Jeffrey LewisChinese Defense Expenditures

Yet again, the strange alliance of incompetence between the Defense Department and the press creates wildly exaggerated estimates of Chinese defense spending. AFP reports that “China is more than doubling its budgeted defense spending this year as part of an aggressive military modernization strategy, including deterring any moves by Taiwan to declare independence, the Pentagon said.”

I don’t know where to start. Perhaps with the facts: China’s budgeted defense spending rose by 11.6 percent in 2004, to about 206.8 billion yuan.

So did the Pentagon really say that China doubled its defense spending? Well, “the Pentagon”—in this case, Deputy Assistant Secretary of Defense for Asian and Pacific Affairs Richard Lawless—appears a little confused about how to calculate defense spending. Here is what Lawless said:

The officially announced budget in 2004 is more than $25 billion, but when off-budget funding for foreign weapon system imports is included we estimate total defense-related expenditures this year between $50 and $70 billion …

The $25 billion figure refers to the Chinese defense budget converted at the official exchange rate, which is set by the Chinese government at RMB 8.28: US$ 1.00. So far, so good. Then Lawless goes off the rails, suggesting that “when off-budget funding for foreign weapon system imports is included we estimate total defense-related expenditures this year between $50 and $70 billion …”

Not even remotely accurate. Lawless either doesn’t understand how to calculate Chinese defense spending, or he is deliberately exaggerating the size of Chinese defense procurement. I’d hate to think Lawless is incompetent – he shares an alma mater (Bradley University in Peoria) with my mother.

“Off-budget funding for foreign weapon system imports” probably accounts for no more than another US$ 2-3 billion (or 8-12 percent) of Chinese defense expenditures, based on the State Department’s World Military Expenditures and Arms Transfers (WMEAT) and the Department of Defense’s Annual Report on the Military Power of the People’s Republic of China.

Much of the difference between the “official” Chinese number of $25 billion and the DOD number of $50-70 billion is based on purchasing power parity (PPP) adjustments. I won/’t kill you an explanation of PPP, but you can read an accessible introduction to it here. The idea is that the exchange rate doesn/’t really capture the “value” of Chinese expenditures: people (to pick just one input) work cheap in China. But the PPP numbers for GNP and defense costs are complete fictions. They date from 1981 and 1984, respectively, adjusted only for inflation. Even the State Department, which produces WMEAT, doesn’t believe their own number: “Due to the exceptional difficulties in both estimating yuan costs and converting them to dollars, comparisons of Chinese military spending with other data should be treated as having a wide margin of error.”

So, how much is China spending on defense? The Chinese do have substantial off budget expenditures and forms for revenue, including what we call RDT&E (research, development, testing and evaluation). The best estimate that I’ve seen is from Shaoguang Wang, who estimates that China/’s total military expenditure has consistently been about 1.7-1.8 times its official defense budget—about RMB 350-375 billion.

I am skeptical about using a PPP estimate to convert to dollars. While the current exchange rate produces a number that is probably too low ($40-50 billion), PPP produces some perverse effects. For example, foreign arms are purchased largely in convertible currencies (no PPP), so RMB 100 spent on Russian fighter aircraft purchases about $12 of “defense spending.” The same RMB 100 spent on personnel expenses (salaries, uniforms, food), which would be calculated using PPP, buys $59 worth of “defense spending.” In other words, every RMB spent on something like uniforms, according to PPP, is five times as valuable as an RMB spent on jet-fighters. Those better be some pretty sharp dressed troops.

We know the PLA is much more interested in reducing the size of the armed forces to concentrate resources on technological modernization. Yet, according to PPP estimates, if China devoted its entire equipment budget (RMB 38.9 billion) to importing American weapons systems, overall defense spending would decrease by $18.2 billion. By his own bizarre logic, Mr. Lawless should be proposing to arm China to the teeth with US weapons systems. Of course, he would say that is foolish. But then again, so are PPP estimates for defense spending.

The headline should have read “Dubious Accounting Confuses Pentagon Official: Bewildered DASD Exaggerates Chinese Weapons Purchases by an Order of Magnitude.”