the size of “gray” income in mainland China: the Wang Xiaolu study

I mentioned in my post from yesterday that in looking over the Li & Fung corporate website, I came across mention in Li & Fung’s 3Q10 China Trade Quarterly of a study by a prominent Chinese economist, Dr. Wang Xiaolu, on the size of the underground, or “gray,” economy in China.  Dr. Wang’s estimate of the gray economy in China in 2008 is RMB 5.4 trillion, or about US$ 815 billion at today’s exchange rate.  That would amount to around 30% of aggregate disposable personal income in the Middle Kingdom–an immense percentage.

The study itself, sponsored by Credit Suisse and a followup to a less extensive earlier analysis using 2005 data, can be found on Scribd.

Dr. Wang’s conclusions

Based on 2008 data:

1.  official average per capita income of the top 10% of wage earners in China =  Rmb 43614 (US$6580)   actual income = Rmb 139,000 (US$20,950).

official income of next 10% = Rmb 26500 (US$3990)     actual income = Rmb 54900 (US$8275).

2.  Two-thirds of the gray income is in the hands of the top 10% of the population.

3.  Official figures substantially underestimate income inequality in China, which is in fact even worse than in the US.  On Dr. Wang’s numbers,

–51.9% of disposable income is in the hands of the top 10% of Chinese earners  vs.  47.2% in the US

–7.8% of income is in the hands of the bottom 40% of Chinese earners  vs.  9.6% in the US.

what is “gray” income?

Gray income is money received in exchange for goods and services that is not reported to the government and on which no tax is paid.  Dr. Wang clearly seems to me to be a reformer who wants to call attention to systematic abuse of power by high-ranking officials.  His examples of gray money all seem to revolve around this issue.

His examples include the semi-legal, like:

–excessive bonuses or perquisites for high officers of government-owned enterprises, or

–excessive wedding gifts to the children of politically powerful parents.

They also include the illegal, such as:

–bribes paid to public officials

–excessive costs in public construction

–government officials profiting from land sales they control

–stock manipulation.

Dr. Wang’s methodology

his reasoning

Dr. Wang points out that official statistics on income are derived from interviews from a random sample of Chinese citizens.  Participation in the surveys is voluntary, however .  Dr. Wang maintains that:

1) all citizens questioned under report their income, and

2) many high-income people contacted decline to participate.

Together, these factors create a systematic downward bias to the official numbers.

an illustration

Dr. Wang illustrates that the official figures cannot be correct by pointing out that one can use them to conclude that Chinese citizens saved, in the aggregate, Rmb 3.5 trillion in 2008.  But data from other sources that show the increase in personal bank savings, private property purchases, and private buying of bonds and stock IPOs–in other words, that act as a proxy for the actual amount of money citizens saved during the year–total to over Rmb 11 trillion!

how Dr. Wang proceeded

In general outline,

–Dr. Wang trained a cadre of interviewers and developed a questionnaire intended to develop detailed information about expenditures on necessities like food and, in a more subtle way than the government’s survey, inquire about income.

–He created a list of potential interviewees from the friends and acquaintances of his interviewers, and selected  a subset of about 5000 of these to be actually interviewed.

–Post interview, the questioners graded the survey questionnaire based on their judgment as to the completeness and truthfulness of the answers, rejecting a bit less than 20% of the questionnaires on these grounds.

–He used the data collected from the remaining 4000+ to generate an Engel coefficient for China, that is, a relationship between expenditure on food and total income.  He then applied this coefficient to the government survey data, on the assumption that the information revealed by interviewees about expenditure on food is relatively correct.

is this scientifically correct?

No.  The biggest issue is that here’s no reason to believe that the friends and acquaintances of Dr. Wang’s interviewers are representative of wage earners in China as a whole.

Also, interviewees in the US tend to be less truthful in person-to-person interviews than in internet or mail (in the old days) surveys.  I don’t know what evidence there is in China.  I also don’t know what evidence there is that the cadre of interviewers is good at telling whether an interviewee is  being honest or not.

is this the best information we can hope for?

Probably yes.

investment implications

Even if Dr. Wang’s results are only directionally correct, they imply that disposable income in China is a quantum leap higher than official figures suggest.

If he’s right that the extra income in concentrated among the wealthiest Chinese citizens, then the market for luxury goods there may be much bigger than is commonly believed.  This would be good news for the Macau casinos and for luxury goods producers around the world–including local brands that may develop.

Severe income inequalities are a potentially politically destabilizing social issue.  This is Dr. Wang’s greatest concern, I think.  As Credit Suisse points out in its report that contains Dr. Wang’s findings, Beijing seems to concur.  It has encouraged/allowed large wage increases for factory workers in eastern China.  And it appears to be signaling it wants workers’ unions to take a greater role in ensuring that workers get a greater share of enterprise profits.

This may also be a big reason the Chinese government is opposed to a one-time large appreciation of the renminbi.  Doing so would simply validate the current, potentially dangerous, income inequalities.  Better, say, to encourage a doubling of workers’ wages over the next five years and allow the resulting demand for foreign goods push up the Chinese currency than to let “hot money” portfolio inflows do the job all at once.

a closing note

Credit Suisse points out that Greater China (the mainland, Hong Kong and Taiwan) already accounts for 28% of Swatch’s sales and 20% of Richemont’s.  Booming watch sales seems to be more evidence for the sharp male skewing of Chinese luxury consumption that Bain points out in its latest annual luxury goods survey (see my posts on Bain).

Credit Suisse’s favorite among the Macau casinos is the Galaxy Entertainment Group (0027:HK), on the idea, prevalent in Hong Kong, that the mass market is the best place to be.  That may well be true, although I’m still a bit skeptical.  But Galaxy appears to me to be the weakest of the casinos, however.  CS also thinks that the stocks of property developers stand to benefit as the world begins to appreciate how much income China has.  Myself, although I really like property stocks, I’d prefer something in financial services.

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