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7 August 2023

Is China’s economy turning Japanese?

The country’s economic travails have echoes in history.

By George Magnus

The idea of China “turning Japanese”, to borrow from a popular 1980 hit single, has drawn much attention recently. Observers are asking whether China is in danger of a “balance-sheet recession” of the kind that condemned Japan to a long stagnation after its asset bubble burst in 1990. Given China’s global heft and significance – it now accounts for 18 per cent of world GDP – a similar outcome would have dramatic implications for everyone.

A balance-sheet recession, for simplicity, describes conditions in which the mismatch between the assets and liabilities in key sectors becomes so extreme that companies or citizens stop spending and borrowing, as they are compelled to reduce debts and dispose of assets. Normally, only painful structural reforms are able to turn economic performance around.

Following the abandonment of zero Covid late last year, China is struggling to maintain economic growth. Its travails, which include excessive debt, low productivity, weak income and consumption, poor demographics, a highly regressive tax structure and a state and party-centric system, have been accumulating for several years, much as Japan’s own problems did in the go-go 1980s. China’s population is ageing quickly. Both countries reached an economic tipping point as their old-age dependency ratios started to rise.

It is small wonder that people talk about the Japanification of China. The economic similarities are noteworthy, but while Japan offers a useful template for contemporary China, it is by no means exact.

It still seems strange to reflect on how Japan, with world-beating firms such as Sony and Toyota – for China, read Huawei and BYD – and a technological prowess that was the envy of the world, ended up in such trouble. In spite of Japan’s success in technology and engineering, its economy faltered because of contradictions and shortcomings in its development model, and the political blockages that prevented reforms. This was primarily due to institutional rigidity: the interlocking vested interests of the ruling Liberal Democratic Party, the state, banks and corporations.

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China has great capacity and ambition in science and engineering, but also similar contradictions. There are deeply embedded vested interests in the Communist Party, state institutions and private enterprises that are resistant to reform and insist on heavily centralised governance.

Japan, like China today, had an economic development model based on high savings, high investment and the pursuit of blatant mercantilism in which large trade surpluses and the accumulation of foreign currency reserves were regarded as an unambiguous good. These characteristics, though, also involve the pursuit of economic policies and strategies that support industry and state-owned firms, restrain wage and salary income and therefore consumption, and contribute heavily to the misallocation of capital and to inefficiency. Like Japan, China is courting deflation, not inflation.

[See also: The end of globalisation]

It is worth noting that China is actually a more pronounced version of Japan in important respects. China’s income per head is comparable to Mexico, its consumption per head no higher than Peru’s. In China, the consumption share of the economy is about 39 per cent, no higher than it was in 2000 and far lower than Japan’s share of 52 per cent in 1991. 

Capital misallocation and over-investment, especially in real estate, finance and industry were hallmarks of the Japan of 40 years ago, as they are of today’s China. Once upon a time, Japan boasted the biggest banks in the world. Now these are Chinese. Once, the emperor’s palace gardens in Tokyo were said to be worth more than all the real estate in California. The eventual fall was spectacular. 

China’s long-running property boom, in which the broadly defined sector expanded to account for a quarter of the economy, is now three years into what looks like a long period of stagnation or decline – because of overbuilding, indebtedness and poor demographics.

Yet there are also features of Japanification that are not present in China, today at least. China’s mismatched balance sheets are mainly in the local government, state enterprise and property sectors, not as in Japan, where it was located across large swathes of genuinely private industry. In real estate, most of Japan’s correction happened though a large fall in prices. While in China, a reluctance to allow prices to reflect valuations means transactions volumes are the major source of weakness – for now.

China is unlikely to have a comparable banking crisis to Japan because the state-owned financial system will not allow significant banks to fail, and it can move assets and liabilities around the system for some time. China’s stringent controls over outflows of capital, which Japan never had, will also help to keep the country relatively immune, but not totally safe, from capital flight. 

There are then similarities and dissimilarities between modern China and 1990s Japan, but it seems likely that China’s economic prospects will, as with Japan, be much more sober. Even after Japan’s bubble burst, Americans and others regarded it as an innovative, long-term-thinking nation that was economically superior and technologically more advanced. Racked by resentment and worry, officials and commentators feared it would go on to overwhelm and overtake the US.

This may sound rather familiar to a 2023 audience focused on China. Things didn’t quite work out for Japan the way it was expected. It’ll be no surprise if the same happens to China.

[See also: Why we need a more balanced approach to China]

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