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China May Boost GDP By Including R&D In Calculation

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Debates over whether China’s GDP will decline gradually or fall off a cliff have been going on for well over a year, but it could get a large, unexpected boost next year as China’s National Bureau of Statistics (NBS) is considering a change to its methodology.

“The NBS is planning to reclassify R&D as gross fixed capital formation rather than its current treatment as ‘intermediate consumption’. According to the NBS, expenditure on R&D was RMB1.2tn in 2013, and its share of GDP has grown steadily from 1.1% in 2003 to 2.0% in 2013. Therefore, recognizing R&D as GFCF will boost the level and growth rate of nominal GDP,” writes Bank of America Merrill Lynch economist Sylvia Sheng (h/t Zero Hedge).

US made a similar change last year

There are a couple of things to note right away. First, while including R&D will prop up China’s GDP, that doesn’t mean the change is unwarranted. The US made a similar accounting change last year that increased annualized GDP from an estimated 1% to 1.7% during 2Q13. Some people will argue that both countries are massaging their GDP numbers, but it doesn’t make sense to criticize one and ignore the other.

The bigger problem is that this gives China another opaque lever that it can use to cook its books. Even if you agree that R&D expenditures should be included as GFCF, it’s measured through a government survey of research institutions and private companies. Having another input that can’t be reliably (or at least easily) checked by independent sources will cast even more doubt over China’s economic data.

Sheng estimates that the inclusion of R&D will increase nominal GDP level by 2.1% and GDP growth by 0.1 pp in 2014, so we’re not talking about an enormous shift (if her estimates are correct, it will be a smaller change in China than in the US).

Other changes to China’s GDP calculations

The inclusion of R&D has raised eyebrows, but it was just one of the NBS’s proposed changes. If the new methodology is approved China will also adopt a rent-based, instead of a cost-based, approach to include owner-occupied housing in GDP; it will replace actual final consumption of households with household final consumption expenditure (effectively adding government services such as education to the tally); and it will include stock options as part of employee compensation.

The new methodology would also make a distinction between economic and legal ownership of land to better reflect farmers’ income. Farmers in China have economic ownership of the land they work, and can sell those right to other people, even though the land is collectively owned from a legal standpoint, a distinction that isn’t needed in the West.

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