In China, I have argued many times, high growth is no longer compatible with a strengthening balance sheet. If China is growing at a rate that approaches or exceeds 5 or 6 per cent, it is probably a safe bet that debt is rising faster than debt servicing capacity.
The good news is that the current leadership seems very clear about the need to implement reforms, and also understands that this is going to be politically a difficult process.
Last week Xi Jinping, the newly elected general secretary of the CPC Central Committee, toured Guangdong Province in a self-conscious reference to Deng Xiaoping’s famous 1992 tour supporting reform. Xi’s tour was widely interpreted as a similar signal about Beijing’s intentions. As an article in the People’s Daily put it:
"Reform is exciting, but it is also full of difficulties and challenges. Xi said in Guangdong that China must squarely face difficulties and challenges, strive for the best results and firmly seize the initiative. This deserves consideration by the entire Party and society."
These expected, and exciting, "difficulties and challenges” are, I suspect, the things we should be most concerned about in our attempts to understand the pace of reform. The history of developing countries suggests that most countries fail in the reform and adjustment process precisely because the sectors of the economy that have benefitted from the distortions are powerful enough to block any attempt to eliminate those distortions.
Certainly not every one in China is confident that Beijing will be able to force through the reforms that are widely accepted as necessary without a serious fight. There were two interesting and related articles in this week’s South China Morning Post that may indicate the degree of worry. They also show that it is not just the economic policymaking elite in Beijing that recognises the urgent need for economic adjustment and reform.
The first article tells you much of what you need to know in the title ("China’s rich and skilled leave in record numbers”). It goes on to say:
"Fourteen per cent of China’s high-net-worth individuals had either emigrated or were in the process of doing so. In addition, 46 per cent were considering permanently moving overseas through various immigrant investor programmes with real estate, foreign currency deposits and stocks being the primary areas of investment."
... For people to look for opportunities abroad suggests at the very least that either some of these people seriously doubt the sustainability of China’s current growth and expect it to come crashing down, or that they are worried about political uncertainty and the possibility of difficulty ahead. Or both.
The second article, also by the South China Morning Post, involves data from a completely different source and for completely different purposes, but it may broadly be telling the same story. The article is based on a very interesting study conducted by Global Financial Integrity on illicit capital flows around the world.
China tops the list of developing countries sending illicit money abroad, either to offshore havens or to financial institutions in developed countries, GFI said in a study. In 2010, illicit money out of China totalled $US420 billion, the report said, and exceeded $US2.7 trillion for the decade ending in 2010 – nearly half that period’s total for all developing countries.
As a share of GDP, in other words, Chinese illicit outflows seem easily to exceed the average for all developing countries. Mexico’s GDP, for example, is roughly one-seventh the size of China’s, and yet for all its drug money, its illicit flows were only one-eighth those of China. This means that the Chinese business and political elite export illicitly a larger share of the Chinese economy than the combination of the Mexican business and political elite and their drug cartels.
One of the most interesting paragraphs in the study, for me, concerned trade invoicing:
"Trade misinvoicing is the preferred method of transferring illicit capital from all regions except the Middle East-North Africa region where it accounts for only 37 per cent of total outflows for the decade ending 2010 (Chart 6). In declining order of dominance, the share of trade misinvoicing in total outflows by region is Asia (94 per cent), Western Hemisphere (84 per cent), Africa (65 per cent), and developing Europe (53 per cent). Large current account surpluses of countries in the MENA region driven by crude oil exports entail larger outflows through the balance of payments. In the case of Europe, the relatively large unrecorded outflows from Russia’s balance of payments dominate regional outflows."
... It is clear that these illicit capital flow numbers are pretty significant in relation to the trade numbers. China’s trade surplus in 2010 was reported to be $183 billion, but GFI claims that Chinese illicit capital flows (I assume that most if not all represents outflows, or even net outflows) for the year were $420 billion, most of which may have been recorded as higher exports or lower imports.
Even if these numbers are way off, they still suggest that China’s real trade surplus may have been substantially higher than reported, with much if not most of the money parked offshore for safekeeping. Among other things these numbers also suggest that the sluggish import growth of the past year, which smart people like Andy Xie insist are among the many numbers that are not compatible with the high official growth rates claimed by the government, may be even lower than reported.
Obviously I am not the first person to complain about the opacity of Chinese economic data and the difficulties we often have in reconciling one set of numbers with another, but I think it is important to note that while opacity may not be a terrible problem during the optimistic up-cycle (in fact hazy data give us more leeway to daydream pleasant things), it can suddenly become a huge problem during the pessimistic down-cycle, when they don’t even constrain our nightmares.
What is worse, an increase in opacity, which we are clearly seeing in the financial system, is usually a herald of bad tidings. When the economy starts to get bad, often the first impulse for many is to massage or hide the data.
Michael Pettis is a senior associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management.
He blogs at China Financial Markets,where a longer version of this article first appeared.