6.9% Growth in China and Other Fairy Tales

The Chinese government announced yesterday that its GDP grew 6.9% in the third quarter, a smidge less than its goal of 7%.

Right. And Osama bin Laden is alive right now, sitting poolside at the Bellagio, quaffing Tanqueray and Tonics as fast as the barman can set them up.

I am not the only one who is skeptical. The Internet is awash with skeptics. Seven percent annual growth is very difficult to reconcile with other economic indicators coming out of China. Little things, like a Shanghai Stock Exchange index that’s down 35% from its peak. Or a dramatic drop in Chinese dollar-denominated imports (down 15% to 20% every month since February.) Or massive capital flight ($150 billion poured out of China in the month of August alone.)

Some people seem to take great offense to this skepticism, as if the critics are heretics who are unwilling to believe in China’s economic miracle.

But this seems silly. You don’t have to doubt the legitimacy or endurance of China’s long-term growth to be skeptical about the country’s recent performance. You really only need to believe in two things.

The Business Cycle

First, you have to believe in the inevitability of the business cycle. Before deciding what you believe, just remember that no country in recorded history has escaped occasional downturns. It happens to the best of us. For reasons economists still can’t explain with complete clarity, recessions come along every once in a while and spoil the party.

The last guy to claim he had figured out how to eliminate downturns was Alan Greenspan with his Great Moderation. As you’ll remember, the Great Moderation was followed by another Great event that didn’t feel all that great to most of us.

Perhaps the best, recent historical analog to what China is going through is the United States in the late 19th century, when we grew from a modest player on the world’s economic stage to a global hegemon. Between 1870 and 1910, we suffered ten downturns, most of which were called a “Panic” of some sort.

China has experienced over thirty years of nearly uninterrupted growth. They have very smartly steered their development policies to create tremendous wealth, lifting half a billion people out of poverty. Unfortunately, none of that insulates them from a recession.

The Distortion of Information in Hierarchies

The second phenomenon you have to believe in is the predictable distortion of information in hierarchical systems.

Part of why the believers in China’s stated growth numbers believe is because they have a hard time imagining top Chinese officials deliberately lying about what’s happening.

I agree. I don’t think China’s leaders are purposely distorting their GDP figures.

But that doesn’t mean the numbers are true. It just means that China’s leadership believes the numbers are true.

Is it really so hard to believe that the leaders in the Chinese Communist Party may be receiving less-than-accurate information from the countless bureaucratic layers below them?

Powerful hierarchies produce lies because they produce fear. Every participant in the system shades the truth to their boss as much as they can. The Soviet Union experienced “record harvests” nearly every year until the fantasy could no longer be reconciled with the reality of empty grocery store shelves.

Even though Uncle Jinping can’t hold a candle to Uncle Joe’s despotism, China still executes over 2000 people a year. Some of those people are government officials. Knowing that, might a state-owned factory manager who has been diverting a few Yuan into his own pockets be tempted to inflate his reported revenues a bit?

But you don’t need to be literally afraid for your life to be motivated to enhance the truth for your boss. The stakes in nearly every job are high, even if you’re a low-level manager at an ordinary company. Your boss’s perception of you can affect your career prospects, your prestige with your peers, and your family’s livelihood. So small lies get created. And they accumulate as each layer of the bureaucracy adds its own lies to the pile.

Where’s the CEO in all this? Or Mr. Xi? Clueless. As far as they know, everything is fine. Their ability to know the truth is completely obscured by the distorting effects of the hierarchy. And that distortion increases as a function of the organization’s size and the power it has over its members.

So yes, I am a skeptic on China’s third quarter growth. I believe China is already in a recession, and the last guy in the country to know the truth about it will be Xi Jinping.

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