China’s gross domestic product (GDP) growth is being overstated by 1 to 2 percentage points due to a glitch in the way it is being calculated, according to estimates from Capital Economics, the Financial Times (FT) reports on Sunday.
According to the estimates from Capital Economics, this would mean China, the world’s second-largest economy, had only grown by 5 to 6 percent in the 12 months to the first quarter (Q1) of 2015, versus the 7 percent growth figure that was announced by Beijing.
China’s official GDP data has long been questioned and has attracted widespread scorn as many commentators have argued that its suspiciously smooth numbers have been manipulated for political reasons.
Analysis by Capital Economics, however, differs as it is suggesting an error arises from a technical issue with how the GDP growth is actually being calculated, versus a deliberate attempt to mislead.
Furthermore, if its analysis is accurate, this would suggest that a broad range of other emerging market countries could also be inadvertently overstating their GDP growth numbers.
The basis of the analysis by Capital Economics is focused on the “GDP deflator”, which is the inflation measure that is used to convert estimates of nominal GDP into real, inflation-adjusted terms.
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The deflator is a broader measure than indicators such as consumer or producer price inflation and is therefore often considered a more useful gauge of overall price pressures in an economy. It is the preferred inflation measure of the US Federal Reserve.
Since GDP is a measure of domestic output, arguably this deflator should only reflect the prices of domestically produced goods and services.
In practice, this means netting out the price of imports in the calculation of the GDP deflator, a routine practice in countries with “robust statistical systems”, as Chang Liu, China economist at Capital Economics, puts it.
For much of the time, a failure to do this might not matter too much. However, at times when import price inflation varies markedly from domestic inflation, such as when global commodity prices are rising or falling rapidly, it matters more.
As the chart shows, in 2007 when commodity prices spiked, the US consumer price index rose much more than the GDP deflator, widening the “inflation gap”, or the difference between the two measures.
More recently, as commodity prices have fallen, the US inflation gap has turned negative. A similar pattern has occurred in Japan, the UK and Germany, Capital Economics says.
However, because China does not net off shifts in import prices when calculating the deflator for most sectors of its economy, its deflator tracks producer price inflation much more closely.
With this in mind, Capital Economics says (Via FT):
“China’s GDP deflator is not an accurate measure of changes in domestic output prices. It exaggerates inflation when import prices are rising, and understates it when import prices fall”.
In the first quarter of the year, China’s deflator turned negative for the second time since 2000, coming in at -1.1 per cent. In comparison, consumer price inflation was +1.2 per cent. This means its inflation gap has jumped to 2.3 percentage points, even as it has fallen sharply in the likes of the US, as the chart shows.
If the deflator is, as a result, understated, then real GDP growth is overstated by the same amount.
“A reasonable guess might be that true inflation was 1-2 percentage points higher than the deflator shows. In that case, real GDP growth in Q1 would have been 5-6 per cent [rather than 7 per cent],” said Mr Liu.
Lui added that the lower rate was closer to Capital Economics’ own estimate, based on activity data, of 4.9 percent.
The GDP growth figure of 5 to 6 percent would also be closer to estimates other forecasters such as Citibank who suggests the “true figure” was actually below 6 percent, the Conference Board’s 4 percent, and Lombard Street Research with a mere 3.8 percent, according to the report.
Liu stresses that Capital Economics isn’t suggesting that China’s National Bureau of Statistics is intentionally skewing the deflator in an effort to exaggerate its reported GDP growth. Instead, he suggests that the problem stems from limitations in its data collection.
In March, Chinese Premier Li Keqiang set China’s official 2015 GDP growth target at “about 7 percent”.