China’s Economic Outlook – GDP Isn’t the Whole Story

The Bank of China recently forecast GDP growth of 7.2% in 2015. While such growth would be the envy of almost any other country in the world, it would be China’s lowest growth rate since 1990 – 25 years.

Still, who can complain about 7.2% growth? Nobody, if that was the total story.

Forget about whether the government is manipulating the data (The Bank of China is a state-owned enterprise), as some critics inevitably assert (I don’t see any evidence of that). The relevant reality is that whoever is keeping score can only tally what it knows and can measure.

And the reality is that a large percentage of the Chinese population is essentially self-employed and they are not on the radar of the GDP statistics keepers for the simple reason that they pay no taxes and report no income.

I have no idea what the percentage is, but judging from my personal experience in hiring housekeepers, plumbers, electricians, and such, it’s material. They accept only cash and provide no receipts.

And that’s not counting the companies that officials know exist but which fudge invoices and the books to avoid paying taxes. Remember, the Chinese ‘make money’; they don’t build legacies.

By implication, the government seems to acknowledge the extent of the problem. The government has developed an elaborate official invoicing system that is electronically connected to the Tax Bureau’s computers. This system issues what are know as fapiao, or ‘official receipts’.

And if you are a business that pays its taxes and wants to deduct an expense on its business tax return it MUST have an official fapiao from the product or service provider. The same goes for personal travel and entertainment expenses you incur on the job.

Further highlighting the potential extent of the unrecorded commerce, you generally have to ask for a fapiao even when staying at a hotel or dining at a renowned world-class restaurant. Many merchants, in fact, will ask you if you need a fapiao before telling you the price of a product or service. Why would they do that if they were planning to report that income on their tax return.

The government even offers an incentive for consumers to ask for fapiaos, making it virtually impossible for the product or service provider not to report the income since it is already in the government’s system in real time. Every fapiao comes with a scratch off that can unveil a cash reward courtesy of the Chinese tax authorities. Most fapiaos offer a simple thank you (meaning you get nothing, of course) but I have personally won up to 50 RMB and the top prize, I believe, is in the thousands. Normally you can redeem your prize right then and there at the store or restaurant where you got the fapiao, but in the worst case you have to go to the local tax authority to collect. Still, it’s all pretty painless.

So why does that matter to the rest of us? Because, by definition, when the government reports economic activity they are, by definition, reporting the recorded economic activity. And that, by definition, is essentially the economic activity on which taxes are paid. (Actual taxes may not be paid, of course, if the business reports a loss.)

As a result, I believe that the GDP data that most of us look at is overly weighted toward the large state-owned enterprises and the multi-national companies with a presence here. If true, that means it is heavily weighted toward banking, energy, real estate, and infrastructure build (i.e. construction of airports, rail lines, etc.)

This is important because in China personal consumption only accounts for approximately 39% of GDP. (In the U.S. personal consumption accounts for 72% of GDP.) But that 39%, of course, is only the recordable personal consumption.

During an economic contraction, of course, it is typically personal consumption that suffers first and the most. (At least in a country where a significant portion of the non-personal economy is owned and controlled by the state.) That naturally suggests that even with 7% GDP growth the average Chinese citizen might, indeed, be suffering economically.

And I believe many of them are. I offer two statistics to support this conclusion. The first is the recent cut in a key central bank interest rate from 6.0% to 5.6% and the concurrent easing of banking reserve limits. While this is far from the essentially free money available in the U.S. and the European Union, the cut appeared to take even the government think tanks by surprise and I have read at least one informed expert’s opinion that this represents a significant change in the perspective of the political leadership regarding the quality (i.e. job creation, income growth) of the current economy.

The second statistic reinforces the first. The official inflation rate for the third quarter of 2014 was 1.2%, down from 1.4% in Q2. This is very similar to the low levels of inflation being experienced among the Western economies, but this occurs at a time when the government has pledged to double wages in five years (i.e. roughly 15% compounded growth per year) and energy costs are rising a minimum of 10% per annum. That can only happen when there is significant over-capacity in the general economy.

And over-capacity, in any economy, ultimately hurts the average citizen (i.e. the quality of the economic growth).

So what is the current state of the Chinese economy? Well, for the 12 weeks ending October 31, the latest data publicly available, traffic at Wal-Mart’s numerous stores in Mainland China declined 6%. (In an economy growing 7%+?)

The reality is that no one knows the current state of the economy for sure. And there are certainly regional and industry differences. From the consumers and small business people that I talk to, however, the outlook is generally not optimistic. While Mercedes and BMW undoubtedly continue to sell a lot of cars in China, my sense is that the average Chinese consumer is playing it safe.

That is NOT to say that the Chinese economic miracle is coming to an end. Far from it. I think there is an enormous economic opportunity yet to unfold. China continues to have one of the highest savings rates in the world and if the government can successfully pivot to a consumption-based economic model (moving from 39% of GDP to, say, 50% of GDP) the economic growth opportunity available to the private and multi-national sector (largely outside of banking, energy, and infrastructure construction) will be enormous.

Time will tell. If you are in an industry that caters to the consumer at some level of the supply chain, however, I believe there remains enormous opportunity for your business to grow. The only question is the timeline.

To calibrate both your opportunity and your success, however, I suggest you largely ignore the official GDP. Keep your eye instead on both inflation and personal consumption as a % of GDP. If both start moving north, good times are inevitably not far behind.

There remains plenty of economic opportunity in China but GDP may not be the guiding light.  And 2015 is likely to be a challenging year for most consumers as the government wisely pivots toward a consumption-led economy.
There remains plenty of economic opportunity in China but GDP may not be the guiding light. And 2015 is likely to be a challenging year for most consumers as the government wisely pivots toward a consumption-led economy.

Note:  The author also writes novels under the pen name of Avam Hale.  You can find them in the Amazon Kindle store and they can be read on any mobile device loaded with the free Kindle App, available for all operating systems.

Copyright © 2014 Glassmaker in China

Notice:  The views expressed in this post are strictly those of the writer acting in a personal capacity.  They are not in any way endorsed or sanctioned by his employer or any other individual with which he may be personally or professionally affiliated.