China has been suspected [Because it’s true? Ed.] of fudging GDP data and called out, even by senior Chinese politicians, for doing so.
However, a discrepancy between local and centrally tabulated GDP isn’t a problem unique to China. In America, according to the paper highlighted this week, local GDP calculations sum to around 1% higher than the nationally reported data; but in China the discrepancy is a more serious 8%.
The work highlighted today from Xia Chen (et. al.) from the Singapore Management University claims to be the first to show not only that local administrators bump GDP upwards but also shines a light on a key tool they use to achieve this subterfuge; corporate earnings.
By analyzing data from all listed companies on the Shenzhen and Shanghai stock markets from 2002 to 2016 they find as follows:
1. Firms in provinces with GDP either lower than the national average or neighbors are guilty of serial upwards earnings manipulation.
2.The common methods are: a) inflating revenue, b) overproduction and c) delaying the recognition of asset impairment charges.
3. These problems are most frequently associated with locally controlled SOEs, younger provincial Governors (it matters more for future careers) and provinces where the Governor’s term is coming to an end (it improves chances of a better gig afterwards).
For new analysts this is a useful checklist. For the more experienced its a proof of the hunch/bias that most will have developed i.e. that the finances of smaller SOEs in weak provinces are likely to require especially close scrutiny.
With commendable restraint the authors conclude “This manipulation is not only costly for the firms that manage their earnings to boost GDP growth, but also for society when governments and corporations make decisions based on the manipulated GDP figures.” Ahem!
Often curing a problem is helped by clear identification and in that regard this paper may prove a valuable contribution to moderating some of these excesses. Stamping them out is probably too big a reach for now.
You can access the work in full via this link Growth Incentives and Earnings Management.
Happy Sunday.