Does Japan's Long Economic Slump Offer Lessons For China?

Beijing’s release of a series of stimulus measures in recent weeks has revived a debate over a worrisome question: Is China fighting off a Japan-style deflationary spiral?

Over the past month, Beijing has eased rates, loosened curbs on housing, offered help to local governments, identified new projects, and stoked hopes for more stimulus. For many, the rapid-fire announcements, while welcome, signaled a conviction forming among the leadership about the dire nature of China’s economic challenges.

Some note similarities between China today and Japan three decades ago and warn Beijing risks falling into the same deflationary "doom loop" that haunted Tokyo: falling prices leading to less production, lower wages, and weak demand, which results in more falling prices. Balance sheets suffer as assets fall in value, but liabilities don’t.

Risk doesn’t mean certainty. The comparisons between China and Japan before its slide from its economic peak are imperfect. For every economist worried China is destined to experience the "lost decades" of Japan’s long deflationary slump, another will argue significant differences will allow Beijing to sidestep the worst. 

This debate matters for business. By any measure, China is a crucial engine of global growth. Many fear China will use its significant production capacity to export its way out of its problems. But the world also has a stake in Beijing’s stimulating the demand needed to overcome worrisome deflationary pressures in the world’s second largest economy. 

Stephen Roach, an economist affiliated with Yale University and a long-time scholar of both China and Japan, joined The Call this week to share measured analysis, noting the similarities do not mean China is destined to suffer Japan’s fate—unless China’s leadership fails to rise to the challenge with much more action.

On December 29, 1989, the Nikkei stock average, reflecting Japan’s turbo-charged growth, hit a peak of 38,916. As a young reporter, that number was seared into my mind as I wrote daily market reports the next year on how far the average was falling: down 5% from its peak, down 10%, down 25%. It ultimately would lose more than two-thirds of its value.

It wasn’t until February this year—after nearly 35 years—that Japan’s economy would recover enough for the Nikkei to surpass that peak, just days before US Chamber of Commerce President and CEO Suzanne Clark took a business delegation to China, ruling out decoupling but voicing concerns over China’s overcapacity and regulatory uncertainty.

China, like Japan around 1990, is coming off decades of stellar growth driven by high savings channeled to productive investments. Over years, savings ultimately overwhelmed sound investment opportunities, and both countries saw money pour into real estate. China, like Japan, sought to prick the resulting property bubble with disastrous results.

As institutions tend their balance sheets and growth slows, China is suffering from what Roach describes as a "growth shock" of rapid deceleration. “No matter how you cut it, a once hyper-growth Chinese economy is now experiencing the wrenching impacts of a major slowdown — just like Japan,” said Roach.

Deflationary pressures are mounting in China’s economy, just as they did for decades in Japan. As demand shrinks, manufacturers look for more customers overseas. Trading partners accuse China of flooding their markets with excessively cheap goods, the same accusation leveled against Japan in the past.

China, to be sure, has a vast pool of migrant laborers who are unable to claim formal residence in the urban areas where they work. Granting more rights for this cohort—measured in the hundreds of millions of workers—would stoke demand and help address everything from the oversupply of housing to what economists say is “chronic under-consumption.”

Optimists have other reasons to dismiss the comparisons with Japan, pointing to China’s sheer size, huge domestic market, massive industrial base, and vast numbers of educated workers with skills to create value-added products. Continued investment in high-end manufacturing could provide a spark.

One other difference, however, is less upbeat for Beijing. Japan’s deflation was driven in part by a population that had been aging for decades, but it wasn’t until nearly 20 years into Japan’s malaise that its population started to decline. China’s population is declining nowand aging more rapidly than Japan's.

Aging could be the biggest challenge because it causes consumers to avoid spending and hang on to cash for their final years. It thus cools demand and adds to deflationary pressures. This is especially true in China with expanding life expectancy, underdeveloped pensions, and a culture in which working children are expected to support aging parents.

"You need to convince the Chinese households and firms that they can do more consumption and more investment and less saving," said International Monetary Fund chief economist Pierre-Olivier Gourinchas, adding that will require “developing social safety nets that will provide for old age."

About the authors

Jay Sapsford

Jay Sapsford is Senior Vice President for Global Risk Analysis and helps lead the Chamber’s efforts in assessing geopolitical and economic risks that impact the business community. He plays a key role in identifying global trends, risks, and opportunities on behalf of the Chamber’s membership.

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