How China can avoid a replay of Japan’s lost decades
Stephen Roach says China’s embrace of structural rebalancing distinguishes it from Japan but success will hinge on its willingness to confront the powerful vested interests resisting economic reform
Despite deepening concerns about China’s economy, the country is not heading towards “lost decades” of Japanese-style stagnation. And yet a worrisome ambiguity clouds this verdict. Japan’s fate was sealed by its reluctance to abandon a dysfunctional growth model. While China’s embrace of structural rebalancing distinguishes it from Japan, it is struggling to implement that strategy. Unless the struggle is won, the endgame could be similar.
The same conclusion emerges from a seminar, “The Lessons of Japan”, that I have taught at Yale for the past six years. The course is primarily one in forensic macroeconomics – distilling key lessons from the rise and fall of the modern Japanese economy and then figuring out their relevance for other major economies.
The seminar culminates with student research papers aimed at assessing which candidates might be the next Japan. As recently as 2012, the US was the top choice, as it struggled to regain its footing in the aftermath of the 2008 financial crisis. Not surprisingly, by 2013, the focus had shifted to crisis-battered Europe. But, this year, more than half of the students in the seminar chose to examine whether China might be the next Japan.
An academic setting provides a wonderful intellectual laboratory. But a couple of quick trips to China after the end of the spring term gave me a different perspective. In extensive discussions with Chinese officials, business leaders, academics and investors, I found great interest in the lessons of Japan and how they might bear on China’s conundrum.
The topic du jour was debt. China’s non-financial debt has risen from 150 per cent of GDP in 2008 to 255 per cent today, with two-thirds of the increase concentrated in the corporate sector, largely state-owned enterprises. As the world’s largest saver – with gross domestic saving averaging 49 per cent of GDP since 2007 – surging debt hardly comes as a surprise. High-saving economies are prone to high investment, and the lack of capital market reform in China – exacerbated by the bursting of the equity bubble in 2015 – reinforces the disproportionate role that bank credit has played in funding China’s investment boom.
The Japan comparison is especially instructive in assessing the risks of debt-intensive growth. At nearly 390 per cent of GDP in late 2015, Japan’s overall debt ratio is about 140 percentage points higher than China’s. But, because Japan has such a high saving rate – averaging 24 per cent of GDP since 2007 – it basically owes its debt to itself. That means it is not vulnerable to the capital flight of foreign investors that often triggers crises.
With China’s saving rate double that of Japan since 2007, that conclusion is all the more pertinent for its debt-intensive economy. The China scare of early 2016 – stoked by hand-wringing over capital flight and currency risk – missed this point altogether. Fears of a hard landing stemming from a Chinese debt crisis are vastly overblown.
Zombie firms – the economic walking dead – are also a topic of intense discussion in China. Key actors in Japan’s first lost decade during the 1990s, zombie corporates were kept alive by the “evergreening” of subsidised bank lending – masking an outsize build-up of non-performing loans that ultimately brought down the Japanese banking system. Significantly, the insidious interplay between zombie corporates and zombie banks clogged the arteries of the real economy – sparking a sharp slowdown in productivity growth that Japan has yet to reverse.
Xi Jinping must use his power and iron will to reform mainland China’s bloated state-owned enterprises
In recent public statements, the Chinese leadership has made explicit reference to zombie SOEs. But, unlike Japan, which remained in denial over this problem for close to a decade, Chinese authorities have moved relatively quickly to rein in excesses in two key industries – steel and coal – while hinting of more to come in cement, glass and shipbuilding.
China’s deteriorating loan quality is also reminiscent of Japan’s experience. The official non-performing loan ratio of 1.7 per cent for listed banks is only the tip of the iceberg. Beneath the surface are “special mention loans” – where borrowers are in the early stages of repayment difficulties – along with bad credits in the shadow banking sector, both of which could raise China’s fully loaded non-performing loan ratio to around 8 per cent. In that case, the authorities will eventually need to inject capital into the banking system.
None of this is a dark secret in Beijing. On the contrary, an interview in early May with an “authoritative insider”, published in People’s Daily, underscored an increasingly open and intense debate among senior officials over how to avoid ending up like Japan. The insider, purportedly close to President Xi Jinping (習近平), highlighted the insidious connection between China’s debt and zombie problems that might well culminate in a Japanese-like “L-shaped” endgame.
This gets to the heart of the China-Japan comparison. Two-and-a-half lost decades (and counting) is simply an unacceptable outcome for China. But knowing what it doesn’t want is not enough to guarantee that China won’t fall into a Japanese-style trap of its own.
Reforms are the decisive differentiating factor. Japan’s failure to embrace structural reforms was a hallmark of the 1990s, and it is an equally serious impediment to the current “Abenomics” recovery programme. By contrast, China’s strategy emphasises the heavy lifting of structural change and rebalancing. In the end, success or failure will hinge on the willingness of the Chinese leadership to confront the powerful vested interests resisting reform.
Interestingly, of the 13 students in my seminar who chose to consider China as the next Japan, two-thirds ultimately rejected the comparison. They argued that the lessons of modern China – especially the reforms and opening up spearheaded by Deng Xiaoping (鄧小平) – are more important than the lessons of Japan. And they got good grades.
Stephen S. Roach is a faculty member at Yale and former chairman of Morgan Stanley Asia. Copyright: Project Syndicate. www.project-syndicate.org