The mountains are high and the Emperor is far away

Collusion between businesses and local government in China’s provinces is causing distortions in economic data, Adrian Raftery writes.

The veracity of China’s economic figures has recently made headlines again. Casting a cursory glance at Chinese Communist Party (CCP) statements, one gets the impression the Party wishes to eradicate provincial economic data falsification. As is always the case, however, beneath the Party’s ritualised and formulaic language the story is less clear.

Many analysts continue to treat China’s macroeconomic data, or targets more broadly, with uncertainty. There appears reasonable justification for scepticism. Government announcements persistently claim they have reached previously stipulated targets. These assertions are obviously self-serving and are made to boost Party legitimacy. Upon closer scrutiny from external sources, however, such contentions often fail to hold water.

In a now infamous diplomatic cable, made public through WikiLeaks, in 2007 then governor of China’s Liaoning province, Li Keqiang, remarked to US Ambassador Clark Randt that China’s economic figures are ‘for reference only’. The current governor of the same province has recently admitted that the province’s economic figures from 2011-2014 were inflated. One can deduce that Liaoning may not have been unique in this regard.

There are a number of ways businesses and local governments contribute towards distorted statistics. One practice used to engineer data is through paying tax on forged invoices, before returning the money to enterprises in the form of subsidies. This method allows companies to profit and officials to obtain higher revenue figures.

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The CCP’s Central branch has endeavoured to crack down on malpractice involving fraudulent business tax invoices by automating receipts (though only for national, not provincial, tax bureaus), incrementally changing business tax to Value Added Tax, and beefing up the National Bureau of Statistic’s data-verification resources with an additional 20,000 staff.

Using business taxation as an example, the main difficulty faced by administrators tasked with gathering corporate tax and checking the information’s authenticity is the sheer size of the job. Within any of China’s provinces, there are hundreds of thousands of businesses operating. And the number is growing rapidly.

At the behest of a State Council circular, effective nationwide on 1 October 2016, business registration reform will significantly reduce barriers to entry by removing minimum registered capital requirements and introducing a ‘single window’ system of registration. Businesses have proliferated as a result of previous reform efforts in this area, particularly in the tertiary sector which experienced 66 per cent year-on-year growth between 2013 and 2014 – as reliably reported by the State Administration for Industry and Commerce.

These tax contributions and favourable inputs to policy-makers’ prioritised economic sectors are certainly beneficial for growth, but a rapid increase in the number of businesses also strains the data gathering capacity.

Collecting accurate economic data is further complicated by the overlap and interdependence between big industry players and local governments. Industry heavyweights – which should be contributing the largest share of tax revenue and production – usually cultivate or possess strong ties to local government. This situation is ripe for exploitation. Off-the-books production and sales, overstated outputs, fraudulent subsidies, asset stripping and overpriced procurement are all enabled by such relationships.

Recognising the ubiquity of government-business camaraderie and its capacity to distort economic data, Beijing has purportedly developed a system that is directly linked to 700,000 large enterprises to measure their industrial output.

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Despite this development, some practices and relationships are too well entrenched to eradicate. Enterprises are eager to collude with provincial officials because they recognise the chance to monetarily and politically profit from the transaction; local cadres enter into the compact for the same reason.

Initiating a process to digitise purchase orders and tax receipts over a certain amount would be beneficial to combatting government-enterprise connivance. Initiating reforms in this vein would also prevent fraudulent company-chopped documents from fleecing investors on China’s bond market – perhaps instilling a measure of investor confidence in the nation’s corporate debt market.

In spite of tough language from the National Bureau of Statistic’s top official, any genuine political initiative for reform in this area appears to be lacking. Even amid Xi Jinping’s and Wan Qishan’s anti-corruption campaign, local governments seem unconcerned about repercussions for statistical manipulation.

There is scarcely reason for them to be fearful. Officials manipulating economic data face mild penalties if exposed, ranging from a warning from the CCP Discipline Inspection Commission to being placed on ‘probation’ within the Party. In the more severe cases, cadres may be demoted from their position.

There are three possible conclusions one can draw from how the CCP treats provincial economic data manipulation: they are unable to prevent it from occurring, it is a work-in-progress to eliminate, or it is tacitly sanctioned. Moving forward, it remains to be seen if Beijing has the capacity or inclination to break local government baronies. If they are unable to do so, collusion will continue, and sceptical investors and analysts will continue to take China’s macroeconomic figures with a grain of salt.