Q&A: China's cash economy

Mario Cavolo, Shanghai-based communications advisor and professional speaker on the media and China, talks about his book on China’s cash economy, The Big Lie

What is the “big lie”?

The “big lie” is the misunderstanding that China is poor. The degree to which we think that we should follow and believe, and therefore forecast, on official statistics that we typically hear from governments and institutional analysis-type organizations. We hear the information about things like China’s annual per capita income is US$3400 per year, and the Gini coefficient is double what the Gini coefficient of the United States is. Fortunately, a deeper look shows that that simply isn’t the case.

Your book discusses the emergence of this shadow cash culture that you’ve estimated at US$6 to US$10 trillion. Could you explain how and why this culture has developed?

I want to first point out the idea that in fact it hasn’t emerged as something new. And that’s a big part of the misunderstanding. China for the last couple of decades, if you talk to any Chinese person or businesspeople, has very much been a cash culture. And so much of that cash culture is in fact off the books by its very nature. We can talk about the negatives of course. For example, when you have such a large cash culture, it makes all kinds of corruption a lot easier. But the positives are that it is a huge economic force that no one is including when they’re doing their analysis and forecasting and estimates of what GDP is in this society.

So with your estimate of US$6 trillion you’re not looking to put a precise figure on this cash economy –  it’s more that you want people to understand just the enormity of what’s going on, and you’re trying to give a figure  that is in some way acceptable to the public?

That’s right. And we do have some references to work with on that. We have the reference from Professor Wang Xiaoli with the China Reform Foundation, who in 2010 worked with Credit Suisse. Now, Credit Suisse, working with Professor Wang, produced the first official report on China’s shadow economy. The reference on that also would be Dr. Edward Feige from the University of Wisconsin, who’s the world’s most famous researcher on shadow economies, and who talks about how in the United States the shadow economy is US$2 trillion. And we’re not talking about the black economy, or illegal things. The gray economy is the shadow economy of workers who are working off the books, and this money is not being reported to Uncle Sam. So we’ve got US$2 trillion in the US, and that’s relative to GDP of US$16 trillion. In China, let’s just call it US$10 trillion of GDP. And even Credit Suisse at that time estimated the lower range of what I’ve said, which is US$6 trillion, as being the size of China’s shadow economy.

So we’ve got a good reference there. I trust that Credit Suisse did a lot of work in figuring out and looking deeply in terms of analysis and surveys and things to be able to reach that number of US$6 trillion. When I look at it a little bit further, I see US$6 trillion as being the low end of the range. It could be as high as US$10 or US$12 trillion. And again, why do I say it? There’s deductive reasoning—three to four hundred million rising middle class Chinese. Now, if you look at 20% of that population, you’re looking at 80 to 100 million people. And if you look at the nine stories of the nine people in the book, who are very common people that I know, who are very much average and part of that middle class, these people have, without any question, US$100,000 to US$500,000. And nobody realizes that they have this money. So if these nine people, the stories in the book, are representative of this 80 to 100 million people, we can easily deduce and say okay, so Mario’s saying there’s 100 million people out there who are just like these nine folks. The thing is, a lot of these people that I know have a lot more than US$100,000 in the bank. It’s really kind of miraculous. And the idea of having this much cash, to a Chinese, is not as shocking as it is to an American. So it’s a very different thinking in the society behind what might be driving this kind of behavior and driving these kinds of numbers.

And just to be clear, when you talk about cash, you’re not including property wealth. You actually mean cash.

Absolutely true, what you said. I am not in any way, shape or form including property wealth in what I’m saying. It’s very natural psychologically for us to assume that China’s street vendors are earning RMB3000 to RMB6000 a month. I mean, you can look at them and see the shoddy state that they’re in and think, yeah, they’re making US$500 to US$1000 a month and they’re barely getting by. And this is proven to be very, very incorrect by personal and direct observation. You’re welcome to go out and just sit down outside a dumpling street vendor and watch for three hours and informally count how many dumplings they’re selling. We’re thinking that they’re only selling 100 a day. Actually, they’re selling closer to 300 a day. So 300 a day times RMB10 of zhayanrou or jipai or whatever it might be, this is RMB3000. Not RMB1000. So the revenue that they’re actually taking in, Oliver, on a daily basis, is triple. And this is very common and, again, easy if you just take the time to take a look and watch and see what’s really happening.

I’ve gone a step further because I’ve known many of the street vendors, they’ve become lao pengyou, you know, I’ve known them for many years, and I would talk to them and I would ask them. And they say, oh yeah, we sell 250 of these dumplings a day and we sell 50 of these chickens a day. And you just pull out your calculator and figure out that that’s US$500 a day of revenue, so we’re going to say that that’s five days a week, even six days a week, so this is US$6000, US$12000, volume revenue per month operating—and I’m speaking in dollars—and now we look at their cost of doing business. Well, we know their cost of doing business is extremely low because they’re a street vendor. They have their food cost, and you can deduct food cost out of that of about 30%, it’s very common, commonly understood, so now we’ve got US$8000 left. And what other expenses do they have, they’ve got some expenses to their equipment, the use of the gas, the use of the electricity, they don’t have rent, they’re collecting cash all day long so they’re not paying taxes. So we have a street vendor we thought was poor, and actually we found out they’re clearing US$5000 a month. And it’s in cash off the books, and they’ve been doing this for 10 years. So US$5000 a month, 10 months out of the year, is US$50000.  

What are the implications of this cash economy? What are the implications of so much cash being available?

The implications are, for the most part, very very positive. I’m going to go very much along the lines of the other folks that we know who are positive on the Chinese economy, and I’ll paraphrase Jim O’Neill, the former chairman of Goldman Sachs. When asked about this idea of whether China’s economy is going to crash, whether there’s some kind of an economic disaster on the horizon, his answer is: I think it’s ridiculous. China is clearly slowing in certain areas, but most of the reason it’s slowing is because the policymakers deliberately want it to slow, and get China readjusted. So as I’ve said for the past two years, China is never going to land anytime soon. So no hard landing in China, and I agree with that 100%.

What other things about the Chinese economy should readers be aware of?

I don’t think anybody realizes that China’s private sector GDP as a percentage of total GDP is now larger than manufacturing, and larger than agriculture. You keep hearing in the newspapers and in a lot of official analysis from official statistics that China’s domestic economy needs to grow, and needs to decrease its reliance on the national-level infrastructure spending, and government spending and SOEs. You still read this in mainstream media articles, as if it hasn’t happened yet. And I’m telling you it’s already happened. China’s private sector GDP is now the largest sector and percentage of GDP compared to any other sector in the country. The private sector is booming. The private sector is also three times more profitable, for example, than SOEs.

Another example is China’s exports. So we say, oh, we’re worried about China’s exports, China’s exports are declining. Well, we know China’s exports are on a decline, and we know that there’s rising labor costs in China, so China’s products are getting more expensive, so China’s exports are declining because they’re not as competitive as they were. And that’s all we hear in the narrative. But what we need to remember in the narrative is that China’s export sector, as a percentage of GDP, is half of what it was ten years ago. Ten years ago China’s exports were 23% of GDP. Today they’re only 11% of GDP. So you can talk to me about how exports are declining, but in terms of how much of an impact that makes on overall GDP, and how much it tells us about the overall health of the economy – it’s half as important as it was just ten years ago. These are things, I believe, very few people factor into their fundamental understandings and forecasting of what’s happening in China.