Behind the smokescreen of Beijing's 2013 defence budget

Yesterday, Beijing announced that it will jack up defence spending by 10.7 per cent this year to 720 billion yuan (HK$897 billion).

With tensions in both the East China Sea and South China Sea already running high, another double-digit increase in Beijing's military budget is bound to make China's neighbours nervous.

Yet although an increase of 10.7 per cent sounds like a big jump, by itself the headline figure is pretty meaningless.

On the surface, it looks as if Beijing's increase in defence spending outpaces even the growth of China's gross domestic product, which the government is targeting at 7.5 per cent this year.

But the GDP target is real growth, which adjusts for inflation, while the defence increase is nominal, which does not.

Factor in inflation at the government's target rate of 3.5 per cent, and the increase in China's military spending falls into line with GDP growth.

That's unlikely to reassure China's nervous neighbours, who can legitimately point out that Beijing's military expenditure is already the second-highest in the world after the United States.

What's more, there are widespread suspicions that the official defence budget deeply understates Beijing's actual spending on China's armed forces.

For example, the cost of arms imports - largely high-technology weaponry from Russia - don't show up in the defence budget, while analysts say that China's own weapons' research and development is funded by a separate budget under the Ministry of Science and Technology.

In addition, it is unclear how much of China's defence costs - financing local garrisons for example - is carried by provincial governments on their own budgets.

Attempting to factor in this hidden spending, last year the London-based International Institute for Strategic Studies estimated that China's true defence budget could be some 40 per cent bigger than the official figure.

Even then, however, China's defence spending does not look excessive. Assuming the institute's estimate is accurate, Beijing's total military spending this year will still be less than 2 per cent of GDP, little changed in relative terms over the past 10 years.

As the first chart shows, that's relatively modest in international terms. It's roughly what Australia spends, and far less than the US defence budget, although twice as much as Japan's military expenditure.

Again, however, it's Beijing's absolute spending, rather than its spending relative to GDP, that concerns China's neighbours.

Here as well this year's headline figure of 720 billion yuan is uninformative. In US dollar terms, 720 billion yuan equals US$116 billion, which is small compared to the Pentagon's US$614 billion budget.

But the two figures cannot be compared. Although the prices of standardised commodities can be assessed using market exchange rates, armaments are not freely traded and prices vary widely from country to country. Spend US$1 billion on a radar system, and you get a lot more for your money in China than in the US.

That means we have to adjust national defence budgets for differences in local purchasing power. Unfortunately, there are no reliable price indices for military spending. But if we use the economy-wide purchasing power parity, or PPP, exchange rates calculated by the International Monetary Fund, as the second chart shows, the value of China's 2013 defence budget jumps by almost 50 per cent.

Factor in Beijing's hidden expenditure, and the real value of China's defence budget climbs to double the headline figure announced yesterday.

Even then, however, it still amounts to less than 40 per cent of the US military's budget for this year.

tom.holland@scmp.com