Will China Follow Japan’s Past?

While Japan is coming out of a decades-long malaise, China is trying to avoid one. There are clear parallels between the two situations, but also some important differences.

First, a brief recap: Following World War II, Japan’s government, manufacturers and banks collaborated to not merely rebuild the ravaged nation, but generate an economic boom. The United States was a crucial partner and sponsor, forging a new alliance with Japan in the Cold War. Japanese factory output progressed from inexpensive but unreliable goods to some of the highest-quality products in the world.

Good times never last forever, and this cycle peaked with an asset bubble that burst in late 1989. A stronger yen in the late 1980s made Japanese exports more expensive, just as other Asian nations emerged as competitors in key categories like steel, autos and consumer electronics. Japan once had 8 of the top 10 banks in the world, but credit problems (mostly related to inflated real estate) caused a crunch that hampered Japan’s economy for a long time. Deflation set in and stayed, hindering consumption.

Social norms that developed in the growth cycle added to Japan’s struggle to rebound. Japanese firms have maintained the expectation of lifetime employment. Decisions in those firms are made by those with the longest tenure, who may be the least open to new ideas. Entrepreneurship is limited, with large incumbents representing the majority of employment. Letting mature businesses lumber along is a costly strategy. While bankruptcies and layoffs are never pleasant to endure, they allow labor and capital to move where they are most productive.

JAPAN’S ECONOMY HAS LANGUISHED FOR MORE THAN 30 YEARS.

Demographics have been especially challenging. Long work hours and impaired economic prospects weighed on the nation’s birth rate. Immigration to Japan is limited, offering few prospects for new arrivals to support the economy. Discouraged young workers often failed to launch careers at all, adding to stagnation.

After a slow start, Japanese policymakers sought to arrest the decline through public spending. The ratio of Japan’s national debt to its gross domestic product (GDP) grew from 49% in 1989 to 199% in 2019. The government always had a reliable buyer of its debt: the Bank of Japan (BoJ) monetized the deficit by printing currency to purchase new Japanese Government Bond issuances. But the stimulus only maintained the status quo, and once the practice began, it was a hard habit to kick. The BoJ’s overnight rate remains a moribund -0.1%, with governors fearful of impairing prospects with positive interest rates.

At long last, Japan seems to have ended its malaise. COVID disruptions played a part in the upward trend, as higher external demand for goods helped get the economy moving. A return to wage growth supported consumer spending. Moderate inflation should bring the BoJ out of its negative rate regime this year.

Japan’s incredible boom and bust offer important lessons for other nations. China is chief among them. History may not repeat, but it often rhymes.

Both countries grew quickly on the back of state-sanctioned, debt-financed technological transformations, which led to a surge in exports. Both countries ascended when their populations were young, and began to struggle when collective aging gathered momentum. Both ascended quickly to global leadership, which attracted both acclaim and disdain around the world.

China’s potential descent after decades of growth is a point of global concern. Foreign direct investment into China is falling; the pandemic illustrated the risk of concentrated production, and the Ukraine war illustrated the potential consequences of sanctions. China’s low birth rate—a rescinded policy that has become a cultural norm—and limited immigration have brought about a population decline. China’s equity markets are worried, falling off while indices in other markets ascend.

Both China and Japan borrowed heavily to finance their growth. Credit comes easy in thriving economies, but must be repaid even in sluggish circumstances. In both cases, leverage fueled excesses in property markets, which eventually cracked. Residents of both nations prioritize saving, making a shift toward domestic consumption a cultural challenge.

IS CHINA HEADED FOR JAPANIFICATION?

As it seeks to avoid “Japanification,” China has one clear advantage: the ability to learn from Japan’s struggles. Ben Bernanke, among others, has noted that Japan’s policymakers did not do enough, or act early enough, to head off persistent deflation. So far, the response of China’s government to its gathering challenge has been restrained. Fiscal stimulus has been minor, and the People’s Bank of China has offered only modest accommodations. Depressions throughout history call for overwhelming policy responses; without them, only time (lots of it) can heal.

Macroeconomics is not a movie. Japanese policymakers cannot jump in a DeLorean and change decisions made thirty years before. While Japan’s economic drama appears to be ending, China’s could be beginning. Unlike the Back To The Future series, no one is eager to watch a sequel.

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