Japan's 20-year rebalancing tells us China's slowdown will be bearable

PUBLISHED : Monday, 15 November, 2010, 12:00am
UPDATED : Monday, 15 November, 2010, 12:00am

In 1990, Japan was 17 per cent of the global economy and two-thirds the size of the United States.

With two decades behind it of nearly 10 per cent annual growth rates, it accounted for a larger share of global growth than any other country. Japan was expected to easily become the world's largest economy within two decades.

Imagine that at the time you had been smart (and foolhardy) enough to predict that for the next two decades Japan's annual growth rate would collapse to below 1 per cent and that by 2010 Japan would be less than one-third the size of the US.

Had anyone believed you, they would have almost certainly made two obvious predictions.

First, a slowdown of that magnitude would create an enormous economic drag for the rest of the world. Without Japan to power it, global growth would be anaemic.

Second, Japan wouldn't have calmly accepted such a disaster. At least there would be a surge in social instability and a revolt by voters.

Although your first crazy prediction would have turned out accurate, the two subsequent obvious predictions would not. In spite of the collapse in Japanese growth, the world grew robustly in the 1990s. What's more, the Japanese turned out to be remarkably accepting of the economic shock.

Why would we have got it so wrong? Although Japan comprised a disproportionate share of global growth, it did not contribute disproportionately.

Japan had at the time the largest trade surplus in history, which meant that it absorbed far more global demand than it provided. Since demand powers growth, the impact of Japan's declining GDP growth would come about largely as a consequence of the change in net demand it provided to the rest of the world.

On that score, Japan's contribution in the past two decades to the rest of the world was positive. Largely because of the decline in Japan's gross domestic product as a share of the world's from the late 1980s to the present, Japan's trade surplus fell from roughly 0.5 per cent of global GDP to less than 0.2 per cent.

In other words, the rise in Japan's net demand (or more accurately, the decline in its deficient net demand) provided an expansionary fillip to the global economy. Perhaps this is why the world was so easily able to shrug off the almost unprecedented collapse in Japanese growth rates.

But what about social instability - why were the Japanese so accepting of such a shocking contraction in growth? Japan successfully rebalanced its economy away from one that penalised growth in household income and consumption to one that supported it. The difficult rebalancing brought an increase in household income's share of GDP. In terms of consumption per capita, the last 20 years were not so bad.

Why? Because before 1990, as households were forced to subsidize growth, Japanese consumption grew much more slowly than GDP. After 1990, Japanese consumption grew faster than GDP as the country painfully rebalanced. Wealth was transferred from the state and corporate sector back to the household sector. Today China is the growth juggernaut, and economists warn increasingly about a sharp slowdown in Chinese growth.

If they are right, it may be worth remembering how the world, and Japan, reacted to the very sharp slowdown in Japanese growth. We may discover that once again our most obvious predictions about the impact of a Chinese slowdown on global growth and domestic instability turn out to be completely wrong.

Growth can slow sharply without too much damage to the world or to its citizens if Beijing is able to rebalance the economy as it slows.

Michael Pettis is a professor of finance at the Guanghua School of Peking University and a senior associate at the Carnegie Endowment