How China Cooks Its Books

It's an open secret that China has doctored its economic and financial statistics since the time of Mao. But could it all go south now? 

In February, local Chinese Labor Ministry officials came to "help" with massive layoffs at an electronics factory in Guangdong province, China. The owner of the factory felt nervous having government officials there, but kept his mouth shut. Who was he to complain that the officials were breaking the law by interfering with the firings, he added. They were the law! And they ordered him to offer his workers what seemed like a pretty good deal: Accept the layoff and receive the legal severance package, or "resign" and get an even larger upfront payment.

"I would estimate around 70 percent of workers took the resignation deal. This is happening all over Guangdong," the factory owner said. "I help the Department of Labor, and they'll help me later on down the line."

Such open-secret programs, writ large, help China manipulate its unemployment rate, because workers who "resign" don't count toward that number. The government estimates that roughly 20 million migrant factory workers have lost their jobs since the downturn started. But, with "resignations" included, the number is likely closer to 40 million or 50 million, according to estimates made by Yiping Huang, chief Asia economist for Citigroup. That is the same size as Germany's entire work force. China similarly distorts everything from its GDP to retail sales figures to production activity. This sort of number-padding isn't just unethical, it's also dangerous: The push to develop rosy economic data could actually lead China's economy over the cliff.

Western media outlets often portray Chinese book-cooking as part and parcel of a monolithic central government and omnipotent Beijing bureaucrats. But the problem is manifold, a product of centralized government as well as decentralized officials.

Pressure to distort or fudge statistics likely comes from up high -- and it's intense. "China announces its annual objective of GDP growth rate each year. In Chinese culture, the government has to reach the objective; otherwise, they will 'lose face,'" said Gary Liu, deputy director of the China Europe International Business School's Lujiazui International Financial Research Center. "For instance, the government announced that it wanted to ensure a GDP growth rate of 8 percent in 2009, and it has become the priority for government officials to meet that objective."

But local and provincial governmental officials are the ones who actually fiddle with the numbers. They retain considerable autonomy and power, and have a self-interested reason to manipulate economic statistics. When they reach or exceed the central government's economic goals, they get rewarded with better jobs or more money. "The higher [their] GDP [figures], the higher the chance will be for local officials to get promoted," explained Liu.

Such statistical creativity is nothing new in China. In 1958, Chairman Mao proclaimed that China would surpass Britain in steel production within 15 years. He mobilized villages throughout China to establish backyard steel furnaces, where in a futile attempt to reach outrageous production goals, villagers could melt down pots and pans and even burn their own furniture for furnace fuel. This effort produced worthless pig iron and diverted enough labor away from agriculture to be a main driver in the devastating famine of the Great Leap Forward.

Last October, Vice Premier Li Keqiang said in a speech after inspecting China's Statistics Bureau, "China's foundation for statistics is still very weak, and the quality of statistics is to be further improved" -- a brutally harsh assessment coming from a top state official.

Indeed, China has predicated its very claim of being the healthiest large economy in the world on faulty statistics. The government insists that even though China's all-important export sector has been devastated -- contracting about 25 percent in the past year -- a massive uptick in domestic consumption has kept factories producing and growth churning along. A close examination of retail sales and GDP growth, however, tells a different story. China's domestic retail sales have risen about 15 percent year on year, but that does not really translate into Chinese consumers purchasing 15 percent more televisions and T-shirts. The country tabulates sales when a factory ships units to a retailer, meaning China includes unused or warehoused inventory in its consumption data. There is ample evidence that state-owned enterprises buy goods from one another, simply shifting products back and forth, and that those transactions count as retail sales in national statistics.

China's retail statistics seem implausible for other reasons, too. They would imply an increase in salaries among Chinese people, allowing them to purchase that extra 15 percent. To be sure, the Statistics Bureau reported salaries had increased 12.9 percent in the first half of 2009. But Chinese netizens complained such numbers were hard to believe -- as did the bureau's chief.

A look at GDP growth also raises serious questions. China's economy grew at an annualized 6.1 percent rate in the first quarter, and 7.9 percent in the second. Yet electricity usage, a key indicator in industrial growth and a harder metric to manipulate, declined 2.2 percent in the first six months of the year. How could an economy largely dependent on manufacturing grow while its industrial sector shrank?

It couldn't; the numbers don't add up. China announced a $600 billion stimulus package (equal to about 14 percent of GDP) last fall. At that point, local governments started counting the dedicated stimulus funds in GDP statistics -- before finding projects to use the funds, and therefore far before the trillions of yuan started trickling into the economy. Local governments keen to raise their growth and production numbers said they spent stimulus money while still deciding on what to spend it, one economist explained. Thus, China's provincial GDP tabulations add up to far more than the countrywide estimate.

Alternative macroeconomic metrics, such as the purchasing managers' index (PMI), which measures output, offer a no more accurate reflection. One private brokerage house, CLSA, compiles its own PMI, suggesting a sharp contraction in industrial output between December 2008 and March 2009. Beijing's PMI data, on the other hand, indicated that industrial output was expanding during that period.

Unfortunately, such obfuscation means China's real economic health is difficult to assess. Most indicators that would help an intrepid economist correct the government numbers -- progress on infrastructure projects, end-user purchases, and the number of "resigned" workers -- are not public.

Still, it is possible to infer the severity of the gap between economic reality and China-on-paper by looking closely at monetary policy. China's state-owned banks dramatically increased lending in the first half of 2009 -- by 34.5 percent year on year, to more than $1 trillion. This move seems intended to keep growth artificially high until exports bounce back. Most analysts agree that it is leading to large bubbles in the stock, real estate, and commodity markets. And the Chinese government recently announced plans to raise capital requirements -- an apparent sign it sees the need to reign in the expansion.

For the long term, China is banking on its main export markets -- in the United States, Europe, and Japan -- recovering and starting to consume again. The hope is that in the meantime, rosy economic figures will placate the masses and stop unrest. But, if the rest of the world does not rebound, China risks the bursting of asset bubbles in property and stocks, declining domestic consumption, and rising unemployment.

That's when the Wile E. Coyote moment could happen. Once Chinese citizens no longer believe that the economy is doing well, social unrest and more widespread worker riots -- already increasing in scope and severity -- are likely. That's something that China will have a harder time hiding. And then we'll know whether China's statistical manipulation was a smart move or a disastrous mistake.

LIU JIN/AFP/Getty Images


Strange Bedfellows

China's problems in Xinjiang are forcing it to reach out to India. But does India care?

In its attempt to stomp out the pro-Uighur movement in its restive western autonomous region, Xinjiang, China might be looking for help from a surprising partner: its major rival in the region, India, according to a recent report in the South China Morning Post.

The two countries don't have a history of ground-level cooperation on counterterrorism -- far from it -- but they could end up moving in that direction as the anarchy in the North Waziristan area of Pakistan begins to spill over into China as well as India. But major questions remain: How far will China go to win India's help? And is Beijing sincerely looking for advice, or just fishing for intelligence from the other rising powerhouse in Asia?

Before attempting to answer these questions, it's important to note that the pro-Uighur movement in Xinjiang is actually two distinct movements. First, there's Western media darling Rebiya Kadeer's Munich-based group, the World Uyghur Congress (WUC), which has been a major irritant to the Chinese, launching demonstrations that led to July's riots in Urumqi. But the Chinese government is also contending with a lesser-known, but more threatening Uighur group -- the East Turkestan Islamic Movement (ETIM), which draws its funding and membership not from the West, as with the WUC, but from the Uighur diaspora in Pakistan, the Persian Gulf, and Turkey.

The ETIM labels itself an agitator for the religious rights of Xinjiang Muslims. It looks upon Xinjiang, which the Uighurs call East Turkestan, as a traditionally Muslim land that has been occupied by non-Muslims. Unlike the WUC, which focuses on Uighur ethnicity -- not religion -- the ETIM's ideology is pan-Islamic, and it claims to fight for the restoration of Eastern Turkestan to the ummah, or the worldwide Muslim community.

The Chinese claim that more than 1,000 ETIM members had been trained by al Qaeda in Afghanistan before the September 11 terrorist attacks, but their claim is treated with some skepticism by the United States and refuted firmly by the ETIM leadership. Still, the U.S. State Department said in 2005 that the two groups were linked, and the United States has listed ETIM, which is based in North Waziristan, as a terrorist organization since 2002.

Because of the ETIM's suspected links with al Qaeda and the Islamic Movement of Uzbekistan, another terrorist group operating from North Waziristan, China has reached out to its ally Pakistan for help. But repeated requests to Pakistan for action against the terrorist infrastructure of the ETIM have not produced satisfactory results. Pakistan arrested and deported to China some identified anti-Beijing Uighurs, but it has not been able to dismantle the ETIM's terrorist infrastructure, as China had hoped. Nor has Pakistan been able to offer much help on the intelligence front, due to the government's weakness in Waziristan.

After China's striking out with Pakistan, then, it seems only logical that Beijing should move on to India -- asking not for operations against the ETIM infrastructure, but for intelligence. There has so far been no reliable information that India has received such a request. But a request to New Delhi would probably not bring the results Beijing wants. For one thing, the focus of Indian intelligence is Pakistani Punjab and Pakistan-occupied Kashmir, the source of most terrorist threats to India. Thus Indian intelligence is not particularly well-informed on the Waziristan area. Second, China has never criticized Pakistan-sponsored terrorism against India. There is, therefore, no built-up reservoir of goodwill that would induce India to help China with its ETIM problem.

Still, the request itself, if correct, is part of a larger movement toward greater cooperation between the two countries on counterterrorism efforts. Since 2002, China has welcomed meetings between Chinese and Indian counterterrorism experts to exchange views and assessments on the state of jihadi terrorism in the region, hoping to benefit from India's experience and expertise on this subject.

India has responded positively to the general Chinese interest, and the cooperation has been expanding through mechanisms such as a joint working group on terrorism that periodically exchanges views and assessments and the joint counterterrorism exercises by the countries' armies that allow each country to learn from the other's tactics.

This new partnership only goes so far, however: Although cooperation against acts of terrorism will continue to expand, the chances of China and India working together against terrorist organizations are remote. The two countries agree on what constitutes an act of terrorism, but not on which are the terrorist organizations of the region. China, for example, agrees with Pakistan's view that the violence in Kashmir is a freedom struggle and not terrorism. It has also blocked a consensus in the U.N. Security Council on declaring certain Pakistani organizations terrorists, against India's wishes. And China -- hoping to maintain good relations with Pakistan in order to keep the threat of a two-front war hanging over India's head -- is unlikely to change its mind on these positions, no matter how unhappy it gets over Pakistan's failure to stamp out the ETIM in North Waziristan.

Working with China on ground-level counterterrorism is also difficult for India because India has the second-largest Muslim population in the world after Indonesia, and members of this community might not want India to help China in what they see as repression of their coreligionists. What's more, the pro-West Uighurs led by Kadeer are close with the Dalai Lama, who is based in India and commands considerable respect there not only as a Buddhist leader, but also as a thorn in the Chinese side. He and the large Tibetan refugee population in India would oppose helping the Chinese out in Xinjiang.

More broadly, relations between China and India in most other areas, though improving, still have their problems, which act as speed bumps: the ongoing border dispute, Indian allegations of the dumping of cheap Chinese goods, competition for oil and gas, and naval competition in the Indian Ocean. However, cooperation over counterterrorism, if it comes about, could bring the two Asian giants closer together.