The Japanification of China

Japan has experienced a number of economic difficulties over the past three decades characterised by weak growth and deflationary pressure despite ultra-loose monetary policy. Following a post-war ‘economic miracle’ the Japanese economy peaked in the late 1980s and has never fully recovered. In light of a recent economic slowdown in China, some economists are beginning to wonder if China is entering a similar period of stagnation that has plagued Japan since the early 1990s.

The term "Japanese economic miracle" pertains to the remarkable stretch of economic expansion that Japan experienced from the aftermath of World War II until the conclusion of the Cold War. During this period, Japan swiftly ascended to become the world's second-largest economic power. Japan’s GDP peaked at $5.4 trillion in 1995, at roughly 70% of the US's $7.6 trillion economy. This is similar to the difference between China ($19 trillion) and the US ($26 trillion) today.

Although the US and Japan were allies, the threat of Japan overtaking the US raised concerns about an "economic Pearl Harbor." Consequently, the US took action to reduce the trade deficit with Japan. The 1985 Plaza Accord intentionally devalued the US dollar against the Japanese yen, eroding Japan's competitive edge. The yen strengthened from 250 to the dollar in 1985 to below 90 in 1995. The BOJ created an asset price bubble as it tried to weaken the yen, and when the bubble burst, the Japanese economy declined, marking the onset of several ‘lost decades’.

Economists have divergent views as to whether it was demographics, central bank policies, or the Plaza Accords which had the greatest impact on Japan’s economic decline. In all likelihood, several factors played a role in the country’s changing fortunes. Although China faces a similar combination of issues today, there are key difference between Japan in the 1990s and contemporary China which makes the Japanification of China an uncertain prospect.

During Japan’s bubble years, stock and property prices tripled, with real estate in Tokyo commanding astonishing prices of up to $1.5m per square metre, 350 times higher than Manhattan prices of the day. Tokyo as a whole was more valuable than the entire US property market and the Imperial Palace in the capital held a valuation equal to the entire state of California. Land-prices were so exorbitant, they constituted almost 65% of Japan’s national wealth at the time.

China

With one of the country’s largest property developers, Evergrande, recently filing for bankruptcy, China’s real estate sector, which currently accounts for 20-30% of GDP, is under pressure, which has led to the comparisons with Japan. But Chinese housing prices are nowhere near the levels of bubble era Japan and much of the recent decline in prices has been driven by intentional government policy to avoid a bubble and lower real estate as a share of the country’s GDP.

Much steeper declines in housing prices have been registered in Denmark, New Zealand, Sweden, and Canada, among others, and China’s house price declines are similar to those of the US market. Disinflation is a global trend at present as commodity prices cool down, supply chains recover, and central banks raise interest rates. As Chinese consumption and exports recover when global interest rates inevitably decline, China’s real estate sector is likely to recover while simultaneously declining as a share of GDP towards US levels at around 18%.

In the meantime, having avoided bailouts for failing firms like Evergrande, and stimulus cheques for the general public during the pandemic, the Chinese, who invented gun powder, have certainly kept theirs dry. While stimulus could weaken the yuan, this would help China avoid a debt-deflation spiral and could help boost exports which is the opposite of what happened in 1990s Japan.

Technology exports

There are other factors which negatively impacted Japan which do not apply to China. As internet companies boomed and cell phones became a must have product in the 1990s, Japanese firms lost their historical dominance in technology related exports. By comparison, while Apple and Samsung account for 40% the global smart phone market, the other 60% belongs to Chinese manufacturers.

Similarly, in terms of the green energy technologies emerging today, China is taking the lead. BYD (the Chinese company which manufactures Golden Arrow’s electric buses) has released an EV which boasts a 190 mile range, with a sticker price of approximately $11,000. That’s half the price of the least expensive gas powered car available in the United Kingdom. Perhaps unsurprisingly, China has recently surpassed both Germany and Japan to become the world’s top global car exporter.

Green energy exports, including electric vehicles, could be a significant source of growth and revenue for China. Cars are the world's most valuable trade commodity, with automotive parts ranking fourth. Likewise, demand for solar panels is booming and China is the leading exporter of the technology. China dominates wind power production too, with Chinese firms contributing almost 60% of the total installed capacity globally in 2022.

China could also increase productively through automation which was not an option for Japanese firms at the onset of their demographic decline while China also has a much larger domestic market to which it can redirect exports should trade relations with the US sour further. According to data from the World Bank, the United States accounts for just 11.5% of global imports today, half of the 23% of global imports it accounted for in 1989.

So while trade tensions with the US, deflation, and property sector woes all hint at the possible Japanification of China, there are significant differences between the two countries and eras that make direct comparisons of this nature somewhat unconvincing. China is leading in many emerging technologies expected to generate significant export revenues into the future, which contrasts with Japan’s declining share of technology related exports in recent decades.

The Chinese economy, still heavily dependent on the domestic property market and exports, may continue to face headwinds in light of a global high interest rate environment, trade tensions with the US, and a potential demographic decline. Nevertheless, comparisons to Japan’s ‘lost decades’ have limited utility in properly assessing the risks China faces or the country’s ability to respond to these on-going challenges.