From Madoff to GDP
This week Madoff died and China published its latest GDP figures. On the importance of digging deeper...
Bernie Madoff died this week. His Ponzi scheme fraud took in private and institutional money alike. People invested because Madoff’s returns were steady. His fund averaged returns of over ten percent for decades. But the recycling of new inflows into fake returns couldn’t last. When the fraud was discovered and his operation collapsed, paper losses ran to $65 billion (including the destruction of fake profits). The feeling against Madoff was intense. Suffering from kidney cancer, Maddoff attempted to get out of prison for the last months of his life but:
Judge Denny Chin, who in 2009 sentenced Mr. Madoff to 150 years in prison, denied the motion. In an opinion last June, the judge said that some 520 victims had written to the court, with the overwhelming majority — some 96 percent — opposing Mr. Madoff’s request.1
We depend on our assets for security and opportunity. Studies have shown that people who experience a “wealth shock” (losing more than 75% of assets) are 50% more likely to die within a 20-year period.2 With hindsight it seems incredible that people invested their fortunes with a single individual. Madoff generated trust, investors didn’t dig into the details of the returns he reported and the accounts he published.
Similar to Madoff’s rate of return, between 1992 and 2010 China’s headline growth came in consistently at around 10 percent. From a longer term perspective, Chinese growth may be seen in the context of “wealth shocks” caused by Japanese invasion3, periods of revolution, upheaval, and famine.4 Since then, the effect of Chinese growth on poverty levels has been remarkable. The national poverty rate fell from almost 90% in 1981 to under 4% in 2016.
In contrast to the faith placed in Madoff’s Ponzi scheme returns, there is healthy skepticism around the nature and meaning of China’s GDP numbers.
As regards the veracity of Chinese GDP figures, in a series of published replies and responses to replies, the academics Carsten Holz and Angus Maddison argue about whether the published growth rates are within a margin of error or whether there is systematic bias.5 In a somewhat tense exchange, Maddison accuses Holz of a “..Manichaean view… that official statistics are good, and downward adjustments are evil...”
Arguments like this are a good thing. Debates around margins of error and bias increase confidence in the overall order of magnitude.
GDP in mandarin is 国内生产总值. The characters break down as: 国内 (guónèi - internal; domestic) 生产(shēngchǎn - produce; manufacture); 总值 (zǒngzhí- gross value). The character 内 (nèi - inner; inside) shows a building 冂 and a person 人 inside the building. Replacing this character with 民 (mín - people) turns GDP into GNP (国民生产总值). The choice between a location versus citizen focused perspective is important. In his book “The Growth Delusion” David Pilling points out that:
In these days of the multinational, when many Western companies have decamped to China, Mexico, or Vietnam, it makes more sense to use gross national product. Incidentally, that would make Western economies look better and the countries where the manufacturing takes place look worse than our current method of calculating the economy.6
Pilling also notes that if we used GNP “we would also have to acknowledge that much of the pollution we currently attribute to countries like China is actually pollution caused by Western companies that just happen to be operating in China.”
In his book “Gross Domestic Problem” Lorenzo Fioramonti draws the parallel between a narrow focus on GDP and Ponzi schemes as follows:
Price tags are the ultimate symbol of GDP. Continuous production and endless consumption are its underlying values. Durability, reusability and self-production are its worst enemies. Things that last are detrimental to GDP, because they only get priced (and thus counted) once… Nature, the ultimate provider of all richness, is enslaved and devalued. GDP gives mankind the illusion that growth is about production, when it actually should be viewed as a transfer. Mankind does not produce anything. It simply turns natural wealth into money. And puts it up for sale, in what looks like …. the most disastrous Ponzi scheme of history. According to E.F. Schumacher, the GDP paradigm ‘consumes the very basis on which it has been erected’ and ‘lives on irreplaceable capital which it cheerfully treats as income’.7
Li Keqiang, China’s Premier of the State Council (head of the central government, highest ranking Civil Servant) is often cited for his ambivalence about GDP. An alternative index, the “Li Keqiang Index”, is made up of the annual growth rate of outstanding bank loans (40%), electricity consumption (40%) and rail freight (20%).8
In 2004 Niu Wenyuan, chief scientist on sustainable development strategy at the Chinese Academy of Sciences, published a paper on adjusting GDP to account for unreal growth, waste and social costs.
Niu states that the official average 8.7 percent GDP growth rate from 1985 to 2000 should have been reduced to 6.5 percent if social and ecological costs were taken into account.
"The cost of one US dollar in output in China is four to 11 times that of developed countries," he says.
"If the current high-cost growth and serious pollution continue, China will face a heavily polluted environment and a serious shortage of natural resources in the near future, which would not support its future development," agrees Pan Yue, vice director of the State Environmental Protection Administration.9
The principles of Niu’s method are summarised by Pilling as follows:
We should not overconsume the environment, If you need “one pile of coal and a hundred units of electricity” but instead use three piles of coal and three hundred units of electricity then the “wasted” part of that process should not be counted. The excess part should be “scraped away.”10
Account for mistakes, i.e. suppose you hire workers to dig up a field and then hire more workers to fill the field back in again. In principle, GDP is created, but in practice the contribution is meaningless.
Don’t count GDP related to mitigating “costs to society”: If society is chaotic and high expenditure on policing is needed, then the GDP related to maintaining basic social order shouldn’t be counted.
The debate continues. Earlier this year Ma Jun from the monetary policy committee of the People’s Bank of China suggested scrapping GDP targets and focusing on employment and inflation instead.11 The most recent GDP figures published on Friday suggested 18.3% growth in first-quarter GDP compared to last year but Li Keqiang stressed the importance of keeping a balance and warned of the challenges ahead.12
Madoff’s Ponzi scheme teaches us to dig below the surface of headline figures. It’s important to be aware of the potential for Ponzi-like “fake growth” distorting shallow figures. We need to focus on what is real, productive and recognise the equivalents of digging holes and filling them back up again. That applies at a macro level as much as it does in everyday personal life. Questions about growth and progress need approaches that synthesise perspectives: from growth in terms of new opportunity generated by technology to growth in terms of happiness.13 Don’t put all your eggs (or thoughts) into one basket unless there’s a really good reason to break the cauldrons and sink the boats (破釜沉舟; pòfǔchénzhōu — commit yourself irrevocably).
https://www.nytimes.com/2021/04/14/nyregion/bernie-madoff-victims.html
https://theconversation.com/losing-wealth-health-and-life-how-financial-loss-can-have-catastrophic-effects-93639
https://www.sciencedirect.com/science/article/abs/pii/S0022199615000021#:~:text=The%20eight%2Dyear%20Japanese%20invasion,have%20not%20reached%20any%20reconciliation.
https://voxeu.org/article/historical-perspective-china-s-success-against-poverty
Maddison, Angus. Do official statistics exaggerate China’s GDP Growth? A Reply to Carsten Holz. Review of Income and Wealth, 52(1), 2006
Holz, Carsten, A. China’s Reform Period Economic Growth: How reliable are Angus Maddison’s Esitmates? Response to Angus Maddison’s reply. Review of Income and Wealth, 52(3), 2006
Pilling, David. The Growth Delusion — Wealth, Poverty, and the Well-Being of Nations
Fioramonti, Lorenzo. Gross Domestic Problem — The Politics Behind the World’s Most Powerful Numbers.
See for example https://thehedgefundjournal.com/china-s-li-keqiang-index/
http://www.china.org.cn/english/2004/Mar/89396.htm
See 4.
https://www.scmp.com/economy/china-economy/article/3119289/chinas-gdp-growth-targets-should-be-scrapped-help-put-cap
https://www.scmp.com/economy/china-economy/article/3129204/china-gdp-new-uncertainties-ahead-economy-premier-li-keqiang
https://ophi.org.uk/policy/gross-national-happiness-index/