China’s Economy is 60% Smaller Than We Thought

China's economy is 60% smaller
than we thought. At least that is the implication. If we are to believe the research
presented in this research paper by Professor Louis Martinez
from the University of Chicago. This would mean that instead of soon
becoming the second largest economy in the world, China's economy is only about a third of the size
of the mighty US economy. And it also means that predictions
such as those made by billionaire investor Ray Dalio that China is soon to overtake
the US as the world's next superpower are way overblown. Finally, having much lower GDP
also means that China's debt levels are actually much higher relative
to the size of its economy, meaning that its debt fueled property bubble
is much more dangerous than we thought. But this all depends on the answer
to one question. Can you trust this research paper
more than China's official GDP figures? Well,
for you to make up your mind about that, I'll first tell you why China's official
figures are so problematic.

Then I'll show you the evidence
that this paper presents and how I used it to calculate China's real GDP number. After that, I'll discuss
both the strengths and weaknesses of the evidence against China's
official statistics, plus what this greatly reduced GDP figure would mean for the global economy. Okay, so China's official GDP figures
measuring the total spending in the economy have actually been
very controversial for a long time. I mean, according to leaked documents,
even China's vice president admitted that China's GDP figures are a man made
and therefore unreliable. You see, to calculate GDP, governments
all around the world typically collect data on transactions
in all sectors of the economy. But the problem is that GDP growth
is often seen as a measurement of success. The numbers for America's economic growth, or GDP, were just released,
and I am thrilled to announce that the United States
economy grew at the amazing rate of 4.1%.

So to stay in power,
politicians need higher GDP numbers. And sure, they could get them by governing
well, allowing the economy to grow. But that is really hard work. It would be much easier
to just get higher GDP numbers by just adjusting the numbers
upwards a little bit every year. However, the problem for politicians in Democratic countries
is that the statistical agencies responsible for recording GDP operate
independently. For example, Donald Trump
could not just walk into the U.S.

Bureau of Economic Analysis
and demand higher growth numbers. And even if he managed to pressure
the statisticians there to fudge the numbers, this would likely
find its way to the free press, making this quite an unattractive option
for politicians in democratic countries. But what if you are a dictator
that controls both the statistical office and the press? Now, suddenly it becomes quite attractive
to adjust the numbers upwards just a little bit every year. Therefore,
more authoritarian countries are likely to overstate GDP growth more. At least that is the main claim
of this paper by Professor Louis Martinez.

And as a scientist,
he backs up that claim with data in this case from satellites. Because sure rules that control
both the statisticians Because sure rules that control
both the statisticians and the press can easily
manipulate GDP statistics. But they cannot fake
real economic activity. And in our modern economies, real economic
activity can be seen from space, especially when night sets
and the lights go on. So to find out if authoritarians manipulate GDP
statistics more, Martinez looked at 184 countries
between 1992 and 2008. Then he compared the growth of lights
at night in each country to the growth of GDP
that each country reported. What he found is that, as expected,
when a nice light grew, all countries
typically also reported that GDP grew. However, when making a distinction
between autocratic and democratic countries,
a clear pattern emerged. Autocratic countries
typically reported a whopping 35% higher GDP growth numbers
compared to nighttime lights growth.

And for China specifically, Martinez
states that, based on his analysis, China's GDP growth between 1992 and 2008 was likely 4.9% per year, rather than its average
reported growth of 6.3%. But frustratingly to us here at Money
Macro, Martinez did not calculate
what that means for China's GDP today. So we decided to do that ourselves. But we will discuss how we did that
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Com slash moneymacro and
take your private data out of the market. All right. Back to how we calculate the
true size of China's economy based on how much authoritarian countries overstate in GDP growth
compared to night light growth. Martinez
produced what he calls a GDP deflator. This GDP deflator is basically a number
by which to reduce official GDP numbers each year based on how authoritarian
a country is using his deflator. We extend Martinez's analysis to the year
2021, and while between in 1992 and 2021 ten, we reported a sky high
GDP growth between 14 and 8%. Martinez Analysis suggests
that China actually only grew between six and 2%. Importantly, this means that instead
of surpassing the U.S.

As the largest economy in the world. China is still quite far from it. Now, don't get me wrong. These are still really impressive
growth numbers. On average, it was still quite a bit higher than the 4.1%
that Trump was so proud of. And this growth was still enough
for China's economy to surpass that of Japan and become the second
biggest economy in the world. But at this point, you might say this paper and your calculations,
they look a bit rough around the edges. Why should I trust them over
the official statistics provided by the Chinese government? And yet there is some truth to that in the sense
that this is a very rough calculation.

Martinez himself even calls it
a back of the envelope calculation. And so, yeah, you should take these
adjusted numbers with a big grain of salt. But that being said,
I do actually think that the adjusted numbers are closer to the truth
than the official numbers. For three reasons. First, it's important to mention
that this paper has been critically assessed
by dozens of economists. It has been presented at seminars
at the University of Chicago and Illinois, as well as at policy institutions such as the Central Bank of Chile
and the World Bank. What's more,
it has been peer reviewed and published in the prestigious Journal
of Political Economy. Second, Martinez has done a lot of checks
to make sure that the findings that authoritarians
consistently have higher GDP growth than nightlight growth cannot be explained
by some other factor. For example, you could imagine that geography has
something to do with this relationship.

Or perhaps most authoritarian countries
were just less developed economies in 1992, which changed
their relationship with nightlights. Or perhaps the structure of authoritarian
economies is just different
because their people move to cities less. Or it could also be that they just rely
on industries that produce fewer lights. Well, Martinez
checked for all of this and more. And it didn't affect his main results. So his analysis
that authoritarians overstates GDP holds. Now, at this point, you might say theory. Okay. Okay. But Martinez is calculations of GDP was about the average manipulation
of authoritarian regimes. It is not applicable to China. and yeah That could be true. So I looked into it. I started by examining
why China's own vice president would ever admit that he didn't
trust his own GDP numbers. And then it turns out that China is quite
unique in that the central government used to set GDP growth targets
for provincial governors.

And if any of you ever worked in a company
with a growth target, you probably know that
while they can be effective, they typically also produce
a lot of unwanted side effects. For example, economic research shows
that sales targets in companies lead to bad sales, such as those sold at unsustainable discounts,
as well as manipulated sales numbers. So it's not surprising
that research has already shown that China's GDP growth targets
led to both wasteful investment projects and, more importantly,
to us manipulated GDP numbers. Similarly to Martinez's study,
another economist uncovered that in the years that Chinese provincial
governments needed to be selected, there were huge differences between
the reported GDP figures for that province and data that could not be manipulated
such as electricity consumption. Even economic researchers
from within China reported that provincial governors
did hit their GDP growth targets. Typically got promoted,
while those that didn't got the boot. You are done. Fired. Finally, when I myself
looked into the nightlife data of a paper published in Nature
and compared that to the World Bank GDP data, I found that indeed
China has reported much higher GDP growth
compared to nightlight growth.

And for example, it's more Democratic
also rapidly growing and larger neighbor India. So yeah, there is a lot of evidence
that China is manipulating its GDP data just as much, if not more,
than other autocratic countries. And this is why, with the caveat
that this is an extremely rough calculation, in my opinion, China's GDP is likely 40% of its official figure now. This still makes China
the second largest economy in the world. But it is only at 30 to 45% of the US economy,
depending on how you measure it. In any case, the Chinese economy
is still very far from being number one, especially now that its economy
is slowing down due to a property crisis. And this means that China's current
economic problems could be much worse than we thought because debt to GDP
is much higher, because GDP is much lower.

What's more, it has huge
geopolitical implications in that China would be far less
threatening to the US than we thought. But what do you think? Are you as convinced by this research
as I am, or do you have a better explanation
for why night lights in China don't grow as fast as a reported GDP? Let me know in the comments. Oh, and as always,
if you think that I misrepresented the issue here,
feel free to have a look at all the research that I mentioned
in this video, in my source list, as well as my own calculations
in the description of this video.

And while you're there, consider
clicking on the link to my bedroom page to support my research out of the country Henry.

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