Nav: Home

The GDP fudge: China edition

March 02, 2020

SMU Office of Research & Tech Transfer - For all its shortcomings, the gross domestic product (GDP) of a country remains an important barometer of its economic health, strongly influencing both private and public spending. Though conceptually simple as the total dollar value of all goods and services produced within a specified time frame, calculating GDP is tricky in practice and can be manipulated by individual firms in a strategy known as earnings management.

In particular, China's economic reporting has been called into question, with the provincial governments reporting in 2016 a collective GDP that was 2.76 trillion yuan higher than the national GDP calculated by the National Bureau of Statistics, or about 3.7% of the national GDP. The central government has acknowledged the issue: in 2017, the National Audit Office singled out ten provinces which had inflated their fiscal revenue to the tune of 1.5 billion yuan.

According to a new analysis presented at the 2019 Review of Accounting Studies (RAST) conference, held from 13 to 14 December at the Singapore Management University (SMU), there is reason to believe that Chinese firms engage in earnings management to prop up provincial GDP figures. Titled "GDP Growth Incentives and Earnings Management: Evidence from China," the study presented by the Dean of the School of Accountancy, Professor Cheng Qiang, also won the "Best Paper Award" by popular vote.

The pressure to grow GDP

"If the government is making decisions based on an inaccurate GDP number, then its decision quality will be lower," said Professor Cheng, explaining the implications of his study findings. Although discrepancies in GDP calculation can simply be a result of poor infrastructure for the collection of statistical data, differences in calculation methods or simple human error, not all such problems are unintentional, he said.

In the case of China, there is a strong incentive for provincial officials to present a rosy economic picture as this is intrinsically linked to opportunities for political advancement. This desire may lead officials to pressure firms into behaviours that negatively affect the accuracy of their financial statements, Professor Cheng suggested.

"The central government controls the personnel: who should be promoted into the central government, who should move to a bigger province. The political careers of provincial officials are decided by the central government," he said. Because a province's GDP is a significant factor in deciding which officials to promote, the system creates competition among them to present the best economic picture to the central government, Professor Cheng explained.

To test their hypothesis, Professor Cheng and his colleagues examined various measures of financial reporting between 2002 to 2016 representing over 21,000 firm-years. Specifically, they looked at three figures as proxies for earnings management: discretionary revenues, overproduction and abnormal asset impairment losses, all of which can be manipulated to directly influence GDP numbers.

These measures were then examined in tandem with potential incentives for inflating GDP growth. One way in which the study calculated such incentives was to compare provinces' GDP growth with that of adjacent provinces (which are more likely to have similar economic situations) as well as the national GDP growth. A province with a lower GDP growth compared to the national average or that of adjacent provinces would hypothetically be under greater pressure to engage in earnings management to inflate future GDP growth.

Additionally, the study also examined the issue of incentives from other perspectives, such as the age of provincial officials. Hypothetically, younger officials are more likely to compete for advancement compared to older officials nearing the retirement age of 65, therefore giving younger officials a stronger incentive to inflate a province's GDP.

Short-term gain, long-term pain

Indeed, Professor Cheng and colleagues found that firms in provinces with GDP growth lower than national or adjacent provinces' average GDP growth were more likely to engage in earnings management in the future compared to firms in other provinces. Specifically, these firms were more likely to inflate revenues, overproduce and delay asset impairment losses.

Lending strength to the study's hypothesis was that these results were more pronounced for firms in provinces with younger officials (60 years old and below), as well as firms which were local state-owned enterprises (SOEs) - over which provincial officials have greater control - compared to central SOEs or non-SOEs.

Besides studying the factors behind GDP inflation, the study also examined the potential consequences of earnings management to the firms (and in turn the province), revealing that there is a heavy price to pay for constructing an artificial image of a flourishing economy.

"When the province reports a high growth, the tax collected as well as other economic expectations will also be higher," Professor Cheng explained. "When you cannot fulfil these expectations, at some point, the situation will just blow up." This was indeed what played out in many provinces that admitted to inflating their GDP between 2017 and 2018, he pointed out.

In short, engaging in earnings management is costly to firms in the long run, Professor Cheng cautioned. "We find that firms that engage in earnings management for the incentive of GDP growth have a high bad debt expense that comes from inflating revenue; high inventory write-off that comes from overproduction; and high asset impairment losses that come from the delaying of asset impairment losses. All these result in a lower return on assets in the future."

"This is the first study that examines how the incentives at the government level affect management at the firm level. The second contribution is that this paper provides evidence about one mechanism by which government officials use to inflate GDP growth," Professor Cheng said.

"The third contribution is in articulating the dynamics between macroeconomic numbers and microeconomic numbers, and how the macroeconomic situation can affect the integrity of a firm's financial reporting."
-end-


Singapore Managment University

Related Age Articles:

How we age
It is well understood that mortality rates increase with age.
When you're 84...What should life look like as we age?
What will your life look like when you're 84? When a health system leader put that question to Lewis A.
Age matters: Paternal age and the risk of neurodevelopmental disorders in children
It is no secret that genetic factors play a role in determining whether children have neurodevelopmental disorders.
'Frailty' from age 40 -- what to look out for
With all eyes on avoiding major illness this year, health researchers are urging people as young as 40 to build physical and mental health to reduce or even avoid 'frailty' and higher mortality risk.
Why life can get better as we age -- study
People say life gets better with age. Now research suggests this may be because older people have the wisdom and time to use mindfulness as a means to improve wellbeing.
What causes an ice age to end?
Research by an international team helps to resolve some of the mystery of why ice ages end by establishing when they end.
New evidence of the Sahara's age
The Sahara Desert is vast, generously dusty, and surprisingly shy about its age.
When considering presidential candidates, age is just a number
A new white paper shows there is no such thing as being too old to be president.
Why sex becomes less satisfying with age
The number of women regularly having sex declines with age, and the number of women enjoying sex postmenopause is even lower.
A new 'golden' age for electronics?
Scientists at Nagoya University, Japan, have created materials that shrink uniformly in all directions when heated under normal everyday conditions, using a cheap and industrially scalable process.
More Age News and Age Current Events

Trending Science News

Current Coronavirus (COVID-19) News

Top Science Podcasts

We have hand picked the top science podcasts of 2020.
Now Playing: TED Radio Hour

Sound And Silence
Sound surrounds us, from cacophony even to silence. But depending on how we hear, the world can be a different auditory experience for each of us. This hour, TED speakers explore the science of sound. Guests on the show include NPR All Things Considered host Mary Louise Kelly, neuroscientist Jim Hudspeth, writer Rebecca Knill, and sound designer Dallas Taylor.
Now Playing: Science for the People

#576 Science Communication in Creative Places
When you think of science communication, you might think of TED talks or museum talks or video talks, or... people giving lectures. It's a lot of people talking. But there's more to sci comm than that. This week host Bethany Brookshire talks to three people who have looked at science communication in places you might not expect it. We'll speak with Mauna Dasari, a graduate student at Notre Dame, about making mammals into a March Madness match. We'll talk with Sarah Garner, director of the Pathologists Assistant Program at Tulane University School of Medicine, who takes pathology instruction out of...
Now Playing: Radiolab

Kittens Kick The Giggly Blue Robot All Summer
With the recent passing of Ruth Bader Ginsburg, there's been a lot of debate about how much power the Supreme Court should really have. We think of the Supreme Court justices as all-powerful beings, issuing momentous rulings from on high. But they haven't always been so, you know, supreme. On this episode, we go all the way back to the case that, in a lot of ways, started it all.  Support Radiolab by becoming a member today at Radiolab.org/donate.