China has the world’s second-largest GDP, the world’s largest monetary base, and the world’s largest foreign exchange reserves. Its large internal and external economic imbalances can matter a great deal to the global economy. There are claims China is now rebalancing. It isn’t.
Claims of rebalancing are based on the current account surplus, a broad measure of trade and other international activities that are concluded over a short period. China’s current account surplus with the world has fallen sharply as a percentage of GDP. However, the current account surplus tells us little.
A more comprehensive measure of the external imbalance is the overall balance-of-payments surplus, which includes investment and other long-term international activities. Here the evidence points to continued imbalances.
On Chinese data, the balance-of-payments surplus set a new record in the first half of 2011 at approximately $350 billion. This surplus—the largest six-month figure ever recorded by any country—essentially vanished in the second half. Presto: instant and complete rebalancing.
Except it was not believable. There had been no dramatic Chinese policy shift nor any dramatic change in the global environment. No explanation for why this happened. Sure enough, China’s balance-of-payments surplus jumped back to $120 billion in the first quarter of this year, larger than the third quarter of 2010. The plunge in the second half of 2011 looks like a statistical illusion.
So, on a better measure than the current account, China’s external surpluses are apparently unstable but not shrinking. This should not surprise anyone. External imbalances in large economies are driven by internal imbalances, and China has not made any progress there at all.
The core of the rebalancing challenge is investment versus consumption. China invests too much and consumes too little. The government first recognized this problem in 2004, but the imbalance then got far worse. Until this internal imbalance is corrected, any improvement on the external side will again prove to be an illusion.
Is China now making progress on internal rebalancing? Is consumption finally gaining on investment? Probably not. The share of investment in GDP rose yet again in 2011, and the share of consumption fell yet again. In the first quarter of 2012, on government figures, investment again grew faster than consumption.
That last part leaves the door ajar. As with the measures of external imbalances, there are problems with numbers on the domestic side. China releases consumption and investment data every month, but they sum to more than GDP, which should be impossible. Accurate measurements of the components of GDP show up only many months after the total GDP figure is released. (Draw your own conclusions.)
Some estimates suggest that consumption is much larger than the government reports. This is certainly possible. Retail sales, the monthly consumption indicator, is known to be seriously flawed. Among other problems, the government’s numbers over time for household income, household savings, and retail sales don’t fit. So perhaps Chinese consumption is larger than the government acknowledges, and the imbalance problem is therefore smaller.
But proponents of this view neglect an obvious possibility: It is very unlikely that China’s State Statistical Bureau just began underestimating consumption. Those who believe that Chinese statistics are improving should believe that more consumption was missed in 2001 than in 2011, say. If so, progressively smaller mistakes and a larger-than-acknowledged base mean that on-year growth in consumption is now being exaggerated. In the first quarter, for example, the auto industry put vehicle sales and prices as slightly lower, but the retail sales segment for autos shows an 11 percent gain in value.
It gets worse. Consumption is part of GDP. If the government missed more consumption earlier, it missed more GDP earlier. So the same adjustment would apply: GDP could be bigger than we think, but current growth would then be slower.
Official data say that China is not rebalancing. Official data are flawed, and one reasonable correction makes consumption larger and the crucial internal imbalance smaller in absolute terms. But that correction also says that present consumption and GDP growth are both slower than the government says, so the economy is weakening and the investment-consumption imbalance widening faster than we thought. Pick your poison.