## Chinese property, the output approach and triple counting

Over the last couple of decades property has been a significant driver of Chinese growth. The dependence on real estate is shown below and it is interesting to note that China was more dependent on housing construction than Ireland and Spain prior to the Global Financial Crisis.

Real estate related activities’ share of GDP by country, 1997-2017

Real estate has impacted consumer spending, employment of workers, investment and demand for raw materials. Investment in property has increased by 5% of GDP in 1995 to 13% in 2019 – 70% of which was residential. As for household consumption 23% is spent on real estate. How do you work out the value of output for residential investment and is there a problem with double counting?

GDP and the Output Approach

Gross domestic product (GDP) is defined as the value of output produced within the domestic boundaries of a country over a given period of time, usually a year. It includes the output of foreign owned firms that are located in that country, such as the majority of trading banks in the market. It does not include output of firms that are located abroad. There are three ways of calculating the value of GDP all of which should sum to the same amount since by identity:

NATIONAL OUTPUT = NATIONAL INCOME = NATIONAL EXPENDITURE

The output approach is the value of output produced by each of the productive sectors in the economy (primary, secondary and tertiary) using the concept of value added.

Value added is the increase in the value of a product at each successive stage of the production process. For example, if the raw materials and components used to make a car cost \$16,000 and the final selling price of the car is \$20,000, then the value added from the production process is \$4,000. We use this approach to avoid the problems of double-counting the value of intermediate inputs. GDP will, therefore, be equal to the sum of each individual producer’s value added.

The Economist look at a simple example of calculating the output approach using a house. House is built and makes up the whole economy. It is made of steel which is made from iron ore.

House is sold – \$1m
Steel is sold – \$600,000
Iron ore is sold – \$500,00

How significant is the construction industry? As the builders add \$400,000 to the value – 40% of GDP. But if the whole economy is the house is it 100% as the iron ore is an ingredient of the steel that is bought by the builder.

The Economist mention a paper by Kenneth Rogoff and Yuanchen Yang “Has China’s Housing Production Peaked?” in which they take a different view on calculating the value of property. They use the input-output total requirement matrix with the economy divided into 17 industries – manufacture of machinery, construction, transport etc. The coefficients indicate the production required directly and indirectly in each sector when the final demand for domestic production increases by one unit. By adding up the coefficients corresponding to the construction industry they found that 1 unit of increase in the construction sector requires 2.12 units of inputs from forward (other contractors) and backward (raw materials) industries. In breaking down the construction and installation as part of Chinese real estate, investment is RMB 7,630 bn. Thus 2.12 x 7,630 = RMB 16,176 which is the total value.

Therefore in the original option the Rogoff and Yang model would include the iron ore and not the value of the house or the \$400,000 value added by the construction industry. Therefore:

Steel \$600,000 + Iron ore \$500,00 – \$1.1m

There way of removing double counting is unusual as if you add the construction output \$1m, steel output \$600,000 and iron ore output \$500,000 there is a double and triple counting:

x2 = Steel – counted twice – purchase of steel and when house is sold
x3 = Iron ore – counted three times – purchased in raw material form, when used to produce steel and when house is sold.

The way that is normally talked about in textbooks is to only count the added value at each stage of production. Iron ore \$500,000 + steel \$100,000 + \$400,000 construction costs – \$1m = 100% of GDP in a one-house economy.

Sources:
China & World Economy / 1–31, Vol. 29, No. 1, 2021. Has China’s Housing Production Peaked? Kenne
th Rogoff, Yuanchen Yang

The Economist: Free Exchange – A universe of worry. November 27th 2021