China repeating Japan’s mistakes ? It’s too early to tell

The bursting of the real estate bubble, depopulation and difficulties in finding jobs for young people. The same problems that Japan faced after the 1990s now seem to be hitting the once fast-growing Chinese economy hard. China’s consumer price index (CPI) turned negative in July, and warnings of deflation are rising. Is China following the same path as Japan?

Only China’s Prices Are Falling

While central banks in Japan, the U.S. and Europe are struggling to figure out how to deal with sticky inflation, China is facing a situation where it is taking the opposite response. Due to the lack of demand on the back of the real estate slump and other factors, prices are under downward pressure, and there is a possibility of “Japanization” that will not be able to get rid of low growth and low inflation.

As for the background of China’s economic downturn, in addition to the downturn in real estate, which accounts for a quarter of GDP, the export industry has been hit by a shift in global demand from goods to services as a result of the Shinkansen epidemic. In contrast to developed countries, Ryutaro Kono, chief economist at BNP Paribas Securities, pointed out that the complete lack of implementation of large-scale financial support, such as cash subsidies for households, has also weakened demand.

China’s decisive economic response after the Lehman crisis in 2008, which triggered problems such as a surplus of equipment, has left a bitter legacy. For better or for worse, the cautious approach to stimulating the economy through monetary and fiscal policies this time around has led to price trends that are different from those in Japan, the United States and Europe.

Declining Population Becomes the Main Cause of Deflation

The question is whether this downturn is only temporary. What will have a significant impact is the population decline that will intensify across the board in the future. China’s population has already begun to decline, and will decline by millions of people per year starting in the second half of the 2020s.

Kono said that China’s population of 25- to 34-year-olds, the core group of home buyers, had peaked in the second half of the 2010s. This is also similar to Japan, where the bubble burst around 1990, when the block generation (people born during the baby boom period of 1947-1949) reached the age of 35-44, which is the main group of home buyers. If housing demand continues to weaken structurally, the adjustment could last a long time.

Naohiko Baba, chief economist at Goldman Sachs Securities, said, “If we follow Japan’s experience, population decline will first bring deflation.” If expectations of economic contraction strengthen as a result of population decline, investment and consumption will be dampened and prices will fall. After a period of time, due to labor shortages, population decline converted into the main cause of inflation, but is now likely to become the main cause of deflation.

In Japan, the huge shock from the bursting of the economic bubble superimposed on population decline led to a decline in economic strength and a prolonged period of low growth and low inflation. China is learning from the experience of Japan, where the problem of non-performing debts triggered a strong credit crunch, and Naohiko Baba believes that it should not decline as much as Japan did, but that downward pressure will continue for now.

Differences between China and Japan

关根敏隆, a professor at Hitotsubashi University in Japan who served as the Director General of Surveys and Statistics at the Bank of Japan, pointed out that “China still has room for policy maneuvering, but if its policies get stuck in a passive mode, it may fall into deflation.” The lesson from Japan is that once the notion that prices won’t rise takes root in businesses and households, it takes quite a long time to get out of that situation.

There are also arguments that countries like China can take immediate and bold measures to guard against a crisis. But Toshitaka Sekine says that policies are susceptible to political intentions and that the ability to actually make a sensible response is key.

China’s leadership, which had previously taken strict measures to prevent and control the epidemic, has now dramatically shifted direction. There is also a view that government intervention in the economy is intensifying. If policy swings from side to side between the cracks, the outlook will become even more uncertain.

Adam Posen, director of the Peterson Institute for International Economics in the United States, published a paper titled “The End of the Chinese Economic Miracle” in August, arguing that the “national immune response to over-intervention” will lead to a prolonged downturn in China’s economy through, among other things, reduced investment.

Of course, China is also different from Japan in the 1990s. According to the International Monetary Fund (IMF), China’s per capita GDP was only nearly $14,000, about one-sixth that of the United States. Japan was already a developed country at the time, with limited room for growth, compared to China, which has huge room for economic growth. The key lies in whether policies can be introduced to stimulate the potential.

What is certain is that the future course of China’s economy will serve as an excellent teaching tool in the sense of understanding how depopulation will affect the economy and prices. Comparing Japan with China, the answers to questions such as “what are the conditions for a country’s economy to go into deflation” and “how did Japan avoid deflation in the 1990s” are likely to emerge more clearly.

If China’s economy goes into deflation, the entire world economy will be greatly affected. Japan will not be able to stay out of it. In order to prevent China from falling into deflation, it is necessary for Japan to actively offer its experience. For Japan, keeping a close eye on the future development of China’s economy and learning from it should make it possible to prepare for the next crisis.

Source: Nikkei Shimbun