China’s economic landscape in 2023 raises concerns about the possibility of it undergoing “Japanification,” a term used to describe Japan’s prolonged economic stagnation in the 1990s. There are many similarities between today’s China and Japan in 1990, amongst which are demographic challenges and an over-supplied and over-priced property market. On these two dimensions, today’s China looks even more extreme than Japan in 1990 by certain metrics. For example, China’s crude birth rate fell to 0.75% in 2022, lower than Japan’s in 1990 (0.99%), and may slide further in 2023.
Comparing China and Japan:
Demographics: China’s demographic challenges, such as a declining birth rate, appear more extreme than Japan’s in 1990.
Housing Market: China’s housing market excesses, including a high vacancy rate and stretched house prices, are a cause for concern.
Counterbalancing Factors: China has lower urbanisation, lower GDP per capita (allowing for growth catch-up), a centralised political administration, and the ability to learn from Japan’s experiences.
Source: Goldman Sachs
Japan’s “Japanification” was driven by a fundamental change in longer-term growth expectations, rather than just demographics. China has recently shown signs of a downward drift in longer-term growth expectations, including reduced private investment, depressed consumer confidence, and downgraded GDP growth projections.
But there were policy errors that made Japan’s situation worse.
First, in Japan, companies not only found they had excess capacity when demand fell due to the property bubble bursting but experienced significant impairment of asset values on their balance sheets as a result of large asset price declines. Meanwhile, since debt remained on the balance sheet, net capital positions deteriorated steeply. This resulted in debt repayment becoming the number one priority, further depressing spending among corporations. In China, by contrast, many healthy private businesses are reluctant to invest not because of balance sheet impairment, but due to policy unpredictability and the regulatory tightening during the past few years that disproportionally hurt privately-owned enterprises.
Second, in Japan, banks attempted to postpone non-performing loan (NPL) disposal and continued lending to “zombie” companies. Both the government and banks maintained a strong incentive to procrastinate the costly (and politically expensive) disposal of NPLs with the hope that land prices would pick up eventually. As a result, financial institutions’ credit supply ability was significantly eroded.
The Chinese government does not face the same political costs that the Japanese government did, but its preference for commercial banks to absorb a large share of losses in property and local government debt may nonetheless constrain their credit creation ability.
Third, on the wage and inflation front, inflation expectations had been heavily affected by a stagnation in wages which started from the late 1990s in Japan. Following Japan’s financial crisis, corporations were confronted with not only debt overhang but also excess workers. It became particularly challenging for graduating students to find jobs. Under such circumstances, workers needed to accept lower wages to prioritise job security and then a deflationary mindset gradually became entrenched among households.
China’s case is somewhat different in that the oversupply of labour was partially driven by the government’s regulatory tightening, from internet to education and from finance to healthcare, which helped produce a similar result to Japan: youth unemployment rate exceeding 20% and wage cuts have been reported by many.
Of course, Chinese policymakers could prevent further deterioration in growth expectations during the transition away from property and infrastructure investment if they adopt appropriate policies.
While China may experience mild Japanification symptoms, avoiding a negative feedback loop between future growth expectations and current growth is crucial. Policy measures are needed to bolster economic development, restructure troubled property developers, and strengthen social safety nets. Policymakers in Beijing must manage expectations, ensure policy predictability, protect financial institutions’ lending ability, and use deflationary policies cautiously.
It is certainly within China’s power to navigate its economic transition successfully and avoid a prolonged period of economic malaise. For the sake of Australian trade, and particularly for its exports, this is an important and growth-defining objective.
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