Lessons for China from Japan’s lost decade

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The writer is the former deputy governor of the Bank of Japan and is now professor of economics at Waseda University

China’s recent economic slowdown has elicited comparison with Japan in the 1990s and its subsequent long stagnation with deflation. But are there real parallels to be drawn between the two countries?

The similarities are abundant. China has problems in the real estate sector. Asset prices have been falling. As the unemployment rate rises, especially among young people, the country seems close to deflation.

Some concerns are clearly overblown. China’s core Consumer Price Index is still rising, so it is premature to declare a Japan-like deflation. What China is experiencing right now is not just the collapse of overvalued asset prices, but the end of a growth model which has been the engine of its economy for the past 30 years. In this sense it is better to compare China today with Japan in the 1970s, when its real growth rate halved as the era of internal migration to its cities came to an end. China can still achieve growth of four or five per cent, reminiscent of 1970s Japan, not the disastrous 1990s.

Nonetheless, China’s current growth rate is clearly well below its potential, and that is reminiscent of 1990s Japan. This is not due to demographics — when youth unemployment is increasing, the problem is not a lack of young people. It is worth recalling that 1990s Japan also had underemployment even with ageing demographics.

So what should the Chinese authorities do to revive economic growth? There are five essential steps. The top priority should be debt restructuring. The pivotal moment for Japan, after the bubble burst, was the initiative to identify and tackle non-performing loans by then minister of Financial Affairs Heizo Takenaka. The Chinese authorities need to calculate the actual net debt across corporate, financial and local government sectors. This is a daunting task given the lack of transparent information about corporate balance sheets and local government’s heavy reliance on real estate revenue. China needs its own Takenaka to take the issue in hand.

Second, China needs an economic stimulus. The task of identifying the amount of net debt becomes increasingly difficult when macroeconomic conditions keep deteriorating and asset prices keep falling. The stimulus needs to be co-ordinated, wide-ranging and sustained to counter the slowdown. The necessary scale of the stimulus will get bigger the longer it is delayed. Monetary-fiscal policy co-ordination is required: given the heightened uncertainty, weak consumer confidence and chronic excess saving, the best policy would be money-financed fiscal transfers, or ‘helicopter money’. The government could cut taxes or support households, while the People’s Bank of China could pursue more aggressive monetary easing.

Third, China should refocus its overall economic policy stance towards growth. Indeed, the economic transformation towards IT, education, and services was already under way before the Chinese government tightened regulations on these potential growth engines. It is time to course correct and loosen the restrictions.

Fourth, beware dangerous policy ideas. Economic crisis breeds debate. Japan had plenty of economic debates, but some policy ideas were counterproductive and downright dangerous. During its long stagnation, Japan witnessed the rise of austerity policy thinking and the downplaying or neglect of standard macroeconomic policy. Never underestimate the perils of asset and general price deflation and do not wait until deflation becomes evident. Debt restructuring and market-orientated reforms are necessary, but they cannot be delivered without the support of macroeconomic policy.

Finally, but most importantly, action needs political will. Japanese policymakers were slow to tackle their problems. They engineered the bursting of the asset price bubble in 1989 to 1990 and welcomed asset price and general deflation even well into the early 2000s. The economy recovered somewhat between 2004 and 2007 during Junichiro Koizumi’s premiership and the first Shinzo Abe administration, when Japan’s non-performing loans problem was finally resolved with the help of improved macroeconomic conditions.

But it took Abe’s determination in 2012, approximately two decades after the onset of Japanese stagnation, to deliver a co-ordinated and sustained stimulus policy package. In this sense, China needs not only its own Takenaka, but a Koizumi and Abe as well.