The economic lesson China must learn from 1980s Japan
Walk into pretty much any bookshop in the English-speaking world and in the prime spot just inside the entrance, you will be confronted by a shelf of books bearing titles like China Shakes The World: The Rise of a Hungry Nation, or China Inc: The Relentless Rise of the Next Great Superpower, or even When China Rules the World: The Rise of the Middle Kingdom and the End of the Western World.
The details inside may vary, but all these publications share a common theme: that the economic and political rise of China is inexorable and that readers in the Western world, and in the United States in particular, had better get used to playing second fiddle on the global stage to the ascendant power in the East. Believe what you read and it seems that in just a few years, people everywhere from Perth to Peoria will be working for Chinese-owned companies, struggling to master Putonghua and ditching their US dollars for yuan if they want to carry an acceptable hard currency when they travel abroad.
To those of us getting long in the tooth, it is hard not to draw parallels between the best-seller lists of today and those of the late 1980s. Back then, the same booksellers' shelves groaned under the weight of works with titles like Japan as Number One, and Yen! Japan's New Financial Empire and Its Threat to America, and even Blindside: Why Japan is Still on Track to Overtake the US by the Year 2000.
Book titles are not the only similarity between the situation now and 20 years ago. Today, the world's largest banks by market capitalisation are Industrial and Commercial Bank of China, China Construction Bank Corp and Bank of China. In 1989, they were Dai-ichi Kangyo Bank and Sumitomo Bank, with Fuji Bank and Industrial Bank of Japan close behind. Today, trade frictions are mounting as politicians in the West complain about unfair competition from China. Back then, their target was Japan. Today, it seems to many that the US is in terminal economic decline and that its eclipse by China is only a matter of time. Then, the next global economic superpower was clearly going to be Japan.
Except, of course, that Japan's rise to economic pre-eminence never happened. It was postponed indefinitely when the bubble economy burst in 1990 and Japan lapsed back into a lost decade that is fast becoming two lost decades.
Now, warns Tomo Kinoshita, a deputy chief economist at Japanese brokerage house Nomura International, China risks following the same economic trajectory.
The danger will arise if Beijing keeps interest rates low and credit conditions loose to compensate for future yuan appreciation while simultaneously pursuing financial-sector liberalisation.
In Japan, the consequences were disastrous. As large companies switched to raising working capital through the newly deregulated corporate bond market (see the charts below) instead of by borrowing from the banking sector, the banks were forced to maintain their margins by ramping up lending to small businesses and consumers.
As a result, the amount of leverage in the Japanese economy ballooned, fuelling an unprecedented bout of asset price inflation. By 1989, the grounds of the Imperial Palace in Tokyo were said to be worth more than the whole US state of California. Meanwhile, share prices soared threefold in four years, with the benchmark Nikkei-225 Index hitting a peak price-earnings ratio of more than 70.
A catastrophic bust followed, leading to years of economic stagnation.
Now with Beijing under international pressure to let the yuan appreciate, domestic credit conditions loose and the authorities pursuing financial deregulation, 'we find striking similarities between 1980s Japan and China', says Kinoshita.
That does not mean an asset price bubble and a lost decade of sub-trend growth are inevitable in China. Apart from anything else, policymakers in Beijing have so far been extremely cautious about allowing financial deregulation, and domestic leverage remains low.
Even so, there are undeniable parallels between China's situation today and the position of Japan in the early 1980s. And by far the most important lesson the comparison offers is that China's rise to economic pre-eminence is certainly not inevitable, whatever the book titles say.