‘So what is China’s real GDP?’ Factoring in environmental degradation

Peking University professor Michael Pettis has a fascinating, wide-ranging post at EconoMonitor dwelling mainly on SMEs under pressure in China. He also discusses the effects of environmental degradation and misallocated investment on China’s GDP. The post is online here.

On the impact of environmental degradation, Pettis writes:

‘Chinese GDP growth has been substantially overstated during much of the past thirty years.  Part of the reason for the overstatement is that the future costs of environmental degradation should in principle be included as a deduction to current growth.

After all if environmental degradation reduces future economic output because of health problems, not to mention because destroying rivers, farm land, and so on is the economic equivalent of selling assets and calling the proceeds income, then the growth in economic value it generates today should be reduced by the destruction in economic value.

So what is China’s real GDP?

This is hard to do, of course, but it eventually gets accounted for in the form of lower growth in the future.  If farmers produce less tomorrow because water is polluted, then future economic value added is lower.  If workers spend additional money on health care tomorrow, this money is transferred from other, more productive spending.

This happens everywhere, of course, but I would argue that in many countries, where environmental degradation has been less and has occurred over a much longer period, it is already showing up in lower GDP growth today, so it probably results in a much lower overstatement of growth.  In fact in rich countries where environmental degradation has slowed sharply, or even reversed, it may be causing GDP growth to be understated.

…

The combination of these two sources of GDP overstatement – uncounted environmental degradation and ignored [non-performing loans] – is pretty substantial.  To show how substantial, assume that GDP has been overstated by anywhere from 2 to 4 percentage points over the past ten to fifteen years.  This would imply that China’s GDP today is actually about 55% to 85% of its stated size – or to put it another way, that China’s economy is anywhere from 15% to 45% smaller than we think.’ [Emphasis added]

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