The lessons of Japan

The legacy of these two global crises offers some very important cautionary lessons for China — namely that it cannot take external demand for granted in a crisis-prone world.

But there is another set of important lessons that can be drawn from the rise and fall of the modern Japanese economy — the first Asian economic miracle of the post-World War II era. After 45 years of 7¼ percent GDP growth from 1945 to 1990, the Japanese economy has slowed to just 1 percent average annual growth since 1991.

China has studied the Japanese experience quite carefully and its senior leadership has actively debated the risks of Japanese-like lost decades. In a celebrated interview on the front page of People’s Daily in May 2016, a so-called “authoritative person”warned of the overhang of China’s debt-intensive growth and the Japan-style quagmire it could lead to. The focus was not just on debt but on the perils of asset bubbles, unsustainable currency policy, banking system perils, and the deadweight of “zombie industries”.

While no two economies are alike, there are three major lessons from Japan that are especially important for China:(https://www.daowen.com)

First, the currency suppression of a mercantilist growth model is bound to elicit a strong response from the rest of the world —especially if other nations are struggling with their own growth problems. That was the case in the mid-1980s when the Plaza Accord put Japan under major pressure and it is the same case today when the United States raises strong objections to Chinese trading practices.

Second, economies are at great peril if they ignore the interplay between asset bubbles and leverage. Japan’s balance sheet recession of the 1990s is an obvious and painful example of the mounting risks to financial and economic stability. Other nations have struggled mightily with the trade-off between growth shortcuts and stability — including the United States and its sub-prime crisis and Europe with its sovereign debt crisis. The stability-growth trade-off is at the core of any system’s political economic balancing act. Resisting the temptation for risky growth gambits is the only way out. China’s newfound focus on deleveraging and financial stability is a sign that it has learned this important lesson.

Third, zombies sap any economy of its underlying productivity and ultimately strangle economic growth. In the end, subsidized lending to insolvent corporations and condoning bank reluctance to write down bad credits doesn’t buy time — it only puts a struggling system in a deeper hole. Keiretsu-like interlocking ownership arrangements are especially insidious in that they magnify cross-company and cross-sector spillovers in the aftermath of distress in asset and credit markets. Until Japan started dealing with its zombies in the late 1990s and early 2000s, the carnage of the first lost decade only worsened. China seems to understand this aspect of the Japanese malaise quite well, with its senior leadership warning explicitly of the zombie-like perils of excess capacity. The challenge will be to transform this into disciplined corporate and banking restructuring.

China is not Japan. It is more pragmatic in adjusting its growth model. It places a much greater emphasis on stability. And it knows full well the benefits of reforms in shaping the opportunities for economic development.