Yesterday I wrote about why I think that China and its economy is just getting started.
But a lot of people think China is headed for a fall. And they point to Japan – probably the worst economic and market crash-and-burn of the past few decades – as a model for how this might happen.
The Asian miracle?
An Asian nation with the world’s second-biggest economy that’s expected to overtake the U.S. as number one… which is reflective of the world’s balance of power shifting from the West to the East.
This describes expectations of China today. But this also describes Japan in 1989, when its economy was called “the Asian Miracle.” At the time it seemed a foregone conclusion that Japan would eventually dominate the world economy.
But it turned out that 1990 was the high water mark for the Japanese, ushering in what has come to be known as “The Lost Decade” (which has now lasted far longer than only one decade).
From the mid-1950s to the mid-1970s, Japan’s economy grew at about 10 percent a year. From 1973 through 1990 it averaged about 4 percent growth. But from 1990 to 2011, Japan’s economy flat-lined at an annual growth rate of less than 1 percent.
China’s economy has been growing steadily for so long that it’s easy to assume more of the same going forward. (This is called “status quo bias” and we wrote about it here.)
But some economists see disturbing similarities between Japan just before its Lost Decade(s), and China today. Japan’s “Asian Miracle” showed that destiny is not written in stone.
Let’s look at the similarities – and differences – between Japan’s economy in the early 1990s and China’s today.
Japan then and China now – the similarities
1/ High levels of debt
From 1980 through 1990, Japan’s debt rose from 105 percent to 176 percent of GDP, according to Bloomberg. Today in China, debt stands at about 280 percent of GDP, up from about 160 percent in 2008.
As debt grows, an increasing portion of a country’s resources are used to service debt. High levels of debt leave a country vulnerable to an economic shock – like Japan’s economic bubble bursting in 1990.
2/ Market bubbles
Japan’s Nikkei Stock index rose over 500 percent in the 1980s before crashing. Today it’s still 52 percent below its December 1989 all-time high.
Japanese real estate collapsed too. Japan’s property market peaked in 1991. At the time, it was estimated that all the land in Japan was worth about US$18 trillion – which was quadruple the value of all the land in the U.S. in 1991. House prices went up 191 percent between 1973 and the beginning of 1991.
But then property prices collapsed. House prices in Japan today are more than 40 percent below where they were at their peak in 1991.
Since December 1990, China’s Shanghai Composite index is up 3,178 percent. And last year saw the market peak in June 2015, before collapsing 32 percent in a month. It’s currently 37 percent below the 2015 peak.
And there are serious concerns that China’s real estate market is a giant bubble that’s ready to pop. Since the end of 1989, Chinese house prices have climbed 389 percent. One of the reasons Chinese investors are buying up so much foreign real estate may be because they think the Chinese real estate market is too risky.
3/ Zombie companies
When Japan’s real estate and stock market bubble burst in the early 1990s, the country’s banking sector was left with trillions of yen of worthless loans on its books. Rather than taking the losses, most banks – with the encouragement of the government – denied the problems and rolled the loans forward.
Companies that should have failed were kept alive – like zombies. By allocating financial resources to bad loans, and keeping zombies in business, the Japanese government distorted competition. It also meant fewer resources were available to the strongest firms that would lead economic growth. It took a decade for Japan’s banks to get rid of their non-performing loans.
Today in China, cities in the country’s “rust belt” – a line of interior cities from China’s northeast to the southwest – are home to many half-dead cement factories and other semi-mothballed heavy industry plants. Many industrial plants expanded production aggressively during China’s long investment boom, gorging on credit from state-owned banks.
But now, these same industries have too many factories producing too much stuff. Many factories are in default on their loans. And – like Japan 25 years ago – the Chinese government feels pressure to keep zombie companies alive. Forcing bankruptcy and closing factories would result in millions of unemployed workers, increasing the government’s assistance burden and raising the prospect of social unrest.
4/ Challenging demographics
Japan’s bad demographics are another reason for its decades of stagnant economic growth.
The working age population in Japan has shrunk from about 87 million in 1995 to about 75 million today, according to Bloomberg. Meanwhile, the number of people over 65 in Japan has grown from about 15 million in 1990 to nearly 35 million today.
An aging population, along with low, or negative, population growth (Japan’s population actually fell by 0.7 percent between 2010 and 2015), results in fewer workers. Fewer workers supporting a larger number of older people means less money available for investment or buying things – which can result in slower economic growth.
China seems to be heading in the same direction. China today has roughly five workers for every retiree. By 2040, this ratio will have collapsed to about 1.6 to 1.
The median age in China is expected to rise to about 46 by 2050, up from less than 30 at the beginning of this century. That would make China one of the older societies in the world.
At the same time, the number of Chinese people over 65 is expected to rise from roughly 100 million in 2005 to more than 329 million in 2050. That’s more senior citizens than the combined total populations of Germany, Japan, France, and Britain.
This huge population of seniors and relatively small working age population will pose a challenge to China’s ongoing economic growth.
Japan and China – the (major) differences
But despite the many apparent similarities between Japan in 1990 and China today, there are major differences in China’s favour.
1/ China is at a very different stage of development
Even before World War II, Japan was already an advanced economy with high labour productivity and mature institutions. The war destroyed much of this, so the post-war decades were in part a rapid rebuilding program – which was faster and easier to do than starting from scratch.
China, however, is in the middle stages of a transformation from an agrarian society to a modern, urban one. This is a much earlier stage of economic development than where Japan was in 1990. Back then, Japan was nearly as rich as the U.S. – its GDP per capita was roughly 80 percent of that of the U.S.
But China today has a GDP per capita of just over US$7,900 – only 14 percent of the current U.S. figure of US$55,800. By this measure China still has a long way to go.
As we discussed, one result of this urbanisation is a quickly growing middle class of consumers. This growing consumer class, spending more money in China, is already transforming China’s economy.
Now the world’s second-largest economy, China – like the rest of the global economy – will continue to experience economic ups and downs. And there is always a chance that China’s communist planners pull the wrong levers, like Japan did in the 1990s.
But the Chinese economic juggernaut is likely to continue, albeit at a slower pace.
A Chinese lost decade won’t happen. In fact, while it won’t be a straight upward line – nothing is – China’s growth is still in its early chapters.