Four lessons China must heed from Japan to get its economy back on track

If Beijing wants to beat the odds, it needs to succeed in key areas where Japan failed following its bad-loan crisis
These include being bold, treating the causes not the symptoms, avoiding policy blunders and having the political will to act

William Pesek

Published: 4:30pm, 15 Nov 2023

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As President Xi Jinping’s team struggles to address China’s property crisis, officials are forgetting the four most urgent lessons from Japan’s lost decades.

Economists are churning out a bewildering number of cautionary analyses about China’s economic development “turning Japanese”. That is understandable considering that Asia’s biggest economy slid back into deflation in October and its 2024 prospects seem to dim by the day.

It hardly helps that Beijing is proceeding as if time is on its side in getting China Inc.’s trajectory back on track. It’s not, with global investors pulling increasing amounts of capital out of Chinese assets. All this has economists adding decades to timelines for when China might surpass the United States in gross domestic product terms.

It is true that investors haven’t made vast sums betting against China as the Communist Party has kept crises from getting out of hand in the past 30 years. Xi’s team might also beat the odds, but only if they prioritise four imperatives that eluded Japan following its bad-loan crisis.

First, act fast and go big. Beijing is arguably already behind the curve as global headwinds mount. China’s leaders have been timid about adding fresh fiscal and monetary stimulus. This reluctance owes much to Xi prioritising deleveraging, both in the property sector and among local governments bingeing on debt.

The world has been watching, though. Just as Xi underappreciated how much economic damage Covid-19 lockdowns would do, his inner circle seems asleep at the wheel as growth loses momentum. This perception has only added momentum to the capital flight driving the yuan lower.

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After its bubble economy imploded, Tokyo was maddeningly slow to comprehend the magnitude of the pain to come. Once Japan ramped up stimulus, deflationary forces were too ingrained to stop.

Second, treat the problems rather than the symptoms. China needs a powerful burst of policy-driven reform to clean developers’ balance sheets of dodgy assets. The centrality of the property sector, which can generate as much as 30 per cent of GDP, means the stakes are high, and growing.

Economists at Citigroup estimate China’s property market hit US$65 trillion in 2020. This is more than 3.6 times China’s annual GDP and more than the combined property sectors of the United States, European Union and Japan. The longer Beijing drags out ridding developers from toxic assets, the deeper China will slide into deflation.

When its own property bubble collapsed, Tokyo’s response was glacial and piecemeal. That allowed Japan’s troubles to fester, deepen and necessitate even bigger interventions over time. Even after Tokyo created mechanisms to dispose of bad loans, deflationary fallout lived on.

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Along with studying Japan’s playbook, Beijing might also want to review the Resolution Trust Company model the US used to address its 1980s savings-and-loan crisis. What both the US and Japan show is that you can’t grow your way out of trouble. Economies must attack their underlying maladies directly.

Third, avoid damaging policy blunders. In the 25 years since Japan’s deflationary funk began, a succession of governments dabbled in austerity moves that squandered any number of recoveries. The most recent example is ill-timed increases in consumption taxes.

During Shinzo Abe’s time as prime minister, Tokyo made this mistake twice. The government raised sales taxes to 8 per cent in 2014 and then to 10 per cent in 2019 to help pay down debt. Both increases slammed growth, necessitating even more government borrowing.

Xi’s team must tread carefully with efforts to recalibrate local government borrowing. No doubt municipal leaders and their local government financing vehicles require serious monitoring, but Beijing needs to sequence these efforts carefully. Among Beijing’s biggest blunders was the late 2020 crackdown on tech platforms, which spread to the point that Wall Street found itself debating whether China might be “uninvestable”.

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Another Japanese strategy Beijing must avoid is leaning on a weak exchange rate to support exporters. This both warps economic incentives and increases risks of property developers defaulting on offshore debt. Even today, Japan is reminding Asia that no one wins this race to the bottom.

Fourth, political will is everything. The scale of the debt restructuring China needs will be deeply disruptive to a growth model so reliant on real estate revenue. It’s made all the more difficult by a dearth of transparency at the central government, municipal and corporate levels.

As the 1990s progressed, Tokyo dragged its feet in producing a bottom-line number for its bad-loan burden of more than US$1 trillion. The murkiness helped delay Tokyo’s response in ways Beijing can’t afford.

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Getting to the bottom of China’s troubles will require a level of political courage not displayed in the past 10 years. When the Xi era began, Beijing promised market forces would play a “decisive role” in decision-making. Instead, the role of the state-owned enterprises has again been elevated, and it is now harder for the global media and international investment banks to survey the financial landscape.

It is great that Premier Li Qiang is “talking the talk” about bold reforms to come. As Li said on November 5: “We will further relax market access … protecting the rights and interests of foreign investment in accordance with the law and continue to create a market-oriented, legal, and international business environment.”

But whether Li can “walk the walk” depends on how much latitude he is afforded. Might plummeting growth make Xi less tolerant of major reform? This is the big question as 2024 approaches. As Xi decides how much change is acceptable to free China’s animal spirits, the ghosts of Japan loom large.

William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades”