into the actual numbers which are lengthy and cumbersome.
Imagine a country with a population of a million people. These are mostly subsistence farmers and therefore they have a primitive economy. Their GDP barely reaches 200 million dollars which means that their per capita income is 200 dollars a year.
They begin to industrialize and they manage to expand their economy at an average real growth rate of 5% a year over the following 50 years. To see what this does to the economy, you grab your calculator and raise the number 1.05 to the power of 50. You obtain the answer 11.47 which means that the 200 million GDP will grow 11.47 times to the approximate value of 2.3 billion dollars over the period. Inflation is excluded from this calculation.
If we assume that the population of the country grows by 1.5% a year, it will grow to 2.1 million people over the 50 years. In this case, the per capita income will go in real terms from 200 dollars a year to 1,095 dollars. Now, let us assume that inflation will grow by an average 3% a year. In this case the 1,095 dollar per capita income of the base year will grow to about 4,800 dollars at the prices that will prevail 50 years hence.
Now let us get realistic. We live today in the year 2008, and fifty years ago was the year 1958. Can you point to an agrarian society that began to industrialize in 1958 which grew at an average 5% a year and is today stuck with a per capita income of only 4,800 dollars? No you cannot point to such a society because there isn’t one.
The reality is that the nations of Asia and Southern Europe which started to industrialize at about that time and scored a consistent rate of growth approaching 5% a year do enjoy a per capita income of no less than 28,800 dollars today. This is 6 times the 4,800 dollars calculated above.
Does this mean those nations grew at 6 times 5% a year? No it does not mean that because what we are dealing with is exponential mathematics. When you do the calculations, you find that a growth rate of only 8.83 % over 50 years will result in a per capita income that is 6 times higher than would the 5% rate of growth. But why did the nations in Asia and Southern Europe indicate a 5% rate of growth rather than 8.83%?
The answer is that they did not spend much time thinking about these matters whereas the Chinese seem to have asked the right questions and found the right answers. Consequently, instead of doing what the other nations did which is to reconcile the value of their GDP with the reality on the ground once every 10 years or so, they did the reconciliation on a yearly basis by showing a higher rate of growth than the numbers seem to indicate. And the question now is this: Why is there a discrepancy between the real rate of growth and the apparent rate?
To answer this question we imagine another situation. A teenager doing odd jobs in rural China earns 2 dollars a day. He migrates to America where he washes dishes in a restaurant and earns 40 dollars a day. He is the same boy with the same level of education and the same skills; so why is he now earning 20 times as much as before?
The simple answer is that he now lives in a country where the per capita income is 20 times that of China. But the comprehensive answer is that he earns 20 times as much because he needs this much money to feed and clothes himself in America, something he could do in rural China with only 2 dollars a day.
This leads to the notion that when China will have fully industrialized and when all of its interior will come to resemble the United States, a boy anywhere in that country with no education and no skill will have to earn 20 times as much as today just to feed and clothes himself.
This is due to something I call the complexity factor. For example, the amount of wheat that goes into making a loaf of bread can be purchased at the farm level in America or in China for only 5 cents. This is how much it will cost to make a loaf of bread in a country where most of the population lives on the farm or near it. But when you buy that same loaf in a country that is fully industrialized, you will pay something like a dollar or 20 times as much.
This is because in a modern industrial nation the wheat will be transported from the farm to the flour mill, from there to the bakery and from there to the supermarket. You will buy the bread there and pay for the flour, the wrapping, the transportation, the fuel, the interest on money borrowed by the various parties, the overhead and so on and so forth. This is the complexity of modern industrial life that adds to the price of everything, every step of the way. I call this the complexity gap between the rural and the industrial.
We may therefore conclude that as modernity sprawls into the primitive interior of China from the modern coastal areas, the gap between the levels of complexity in the two regions will steadily shrink until it disappears completely. In fact, the gap between China as a whole and America has now shrunk to a 20 fold gap from the 40 fold gap that it used to be.
Thus, when we do calculations, the rate of growth we assign to a country that is industrializing must incorporate two components. A component that is the apparent rate of growth which is normally in the range of 5%. And a component that would range from negligible to perhaps as much as 4% and that will reflect the complexity gap.
Failing this, there will have to be a periodic adjustment to the GDP in order to boost it by something like 30% or 50% every decade or so to reconcile the numbers. In fact, this is being done now to the emerging economies. It was done to the Thai, Turkish and Ukrainian economies not long ago and it will soon be done to the Egyptian and Moroccan economies because the stated GDPs of these countries are far below their real values.
Now, the beauty about mathematics is that there is always a way to double check your answers. So let us ask the question: At what rate must a country grow in real terms to boost the per capita income of its citizens by 40 fold in 50 years? To answer the question you grab your calculator and take the 50 th root of the number 40. This gives the approximate answer of 1.0766. It means that each year, the per capita income must grow by that much. To turn this into a percentage value, you deduct 1 and multiply the remainder by 100. You get the result 7.66%.
If you do not have the root function in your calculator but have the log function, you take the log of 40, divide it by 50 and then take the antilog of the result. You get the same answer as before and then do the percentage transformation.
Add to this percentage the rate of growth in the population and you come close to the 10% rate of GDP growth that China is consistently showing. You conclude that the other emerging nations are underestimating their own rates of growth because in reality they should be closer to the Chinese rate than they are willing to indicate.
Finally, there are a number of other ways to estimate the GDP, the rate of growth and the per capita income of a country. When you check them out, they all confirm that the emerging nations score higher values than those countries are willing to report, and that China’s figures are closer to the real values.
Thus, if the question is: Do the emerging economies fudge their economic numbers? The answer is yes they do but they do it on the low side. As for the Chinese, the answer is no, they do not fudge because the figures they publish are close to the real thing. But yes, they do fudge if you look at the technical definition of what those figures are supposed to represent.