Its policymakers have a firmer grip on what the problems are
and fixing them
Despite deepening concerns about China’s economy, the
country is not heading toward “lost decades” of Japanese-style stagnation. And
yet a worrisome ambiguity clouds this verdict.
Japan’s fate was sealed by its reluctance to abandon a
dysfunctional growth model. While China’s embrace of structural rebalancing
distinguishes it from Japan, it is struggling to implement that strategy.
Unless the struggle is won, the endgame could be similar.
The same conclusion emerges from a seminar on “The Lessons
of Japan” that I have taught at Yale for the past six years. The course is
primarily one in forensic macroeconomics — distilling key lessons from the rise
and fall of the modern Japanese economy and then figuring out the relevance of
those lessons for other major economies.
The seminar culminates with student research papers aimed at
assessing which candidates might be the next Japan. As recently as 2012, the US
was the top choice, as it struggled to regain its footing in the aftermath of
the Great Financial Crisis of 2008.
Not surprisingly, by 2013, the focus had shifted to
crisis-battered Europe. But this year, more than half of the students in the
seminar (13 of 23) chose to examine whether China might be the next Japan.
An academic setting provides a wonderful intellectual
laboratory. But a couple of quick trips to China after the end of the spring
term gave me a different perspective. In extensive discussions with Chinese
officials, business leaders, academics, and investors, I found great interest
in the lessons of Japan and how they might bear on China’s conundrum.
The topic du jour was debt. China’s non-financial debt has
risen from 150 per cent of GDP in 2008 to 255 per cent today, with two-thirds
of the increase concentrated in the corporate sector, largely state-owned
enterprises (SOEs).
As the world’s largest saver — with gross domestic saving
averaging 49 per cent of GDP since 2007 — surging debt hardly comes as a
surprise. High-saving economies are prone to high investment, and the lack of
capital-market reform in China — exacerbated by the bursting of the equity
bubble in 2015 — reinforces the disproportionate role that bank credit has
played in funding China’s investment boom.
The Japan comparison is especially instructive in assessing
the risks of debt-intensive growth. At nearly 390 per cent of GDP in late 2015,
Japan’s overall debt ratio is about 140 percentage points higher than China’s.
But, because Japan has such a high saving rate — averaging 24 per cent of GDP
since 2007 — it basically owes its debt to itself.
That means it is not vulnerable to the capital flight of
foreign investors that often triggers crises.
With China’s saving rate double that of Japan’s since 2007,
that conclusion is all the more pertinent for its debt-intensive economy. The
China scare of early 2016 — stoked by hand-wringing over capital flight and
currency risk — missed this point altogether.
Fears of a hard landing stemming from a Chinese debt crisis
are vastly overblown.
Zombie firms — the economic walking dead — are also a topic
of intense discussion in China. Key actors in Japan’s first lost decade during
the 1990s, zombie corporates were kept alive by the “evergreening” of
subsidised bank lending — masking an outsize build-up of nonperforming loans
(NPLs) that ultimately brought down the Japanese banking system.
Significantly, the insidious interplay between zombie
corporates and zombie banks clogged the arteries of the real economy — sparking
a sharp slowdown in productivity growth that Japan has yet to reverse.
In recent public statements, the Chinese leadership has made
explicit reference to zombie SOEs. But, unlike Japan, which remained in denial
over this problem for close to a decade, Chinese authorities have moved
relatively quickly to rein in excesses in two key industries — steel and coal —
while hinting of more to come in cement, glass, and shipbuilding.
China’s deteriorating loan quality is also reminiscent of
Japan’s experience. The official NPL ratio of 1.7 per cent for listed banks is
only the tip of the iceberg.
Beneath the surface are “special mention loans” — where
borrowers are in the early stages of repayment difficulties — along with bad
credits in the shadow banking sector, both of which could raise China’s
fully-loaded NPL ratio to around 8 per cent. In that case, the authorities will
eventually need to inject capital into the Chinese banking system.
None of this is a dark secret in Beijing. On the contrary,
an interview in early May with an “authoritative insider”, published in China’s
flagship official newspaper, “People’s Daily”, underscored an increasingly open
and intense debate among senior officials over how to avoid ending up like
Japan.
The insider, purportedly close to President Xi Jinping,
highlighted the insidious connection between China’s debt and zombie problems
that might well culminate in a Japanese-like “L-shaped” endgame.
This gets to the heart of the China-Japan comparison.
Two-and-a-half lost decades (and counting) is simply an unacceptable outcome
for China. But knowing what it doesn’t want is not enough to guarantee that
China won’t fall into a Japanese-style trap of its own.
Reforms are the decisive differentiating factor. Japan’s
failure to embrace structural reforms was a hallmark of the 1990s, and it is an
equally serious impediment to the current “Abenomics” recovery programme. By
contrast, China’s strategy emphasises the heavy lifting of structural change
and rebalancing.
In the end, success or failure will hinge on the willingness
of the Chinese leadership to confront the powerful vested interests resisting
reform.
Interestingly, of the 13 students in my seminar who chose to
consider China as the next Japan, two-thirds ultimately rejected the
comparison. They argued that the lessons of modern China — especially the
reforms and opening up spearheaded by Deng Xiaoping — are more important than
the lessons of Japan. And they got good grades.
— Project Syndicate, 2016
The writer, a faculty member at Yale University and former
Chairman of Morgan Stanley Asia, is the author of “Unbalanced: The Codependency
of America and China”.
