Can China avoid the Japan trap?
Two concerns dominate elite politics in China. One is the collapse of the political system similar to the Soviet Union. The second is the Japanese period of economic stagnation in the 1990s. The fear of economic stagnation is behind the sharp cutbacks in the property market and the collapse of Evergrande. How real is this possibility? I would argue that China’s financial, governmental and corporate institutions are very different from Japan’s. A readjustment process is a more likely outcome than a long stagnation.
There’s no doubt that China and Japan – on the face of it – look similar. Both suffered through a property bubble, both had export-focused economies, and both have suffered through significant capital misallocation and industrial over-capacity. China’s increasing isolation, partly the result of deteriorating US-China relations and a decoupling in certain sectors such as semiconductors, has exacerbated the economic problems.
However, there are important institutional differences between the two countries that could result in a sharply different outcome for China. The credit bubble in Japan grew out of private investment in the property market, uncontrolled banks, and an expansive monetary policy. The bubble was created as Japan was abandoning the export-driven model and liberalizing the capital account.
In contrast, China’s credit bubble is the result of a government-imposed investment boom. Capital was supplied by both private and state financial intermediaries. There was direct government control of the policies leading to the Chinese bubble. Admittedly, once we throw in local governments, quasi-government-owned firms (LGFVs), and shadow banks, the nature of state control becomes increasingly muddy. Nonetheless, there is little doubt that China had a much more top-down economy than Japan in the 1990s.
The Chinese leadership has reacted to fears of a Japan-style financial crisis with a series of policies. These include boosting domestic incomes (and consumption) through programs such as “dual circulation,” deflating the property bubble through the “Three Red Lines” policy, and encouraging a shift of consumer savings from property speculation to consumption. Common Prosperity is another policy directed at increasing domestic consumption by distributing wealth. However, most of these policies will not create growth.
Controlling the downturn is one thing. Reforming credit allocation is another. Can China do this? Shifting credit to the private sector, and also forcing inefficient firms to leave the market, would increase corporate productivity. The first test case is Evergrande. The Evergrande near default is forcing local governments to manage a painful adjustment of investment in local projects. Beijing has told the provinces to support local Evergrande projects as best they can. The question is whether China is prepared to continue these draconian measures and create “creative destruction” in the provinces.
Now read on...
Register to sample a report