Investigating the Validity of China's GDP Numbers

China's GDP statistics are often viewed with a dose of skepticism. The government frequently sets targets and those targets are almost always surpassed. When the government aimed for 8% full-year GDP growth, they got 10.7%  growth. If an investor is suspicious of these numbers, is there a way to get at the real number or at least find out whether or not this number is completely off and misleading? After all, inflated numbers can add to an irrational optimism that could create bubbles in the Chinese stock market.

A creative way to solving this problem, pointed out by a few economists, has been to measure the electricity consumption of China. Throughout the histories of the major economies, there has tended to be a very strong positive correlation between electricity consumption and GDP growth. This makes intuitive sense. As the economy grows and businesses need more energy to operate, electricity consumption will obviously follow. Further, as standards of living increase, electricity consumption per head increases. No wonder many economists doubt China's economic numbers, especially when situations like this arise:

"Power consumption in Sichuan dropped 9.9% in the first quarter, but its economic growth in the same period reached 10.8%. The local government explained the economic growth is mainly led by the post-disaster reconstruction. "I don't know how the economy grows in this area," said Zhao Bingren."

 However, I believe at times the positive correlation between electricity consumption and GDP growth can weaken. Through extraordinary advancements in productivity and investment, an economy can rapidly grow while electricity consumptions stagnates or even declines. Think of it this way: China leapfrogged two generations worth of old and slow computers and jumped right into the fast Dells and HPQs with Intel pentium processors. This huge investment resulted in amazing gains in productivity, relative to years without the computers. Was electricity consumption greatly impacted? No. New machinery and methods of production can result in tremendous productivity gains while still requiring the same amount of electricity as old machines. In fact, China's productivity grew at an extraordinary 8.2% in 2009 and once comprised more than 40% of GDP growth in periods within the decades of 1970-2002.

It may be time to grant China more credit.