New report cuts China's economy down a size

The ADB suggests China is 40% poorer and smaller than previously believed, and that its exchange rate is less undervalued.
An Asian Development Bank report is suggesting that ChinaÆs GDP on a purchasing power parity basis (PPP) is 40% smaller than previously believed, according to Albert Keidel, a China specialist at the Carnegie Endowment for International Peace.

Keidel wrote an article in the Financial Times on the topic last month. Keidel is an expert on PPP, and did groundbreaking research on China in the 1990s.

The report will delight the Chinese government which has frequently complained about the previously accepted PPP GDP figure û an astonishing $10 trillion, according to AmericaÆs Central Intelligence Agency. ThatÆs not far off the size of the US economy in nominal dollar terms, on $13 trillion.

The Asian Development Bank prepared the report as part of the International Comparison Programme and was responsible for the Asia-Pacific portion. The figures are for 2005. Keidel does not describe his methodology, but if anything, the Chinese economy seems to have shrunk by closer to 60% - the ADB puts PPP GDP at just $4 trillion for 2005, converted from the Hong Kong dollar figures its researchers used.

PPP is an attempt to look at the volume of identical goods and services people can buy for the same amount of money across several economies û essentially a study of purchasing power.

The first problem is establishing what the æsame amount of moneyÆ is for all countries being compared. The usual conversion from one currency into another doesnÆt work, since exchange rates are buffeted by numerous political and international trade issues. The renminbi, for example, is kept from appreciating against its trading partners through central bank interventions. Its international value therefore does not reflect its domestic value.

PPP economists try to strip out those considerations. They do this by setting the exchange rate based solely on domestic prices. Thus, if a can of Coke is one dollar in the US, and 3 renminbi in China, thatÆs the exchange rate ($1=Rmb3), not the then official exchange rate of 8.2. (In practice, of course, researchers look at hundreds of prices, not just one).

The next step is to aggregate all the prices and come up with a total figure for GDP. Translated into dollars, the final GDP will be much larger than in nominal terms, since the exchange rate derived only from domestic prices is much stronger (that is, the renminbi is much stronger relative to the dollar).

The ADB has a figure for this. It estimates that the renminbi for 2005 was worth 0.599 of one Hong Kong dollar. The official exchange rate at the time was Rmb1.05. In other words, the implication is that the renminbi was then undervalued by more than 40%, since Rmb0.599 buys the identical volume of goods and services as HK$1.05. That may sound like a significant undervaluation, but itÆs actually much less than previous studies suggested, and which made the exchange rate even stronger in China's favour, thus reaching the $10 trillion figure. So one important implication is that the renminbi is less undervalued than previously estimated.

The ADB report suggests that prices in China have risen tremendously û which weakens the PPP exchange rate and reduces the size of the total economy in PPP terms, to $4 trillion. In other words, that Coke in China now costs Rmb5, leading to a new exchange rate of 5:1 instead of 3:1. So translated into dollars, the PPP GDP figure will be much lower.

In nominal terms, the ADB puts ChinaÆs GDP at $2.2 trillion. Because this figure is much easier to calculate, it is not significantly different to other estimates. ChinaÆs national bureau of statistics put nominal GDP at $2.7 trillion for 2006.

Observers point out that the new findings make poverty in China a more pressing issue than previously realised. China has reaped a huge amount of kudos from the supposed decrease in the number of people living in poverty. But if the purchasing power of the renminbi is 40% less than previously thought, then the number of people living in poverty rockets.

This makes sense. Many Chinese are cynical about the benefits of rocketing GDP growth, which is bypassing the majority of the population living in the countryside. One joke refers to the letters GDP being a Chinese homonym for æthe arse of a chickenÆ. The latest figures are bound to increase the disillusion which many rural residents feel about the countryÆs manufacturing-biased and city-centric growth.
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