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As an economy that , only to subsequently experience structural deceleration characterised by a declining population and low potential growth, Japan can offer valuable economic lessons for China, which is undergoing its own structural deceleration. Some Chinese trends resemble Japan’s experience in the 1990s, often referred to as the ‘lost decade’. But differences remain, namely China’s geopolitical weight and the fact that it is a poorer country now than Japan was at the onset of deceleration.  

The key similarities between Japan in the early 1990s and China today are the macroeconomic imbalances that both countries have grappled with, including excessively high savings rates and very low consumption relative to GDP, leading to over-investment and persistent current account surpluses. Japan’s investment-heavy economic model had significant negative economic consequences for the country, causing the rapid accumulation of public debt and deflationary pressures. In recent years, China has been following this path.

China’s response to the collapse of the real estate bubble has been similar to that of Japan in the 1990s, doubling down on its industrial policy to increase manufacturing and exports while increasing expenditure in research and development. In Japan’s case, this industrial and innovation push did not halt the country’s structural deceleration, deepening deflationary pressures due to overcapacity in the manufacturing sector. Furthermore, Japan’s aging population became another major force behind the country’s structural deceleration. China’s population is also aging, and the country will feel these effects more significantly after 2035, when the mitigating effects of urbanisation on the negative impact of aging on Chinese growth come to an end.

Nonetheless, there are also major differences between Japan in the 1990s and China today. Some make China’s case more concerning. First, China’s macroeconomic imbalance, especially the low share of private consumption relative to GDP, is much worse than it ever was in Japan. Second, the lack of a welfare state and less developed private insurance markets force households to maintain high precautionary savings. Third, China’s capital controls are especially tight, particularly in comparison to Japan, meaning that its savings cannot be deployed externally. Fourth, Japan’s role as a major global creditor protected the country to some extent, providing an income flow. China does not provide sufficient outbound foreign direct investment to count on this projection. Finally, whilst the US viewed Japan as an economic competitor, China is also perceived as presenting military and security challenges. This means that the US containment of China is stronger, not only on trade and investment but also technologically.

Nonetheless, China also has certain advantages over Japan. To start, China is poorer than Japan was at the time of the collapse of its bubble, which should allow for higher growth to be maintained for longer, based on convergence with richer countries. In addition, its urbanisation is still ongoing, supporting growth through related infrastructure investment and increased labour productivity when people move to the cities.

China has made great strides in innovation, particularly in critical technologies, which have bolstered its technological self-reliance. Nonetheless, the tangible impact of this innovation drive on growth, specifically through increased productivity, is not yet visible, casting doubts on its innovation advantage, at least as far as its growth outlook is concerned.

The comparison between China and Japan offers valuable insight into the challenges facing the Chinese economy. While industrial policy and technological advancement are important, China must address its fundamental imbalances, particularly the lack of domestic consumption and the excessively high savings rate. Balancing these competing priorities in a complex geopolitical environment will be crucial for China to avoid the prolonged stagnation experienced by Japan.

ZhōngHuá Mundus is a newsletter by Bruegel, bringing you monthly analysis of China in the world, as seen from Europe.

ZhōngHuá Mundus is a newsletter by Bruegel, bringing you monthly analysis of China in the world, as seen from Europe.

This is an output of China Horizons, Bruegel's contribution in the project Dealing with a resurgent China (DWARC). This project has received funding from the European Union’s HORIZON Research and Innovation Actions under grant agreement No. 101061700.