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
Start your day with The Independent, sign up for daily news emails
ebookA unique anthology of reporting and analysis of a crucial period of history
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

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

iJobs Job Widget
iJobs Money & Business

Guru Careers: Software Developer / C# Developer

£40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

Neil Pavier: Management Accountant

£45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

Sheridan Maine: Commercial Accountant

£45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

Laura Norton: Project Accountant

£50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

Day In a Page

Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine
Letterman's final Late Show: Laughter, but no tears, as David takes his bow after 33 years

Laughter, but no tears, as Letterman takes his bow after 33 years

Veteran talkshow host steps down to plaudits from four presidents
Ivor Novello Awards 2015: Hozier wins with anti-Catholic song 'Take Me To Church' as John Whittingdale leads praise for Black Sabbath

Hozier's 'blasphemous' song takes Novello award

Singer joins Ed Sheeran and Clean Bandit in celebration of the best in British and Irish music
Tequila gold rush: The spirit has gone from a cheap shot to a multi-billion pound product

Join the tequila gold rush

The spirit has gone from a cheap shot to a multi-billion pound product
12 best statement wallpapers

12 best statement wallpapers

Make an impact and transform a room with a conversation-starting pattern
Paul Scholes column: Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?

Paul Scholes column

Does David De Gea really want to leave Manchester United to fight it out for the No 1 spot at Real Madrid?