Ben Chu: China could be the new Japan if it doesn't heed signs of stagnation

Economic View: Looking at the numbers, the outlook could actually be even worse for China

Not long ago there was talk about Western economies falling prey to the Japanese economic disease – a reference to endless stagnation in the wake of a massive asset bubble burst. But perhaps that was the wrong comparison.

A compelling new paper from Brian Reading and Diana Choyleva of Lombard Street Research suggests that it's actually China, rather than the West, which is at greatest risk of turning Japanese.

At first glance that sounds far fetched. China's growth might have moderated of late but the economy is still growing at around 7.5 per cent a year. If the country carries on expanding at that rate it will be the world's largest economy by the end of the decade, surpassing the United States. The idea that this powerhouse could be at risk of slumping into decades of disappointing growth in the manner of its Asian neighbour calls for a stretch of the imagination.

Yet Mr Reading and Ms Choyleva see similarities between Japan in the era of its economic miracle between the 1950s and the 1970s and China's growth model today. Both show a large class of repressed savers, with the public essentially compelled to lend cheaply, through the tightly controlled banking system, to the business sector. Both exhibit high investment rates, with GDP growth driven by high rates of capital spending. And both countries rely on strong foreign demand for exports, boosted by an undervalued currency.

The authors also point to structural parallels. They highlight the similarities between the Japanese "keiretsu" system – the tight links between businesses in different sectors involving cross-shareholdings – and the crony arrangements that prevail in much of Chinese industry and government today.

The Japan analogy is, obviously, an unwelcome one for the authorities in Beijing given the implication that stagnation could set in at some point. And looking at the numbers the outlook could actually be still worse for China if this analysis is correct.

The authors argue that Japan's business and government sector invested to excess in its boom, resulting in a misallocation of resources which, ultimately, turned into a significant drag on growth as banks were encumbered by bad loans. But, as the chart above shows, China's gross capital investment levels in recent decades have actually been even higher. While Japan invested up to 36 per cent of its GDP in its fast growth phase, China has lately been investing close to 50 per cent. As the University of California economics professor Barry Eichengreen puts it: "No economy can productively invest such a large share of its national income for any length of time."

It is a sign of how reliant on investment China has become that trade, though exports are still a large share of GDP, has been making no net contribution to annual growth since the global financial crisis of 2008.

A slowdown could also be more painful for China than it was for Japan if it happens any time soon. When Japan's asset bubble burst in the late 1980s per capita incomes had pretty much caught up with those in the West. In China average incomes are, at present, only around a fifth of those in the US.

China's population is also ageing faster than Japan's did, thanks to the one-child policy, which will add further to the economic pressures of any slowdown. Japan developed world-class manufacturing and technology companies such as Toyota and Sony by the time it stagnated, which enabled it to continue exporting and innovating. China has yet to develop national business champions of similar quality and levels of innovation fall well short of its main competitors.

The China/Japan parallels identified by Lombard Street Research are illuminating. And the conclusion of the authors – that China urgently needs to enact far-reaching structural reforms – is well made. China can't keep driving growth through high savings, high investment and by the accumulation of ever higher mountains of questionable bank loans. Internal consumption needs to take on a bigger role in driving growth. The financial system needs to be liberated and interest rates determined by the markets.

It will not be easy. Japanese governments, despite a democratic political system, found it impossible to take on powerful vested interests. It could prove even harder for a post-Communist authoritarian regime like China, which is only really held together by mutual material self-interest. One previous attempt at banking reform, led by former prime minister Zhu Rongji, was beaten back.

But there is a small light of comfort for China. There was nothing inevitable about Japan's economic malaise over the past 20 years. The country has been cursed by a hidebound central bank which tolerated destructive deflation and whose blocking influence on stimulus has only this year been overcome by Shinzo Abe's administration.

China doesn't suffer from such monetary conservatism. If anything the Beijing authorities have been too willing to stimulate in response to growth slowdowns. And President Xi Jinping and his team, which took power last autumn, certainly say all the right things about reform. Now we wait for the delivery.

In the end, all economies, like Tolstoy's families, are dysfunctional in their own individual ways. But that doesn't mean they can't learn from each other's mistakes. They can and must.

Suggested Topics
PROMOTED VIDEO
News
video
Life and Style
tech
Sport
Jodie Stimpson crosses the finishing line to win gold in the women's triathlon
Commonwealth games
Arts and Entertainment
While many films were released, few managed to match the success of James Bond blockbuster 'Skyfall'
film
News
John Barrowman kisses his male “bride” at a mock Gretna Green during the Commonwealth Games opening ceremony
peopleBarrowman's opening ceremony message to Commonwealth countries where he would be sent to prison for being gay
Arts and Entertainment
Jamie Dornan stars as Christian Grey in the Fifty Shades of Grey movie
filmFirst look at Jamie Dornan in Fifty Shades of Grey trailor
Life and Style
Phillips Idowu, Stella McCartney and Jessica Ennis
fashionMcCartney to continue designing Team GB Olympics kit until 2016
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Sport
Shinji Kagawa and Reece James celebrate after the latter scores in Manchester United's 7-0 victory over LA Galaxy
football
Sport
Farah returns to the track with something to prove
Commonwealth games
Voices
voicesGood for Lana Del Rey for helping kill that myth, writes Grace Dent
Life and Style
fashion Designs are part of feminist art project by a British student
Arts and Entertainment
The Tour de France peloton rides over a bridge on the Grinton Moor, Yorkshire, earlier this month
film
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Junior Research Analyst - Recruitment Resourcer

£18000 - £20000 per annum + OTE £25K: SThree: SThree Group has been well estab...

Senior Analyst - Financial Modelling

competitive: Progressive Recruitment: This really is a fantastic chance to joi...

Associate CXL Consultant

£40000 - £60000 per annum + BONUS + BENEFITS: Harrington Starr: CXL, Triple Po...

Business Anaylst

£60000 - £75000 per annum + BONUS + BENEFITS: Harrington Starr: Business Anal...

Day In a Page

Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Beyoncé poses as Rosie the Riveter, the wartime poster girl who became a feminist pin-up

Beyoncé poses as Rosie the Riveter

The wartime poster girl became the ultimate American symbol of female empowerment
The quest to find the perfect pair of earphones: Are custom, 3D printed earbuds the solution?

The quest to find the perfect pair of earphones

Earphones don't fit properly, offer mediocre audio quality and can even be painful. So the quest to design the perfect pair is music to Seth Stevenson's ears
US Army's shooting star: Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform

Meet the US Army's shooting star

Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform
Climate change threatens to make the antarctic fur seal extinct

Take a good look while you can

How climate change could wipe out this seal
Should emergency hospital weddings be made easier for the terminally ill?

Farewell, my lovely

Should emergency hospital weddings be made easier?
Man Booker Prize 2014 longlist: Crowdfunded novel nominated for first time

Crowdfunded novel nominated for Booker Prize

Paul Kingsnorth's 'The Wake' is in contention for the prestigious award
Vladimir Putin employs a full-time food taster to ensure his meals aren't poisoned

Vladimir Putin employs a full-time food taster

John Walsh salutes those brave souls who have, throughout history, put their knives on the line
Tour de France effect brings Hollywood blockbusters to Yorkshire

Tour de France effect brings Hollywood blockbusters to Yorkshire

A $25m thriller starring Sam Worthington to be made in God's Own Country
Will The Minerva Project - the first 'elite' American university to be launched in a century - change the face of higher learning?

Will The Minerva Project change the face of higher learning?

The university has no lecture halls, no debating societies, no sports teams and no fraternities. Instead, the 33 students who have made the cut at Minerva, will travel the world and change the face of higher learning
The 10 best pedicure products

Feet treat: 10 best pedicure products

Bags packed and all prepped for holidays, but feet in a state? Get them flip-flop-ready with our pick of the items for a DIY treatment
Commonwealth Games 2014: Great Scots! Planes and pipers welcome in Glasgow's Games

Commonwealth Games 2014

Great Scots! Planes and pipers welcome in Glasgow's Games
Jack Pitt-Brooke: Manchester City and Patrick Vieira make the right stand on racism

Jack Pitt-Brooke

Manchester City and Patrick Vieira make the right stand on racism
How Terry Newton tragedy made iron men seek help to tackle their psychological demons

How Newton tragedy made iron men seek help to tackle their psychological demons

Over a hundred rugby league players have contacted clinic to deal with mental challenges of game