Does China data reflect true price pressures on its middle class?
At a time when the Chinese economy is under pressure on multiple fronts, such as swine flu and the trade war, experts are asking: Why does China’s inflation look so stable?
The most recent measurement of the public’s sentiment about prices, in the first quarter of last year, clearly showed concern about rising inflation among China’s middle class.
Since then, the Chinese economy has experienced additional price pressures, resulting from the effects of swine flu and the trade war with the US. So why, the experts are asking, does China’s inflation look so stable?
The People’s Bank of China (PBOC) has been conducting a quarterly survey of people’s finances and their views on the economy since 1999, questioning 20,000 randomly selected people from 50 Chinese cities.
Until last year, on price satisfaction, the central bank asked, “Do you think the current price is too high to bear, high but bearable or satisfying?”
Without explanation, the central bank quietly dropped the price satisfaction index from its 2017 second-quarter report.
While it is unclear why the PBOC removed the question from the survey, it’s fair to say fewer Chinese have been pleased with the price of goods in recent years.
The index plunged to its lowest in 2010 and hadn’t increased much before its removal. In its last appearance, fewer than a third of respondents were satisfied with prices, while two-thirds expected them to continue to rise.
Public dissatisfaction was aggravated this year when sales promotions were delayed and the size of salary increases declined as the economy slowed, producing a public narrative of financially strapped individuals engaging in “consumption downgrades” – cutting back on spending to fit their budgets and prices.
LACK OF TRANSPARENCY
The PBOC’s willingness to stop publishing information that does not support the government’s preferred narrative is matched by a similar lack of transparency in how the government calculates the consumer price index (CPI).
Without knowing exactly how the CPI is calculated, it is difficult for outside observers – let alone policymakers – to understand precisely the price picture in the world’s second-largest economy.
Officially, China’s CPI, which measures price increases of a basket of goods and services and acts as a main indicator of inflation, has moved in a narrow range below 3 per cent since 2012, close to the annual target of 3 per cent each year set by Beijing since 2015.
The decision of which items to measure, and how big an influence on the overall figure these items are allowed to have, determines how the overall inflation figure responds to changes in real world prices. In particular, how the government measures rapidly rising residential prices is critical to the CPI result.
It’s not uncommon for people to feel the price pinch differently to what they see in the headline CPI. Consumers are sensitive to the prices of their favoured goods, such as a certain brand of chips, gum or noodles, while CPI records price fluctuations more broadly.
But the lack of transparency in how CPI numbers are generated by the National Bureau of Statistics (NBS) has left people in the dark about the real driving forces behind inflation. The weighting of different products in China’s CPI is updated every five years but the details have never been made public.
Xu Jianwei, senior China economist from French bank Natixis, said that during data collection statisticians tended to survey necessity items – such as a carton of the cheapest milk – which are unlikely to experience big price swings. This tends to hold down the overall inflation rate.
It’s widely believed that food accounts for a third of China’s CPI. Disease and supply issues often affect the price of pork, believed to be the biggest food category in the CPI, which makes food prices volatile and can have a major influence on the overall inflation rate.
“While central banks in developed economies tend to focus on measures of ‘core’ inflation that exclude volatile food prices, this fashion has never taken off in China,” Ernan Cui, an analyst from Beijing-based research firm Gavekal Dragonomics wrote in a report.
“This is for the sensible reason that in a developing economy food consumption is a large share of household budgets, and changes in food prices are thus quite relevant for household living standards and inflation expectations.”
Housing is given a relatively small weighting in the CPI – around 20 per cent according to some estimates – even though it is currently the biggest concern flagged by Chinese residents, faced with skyrocketing home prices and rising rental costs in many cities this year.
It’s not an exaggeration for someone living in a major city to spend well over one third of his or her income on rent, much more than the proportion represented in the CPI calculation.
In comparison, housing is weighted at more than 40 per cent of the US consumer price index calculation for urban dwellers.
Weightings aside, the way the NBS calculates housing-related expenses is also puzzling. Apart from payments for utilities and rents, the bureau uses a relatively stable mortgage interest rate to gauge the cost of purchasing a house, resulting in little contribution to the price index.
“The biggest problem in recent years is the fast growth of the service sector,” Natixis analyst Xu said.
Compared to volatile food prices, China’s non-food inflation has barely changed in years.
But the service sector is now the main driver of growth, contributing 60 per cent to last year’s GDP. In PBOC’s third-quarter survey this year, the biggest expenditures respondents said they expected to make in the next three months were dominated by service spending: travel, education, health care, and residential costs.
TOO SMOOTH TO BE TRUE?
Like a number of other statistics, China’s low and stable inflation rate over a relatively long period of time has generated accusations of political tampering.
In a 2016 paper published in the American Economic Journal: Macroeconomics, a team of economists led by Emi Nakamura from Columbia University found that China had smoothed inflation in the 1990s and 2000s.
In the late 1990s, China was suffering from mild deflation partly because of declining commodity prices. But the economists said officials overestimated inflation and in turn underestimated consumption growth at the time.
By contrast, after 2002, inflation rose much faster than was officially announced and consumption growth was thus overstated.
From 2007 to 2008, China saw an inflation spike after disease killed many hogs and pushed up pork prices. The economists estimated the inflation rate could have been as high as 20 per cent instead of the more than 6 per cent that was officially reported.
“While we present no direct evidence on this topic, we suggest two possible interpretations of our finding that Chinese official statistics are ‘too smooth’,” the economists said in their paper.
“First, they may reflect political motivations to report low and stable inflation and high and stable growth statistics. Second, they may reflect true difficulties measuring inflation.”
Xu Qiyuan, from the Research Centre for International Finance under the Chinese Academy of Social Sciences, reached the same conclusion in 2010, suggesting the NBS might have manipulated its opaque weightings system to understate inflation in 2007 and 2008.
This understatement coincided with consumers’ declining satisfaction with prices seen in the PBOC’s survey during that period.