What GDP Means in a Soft Budget Economy Like China

China’s official growth target should be understood as a policy goal, not a forecast: the argument is that Beijing can produce growth close to its chosen target while financing investment, even when that investment creates little economic value. This does not require falsifying GDP figures. Rather, GDP can mean different things in economies with hard budget constraints, where failing projects are forced to recognize losses, and soft-budget economies, where borrowers - often local governments or state-owned enterprises - can expect continued credit or a bailout. China’s increasing reliance on the latter makes its reported growth less directly comparable with growth in economies that write down bad investments promptly.

The key mechanism is delayed loss recognition. If a project uses $100 worth of resources but creates only $80 of value, a hard-budget system records the $20 loss, lowering profits, asset creation, and value added - and thus GDP under each of its three calculation methods. A soft-budget borrower may keep the asset valued at its original cost, leaving the loss out of current accounts and reported GDP. The gap can persist while new borrowing refinances debt that the project’s returns cannot cover. But this process depends on debt continuing to grow. When borrowing slows or stops, losses must be recognized and paid for, reducing growth either through a sharp crisis or a prolonged period of weak performance. Rising debt relative to GDP is therefore a sign of the costs being deferred, not eliminated.