TEN YEARS ago Chinese property was described as “the most important sector in the universe” by Jonathan Anderson, now of Emerging Advisors Group, a consultancy. Property was a big source of China’s growth, household spending and appetite for commodities, like iron ore. Today the sector has become a source of universal concern, as housing sales have dropped, developers have defaulted and the price of iron ore has tumbled. China-watchers are eager for a rigorous measure of the sector’s importance to the country’s economy. And in recent months, the world’s press has converged on a number: 29% of GDP.
That estimate, which has been cited in this newspaper, the Financial Times, the Wall Street Journal, Bloomberg and elsewhere, comes from a paper by Kenneth Rogoff of Harvard and Yuanchen Yang of the IMF. Both economists have impeccable credentials. But their number (28.7%, to be precise) does not count what most people think it counts. The most prominent measure of the most important sector in the universe is widely misunderstood. So how should it be interpreted? To grasp it properly requires a gentle walk through the ins and outs of inputs and outputs.
Imagine an economy that makes a house and nothing else. The house is the output of the construction industry. But to make it, builders require inputs. They need steel, which is the output of the metals industry. And the steel requires iron ore, the output of the mining industry. Assume these are all that is required. The house sells for $1m, the steel for $600,000 and the iron ore for $500,000. Now ask yourself, how important is the construction industry?
One narrow answer is 40% of GDP. In making the house, builders add $400,000 to the value of the steel they buy. They therefore account for two-fifths of the home’s $1m value. Since the house represents the entirety of the economy’s GDP, a narrow measure of the construction industry’s importance is 40% of GDP.
A broader answer is 100% of GDP. The house is the economy’s only “final” product. Everything else the economy makes is just an ingredient in that cake. The only reason to make ore is to make steel. And the only reason to make steel is to make houses. These “upstream” industries are therefore intimately linked to construction. If housing demand wavers, so will demand for steel and ore. So 100% of the demand for final products in this economy is demand for the things the construction industry makes.
How would Mr Rogoff and Ms Yang measure the importance of property? Those who have not read their paper might assume their figure is similar in spirit to the first, narrow answer. They may think it refers to the value added by the property sector (which in their paper includes services like estate agents as well as developers). People who have glanced at the paper may assume their approach instead conforms to the broad answer. The property sector has tight links with upstream industries. Therefore its importance includes not just the value it adds, but also the value added by its upstream suppliers (of steel and other inputs) and their suppliers (of ore and other materials).
In fact Mr Rogoff and Ms Yang do not exactly follow either approach. Applied to our simple economy, their method would yield an answer of $1.1m or 110% of GDP. It would count the iron ore ($500,000). It would also count the full value ($600,000) of the steel (even though that includes the value of the ore, an input to the input). But it would not count the $1m value of the house or even the $400,000 of value added by the construction industry.
Why not? Their approach is an unusual attempt to correct for double-counting. If you were to add construction output (the $1m home), steel output ($600,000) and mining output ($500,000), you could be accused of double- or even triple-counting. You would have counted the steel twice and the ore three times (once on its own, a second time when it is embedded in the steel, and a third time when the steel is embedded in the home).
The typical, intuitive way to avoid this problem is to count only the value that is added at each stage of production ($500,000 plus $100,000 plus $400,000 in our simple example). That method yields the “broad” answer of 100% of GDP in the one-house economy. The method employed by Mr Rogoff and Ms Yang includes some things not counted in this measure and excludes others that are. In the one-house economy their approach would count the steel once, the ore twice and the construction not at all. In the case of China’s economy, they argue, these inclusions and exclusions cancel out in practice. “The direct construction value added we did not include and the inputs of input we did include…are very similar in scale, and offset,” writes Ms Yang. “The alternative (perhaps more intuitive) approach does not change our message.”
In a forthcoming comment on Mr Rogoff and Ms Yang’s paper, a team of economists at the Asian Development Bank (ADB) including Mahinthan Mariasingham and John Arvin Bernabe has taken the more intuitive approach, totting up the value added by construction and property services, as well as the value added by other industries in supplying them, and by the suppliers of their suppliers. Using the same numbers as Mr Rogoff and Ms Yang for real-estate investment and services (albeit for 2017 not 2016) they reckon that China’s property sector accounted for 15.4% of GDP in 2017. Excluding imports, the number fell to 13.8%.
There is another wrinkle, however. The investment numbers used by Mr Rogoff and Ms Yang, and the ADB, may miss some buildings constructed by enterprises that are not officially classified as property developers. Including them, while using the more intuitive approach, increases the property sector’s importance to a little over 23% of GDP in 2018, according to Andrew Tilton and his team at Goldman Sachs. The sector remains of cosmic significance. But anyone alarmed by the 29% figure can rest about six percentage points easier. ■
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This article appeared in the Finance & economics section of the print edition under the headline “A universe of worry”