Satyajit Das: China must not follow Japanese path of growth and stagnation
Midweek View: Recent Chinese growth has been driven by a rapid expension of credit which has driven an investment boom
Tuesday 11 June 2013
Despite a history of conflict and competition, China and Japan share a contiguous geography and development models. China may also share Japan's economic fate.
Japan's post-war economic recovery and China's more recent growth were export-driven, using low-cost labour to drive manufacturing. Both used under-valued currencies to provide exporters with a competitive advantage. Exports were promoted at the expense of household income and consumption. Both encouraged high domestic savings rates, used to finance investment. Both generated large trade surpluses which were invested overseas, primarily in US government securities, to avoid upward pressure of their currencies and to help finance purchases of their exports. Both also used high levels of investment financed domestically to drive growth.
The 1985 Plaza Accord forced Japan to revalue its currency in the appreciation of the yen, reducing Japanese exports and economic growth. In order to restore growth, policymakers engineered a credit-driven investment boom to offset the effects of a stronger yen, driving a bubble in asset prices that collapsed. Government spending and low interest rates have been used to avoid a collapse in activity, exacerbating imbalances. This has resulted in large budget deficits, very high levels of government debt and enlargement of the central bank balance sheet, in part to finance the government and support financial asset prices.
China's resistance to a sudden, sharp revaluation of the renminbi is based on avoiding the Japanese experience. China's response to the global financial crisis, which triggered a large fall in Chinese exports and slowdown in economic activity, is similar to that of Japan following the Plaza Accord. Recent Chinese growth has been driven by a rapid expansion of credit which has driven an investment boom.
There are points of correspondence and divergence between the positions of Japan in the early 1990s and China today. Investment levels are high, in similar areas such as property and infrastructure. Chinese fixed investment at around half of gross domestic product is higher than Japan's peak by around 10 per cent and well above that for most developed countries of 20 per cent.
Like Japan before it, China's banking system is vulnerable. Rather than budget deficits, China has directed bank lending to targeted projects to maintain high levels of growth.
The reliance on overvalued assets as collateral, and infrastructure projects with insufficient cash flows to service the debt, means that many loans will not be repaid. These bad loans may trigger a banking crisis or absorb a big portion of China's large pool of savings and income, reducing the economy's growth potential.
At the onset of its crisis, Japan was much richer than China, providing an advantage in dealing with the slowdown. Japan also possessed a good education system, strong innovation, technology and a stoic work ethic which helped adjustment. Japan's manufacturing skills and intellectual property in electronics and heavy industry made it less reliant on cheap labour, allowed the nation to defer but not entirely avoid the problems.
In contrast, China relies on cheap labour, to assemble or manufacture products for export using imported materials. Labour shortages and rising wages are reducing competitiveness. China's attempts at innovation and hi-tech manufacture are still nascent.
Chinese authorities admit that the credit-driven investment strategy in response to the financial crisis increased domestic imbalances and resulted in misallocation of capital, unproductive investments and loan losses at government-owned banks.
Until 1990, Japan was successful, growing strongly with only brief interruptions. After the bubble economy burst, Japan has had almost two decades of uninterrupted stagnation.
In recent years, popular awe of the achievements of China has increased. But China's spectacular success could end in surprising failure, as the country fails to make the needed economic transition. The question now is can China avoid "turning Japanese"?
China faces challenges in shifting away from its investment-led growth model. Growth based on subsidised expansion of capacity is not viable. Attempts to continue the present strategy or the required adjustment may cause an economic slowdown with consequences for China's social and political stability.
Satyajit Das is a former banker and author of 'Extreme Money' and 'Traders Guns & Money'
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