Will China's economy follow Japan's path?

A deep dive into the similarities and contrasts between two Asian economic powerhouses and their paths to prosperity.

In recent years, and particularly recently, as China's economic growth has slowed down, there has been a fervent discussion about whether China will follow in Japan's footsteps in terms of its economic trajectory.

In today's piece, we delve into the fascinating parallels between China's economic trajectory and Japan's rise and subsequent decline. As the world's second-largest economy, China has experienced significant growth over the years, but questions remain about its ability to sustain this momentum.

Drawing insights from the economic slowdown and debt cycle in China, as well as Japan's historical experience, the following article was originally published on 西西弗评论 Xixifu Pinglun (Sisyphus Review), a WeChat Blog focused on macroecomics and current affairs. The author of this blog is Dr. Huang Jian, Ph.D. from Tsinghua University's PBC School of Finance. Dr. Huang is primarily engaged in technology venture capital.

According to the article, beyond balance-sheets, debt figures, ratios, and margins, there lies a metaphysical force of spirituality that yields a deciding power over the economy. The "spirits" of the Chinese government, enterprises, and citizens comprise a collective state of mind that has a final say in the "swim or sink" scenario. If the "spirits" be uprising and indomitable, China has a very good chance of surpassing the United States; if the "spirits" be deflated and distressed, China will be no better than Japan after 1990, a country that desires nothing and aspires for nothing.

The underlying philosophy is very similar to the traditional Chinese concept of 气 "qi", i.e. the vital and ever-pervading spiritual energy that can be channeled into material strengths. And there is no lack of references to Chinese folklore, Chinese history, and Confucian thinking throughout the article.

Highlights:

• China's economic challenges: China’s optimization of COVID policies helped the economy rebound in the first quarter, but challenges in the second quarter raised worries about a potential slippery slope akin to Japan's experience.

• Lessons from Japan's economic recession: The author reflects on Richard Koo's concept of a balance-sheet recession and its applicability to Japan's economic decline. While some argue for proactive fiscal policies to combat recessions, the author questions whether extreme measures alone can guarantee recovery.

• The rise and fall of Japan’s economy: The 1980s witnessed Japan's remarkable economic boom, with its companies dominating global markets and even challenging the United States. However, Japan's decline after 1990, characterized by a significant contraction in various industries, raises concerns about the long-term sustainability of economic success.

• Unequal trade agreements: The author explores how unequal trade agreements, such as those between Japan and the United States, limited Japan's ability to surpass its American counterpart. This raises questions about China's own economic ambitions and its relationship with the United States.

• Ambition and growth: The article examines the role of ambition in a country's development, considering the aspirations of the government, enterprises, and individuals. While Japan lost its drive to catch up with the United States, the author explores whether China still possesses the ambitious spirit necessary to overcome obstacles and achieve global leadership.

• Industry comparisons: The article also highlights the gaps between China's leading companies and Japan's giants during the 1980s and 1990s across various sectors, such as automotive, consumer electronics, beauty, and semiconductors. These gaps represent areas of future growth for China.

• Balancing ambition and egalitarianism: Maintaining a positive and upward spirit requires finding a balance between allowing companies to thrive and ensuring social mobility for individuals. The author discusses the importance of striking this delicate equilibrium to sustain China's ambition while avoiding the pitfalls of inequality and monopoly.

• China's unique path: Unlike previous competitors like the Soviet Union and Japan, the author concludes that China is determined not to yield to the United States. While challenges lie ahead, China's unwavering ambition and refusal to succumb to external pressures set it apart, suggesting a different trajectory from that of Japan.

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During the lockdown in 2022, I wrote an article to the effect that the main reason for China's economic slowdown is the debt cycle; and that it is unreasonable to expect a sudden revival after the end of zero-COVID. After China optimized its COVID policies, the economy went well in the first quarter. But the second quarter presented quite a lot of challenges, which made many people worry whether China will go down the same slippery slope as Japan.

I also recall an article titled 当资产负债表不想奋斗了 "When Balance-Sheets Quit Struggling", written by Boss Dai [an investor and influencer in the financial area] in 2022. More recently, I have seen many shares on WeChat Moments about a speech delivered at the annual meeting of Soochow Securities (HK) by Richard Koo, inventor of "Balance-Sheet Recession" and author of The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession.

No one can claim to be the soothsayer of the economy. Whether China will repeat the mistakes of Japan will not be revealed until two or three decades later. But I've always been skeptical of economists' forecasts and prescriptions for managing the economy. They always come up with the perfect explanations in hindsight, but I don't think they're very good at predicting the future.

Macroeconomists always feel that they can find some panacea for economic development, and that things are bound to turn for the better if only they were listened to. Economists, in that sense, are not unlike traditional Confucian scholars who believe that they can know the goings-on entirely by reading. And when a sagacious emperor has enough wits to rule by their ideas, it will then come a time of ideal governance.

The only example in Chinese history, where the fate of the nation was decided by a scholar is probably the reforms instigated by Shang Yang [c. 390—338 BCE, Chinese statesman and thinker whose successful military and agrarian reforms paved the way for the eventual unification of the Chinese empire]. Wang Anshi [1021—1086] and Zhang Juzheng [1525—1582] only managed to delay the death of the dynasty. Of course, there was a case where a scholar tossed the country down with his heedless ideals — Wang Mang [45 BC—AD 23] and his Confucian remodeling of society.

Is the fate of a country really subject to monetary and fiscal policies based on macroeconomic regulation and control? If the Japanese government had done everything right, could it have avoided a major recession? I don't think so. It is not a balance-sheet recession that determines where a country's heading.

2

In the 1980s and 90s, Japan was booming in top gear in a way that no other country has ever seen. Japan as Number One, written by Ezra F. Vogel and published in 1979, presented controversial predictions that unsurprisingly turned into reality during the next decade -- Japan became an economic superpower as Japanese enterprises took over the global market. In 1989, the publication of That Japan Can Say No by Akio Morita and Shintaro Ishihara was an epitome of ballooning confidence that Japan can now stand up against the United States.

The War of Chips by Yu Sheng, which I've been reading, also mentioned Japan in the good old times. In just ten years (1976-1985), Japan changed itself from the importer of 1/3 of U.S. semiconductors into an even larger producer than the United States. In March 1976, the Japanese government established the VLSI program. And in ten years, it became No.1 in the world's semiconductor industry.

Before 1990, the whole of Japan smelled of adrenaline. Everybody was energized and everything was vibrant. In 1985, the Japanese shipbuilding industry accounted for more than 50 percent of the world market share. Since 1982, when Japan's steel production surpassed that of the United States, Japan has maintained its position as the world's biggest steel production outside the Soviet Union for 14 years (the figure of steel production in the Soviet Union in 1991 is in doubt, however). In the 1980s, Japanese automobiles and home appliances were synonymous with high quality. Sony, Panasonic, Toshiba, and Toyota, these star companies were taking over the world. In 1980, nine American companies and one Dutch company (Shell) made up the top ten companies by market cap in the world. Yet in 1990, the list comprised eight Japanese companies and two American companies.

It was indeed a golden age for Japan. But it all came to an abrupt end around 1990. After 1990, Japan seemed like a completely different country, gone from the adrenaline-driven highroad to a "low-desire society".

After 1990, Japan's industries came crumbling down.

The Japanese semiconductor sector fell from 50 percent to less than 20 percent of the market share. Shipbuilding, too, fell from 50 percent to less than 20 percent. The consumer electronics sector had a total collapse. The automobile industry managed just to maintain the market share, though. In 2000, there was not one Japanese company in the world's top ten companies by market cap.

After 1990, the spirits of the entire Japanese country, from the government to the enterprises and to the people, suddenly fell to the bottom. No investment, no entrepreneurship, no expansion -- the whole people went into goblin mode.

The burst of Japan's "bubble" economy surely is a principal cause of the major societal shift. But other countries that also experienced bubble economy can manage to get back on their feet. Koo attributed this to a balance-sheet recession. I believe that balance-sheet recession is the consequence, not the cause.

Richard Koo believes that this recession could be avoided if a proactive fiscal policy was adopted. I beg to differ. In order to stimulate the economy, the Japanese government has used monetary and fiscal policies to the extreme.

The case is clear with monetary policies. Japan has maintained a long-term zero interest rate policy and is also the originator of quantitative easing. Richard Koo believes that the Japanese government's fiscal policy is not strong enough. But since 1990, Japan's government debt-to-GDP ratio has skyrocketed from a relatively healthy 60-70 percent to an unprecedented 264 percent. Extreme fiscal policies were not the cure to Japan's economic recession. What else can be done? A 500 percent debt-to-GDP ratio?

The truth is, the Japanese government had used every trick up their sleeves. And the recession still caught up with them.

3

Many countries in the world have encountered economic crises. Why is it that after three decades of bubble economy collapse, Japan is still prostrated with depression, devoid of any vitality it once had?

My opinion is, after the trade frictions with the U.S. in the 1980s and 90s, Japan fell victim to the painful realization that Japan CANNOT say no. Japan will always be tyrannized by the United States and never be allowed, even in the economic realm, to overtake the U.S. The ceiling is unbreakable. Then why work hard when there is no hope?

When Sun Wukong the Monkey King found out that he could never escape Buddha's hand, and that resistance meant imprisonment under Wuzhi Mountain, would he then ever try to rise up again? The monkey who brought back the sacred scriptures of Buddhism was not the same character as Great Sage Equal to Heaven (齐天大圣) who struck terror into the hearts of gods.

In 1984, the U.S. Congress restricted imports of all steel mill products to about 15 percent of the domestic supply. In 1977, under pressure from the United States, Japan restrained exports of color TV sets to U.S. In 1981, Japan restricted the exports of automobiles to the United States of its own accord. In 1986, the United States demanded that Japan secure 20 percent of the Japanese semiconductor market for U.S. producers. In 1994, the United States demanded that Japan buy $19 billion worth of U.S. automobile parts. On top of this was another series of open market agreements and structural entry barriers.

All of these agreements were unequal treaties that unilaterally benefited the United States, setting a cap on Japanese exports and a minimum amount on Japanese exports. Japan, however, had no choice but to submit.

Akio Morita once said with confidence, "Militarily, we can never defeat the United States. But, economically, we can overtake the United States and become the top of the world." However, after a series of trade wars, the whole of Japan finally came to admit the painful truth that Japan is a semi-colonial country both politically and militarily. How can a semi-colonial country become an economic superpower that challenges its lord and master? So that was how Japan succumbed to its fate, like the Monkey King who succumbed to the golden headband and went to the West with resignation.

Japanese leaders who dared to pursue independence and equal Japan-US relations never ended happily ever after.

Japan has always had a dream of being a great power. Before World War II, Japan attempted to become a political and military hegemon in Asia, and eventually a superpower. After three victories in the First Sino-Japanese War, Japan and Russia, and World War I, it lost a handful in World War II. Japan abandoned its political and military dreams in favor of becoming an economic superpower. Subsequently, in the trade war between Japan and the United States in 1980-1990, Japan was once again defeated.

In the end, it was clear that politically, militarily, or economically, there was no chance of Japan surpassing and replacing the United States.

You can only be second best no matter what you do. What more reasons are needed for sinking into goblin mode?

4

At that time, Japan, on the one hand, felt oppressed by the United States and believed that no matter how hard it tried, it was impossible to surpass the United States and become the number one. On the other hand, Japan felt it had done quite well already, with its economy stably ranking as the second largest in the world. It seemed to make no difference whether Japan strives or not, so its ambitions finally faded away.

So, where does China stand now?

Honestly speaking, although China's GDP, calculated by exchange rates, has reached about 70 percent of the United States', surpassing Japan's level in terms of scale, the overall position of China's leading companies in various industries globally is still not as good as Japan's between the 1980s and 1990s.

In the automotive industry, China does not have any companies that can compare with Japan's Toyota. With the trend of new energy, BYD has a good chance of becoming China's "Toyota". However, there is still a considerable gap between today's BYD and the Toyota of the 1980s and 1990s.

In the consumer electronics industry, I am skeptical whether Huawei, the most advanced Chinese company, has surpassed Sony of Japan at the height of its prime.

In the beauty industry, China still does not have any companies that can rival Shiseido of Japan. Japan is relatively weak in the pharmaceutical industry -- not one Japanese company ranks among the top ten global pharmaceutical companies. Takeda Pharmaceutical, the largest pharmaceutical company in Japan, should rank 12th with a revenue scale of 30 billion US dollars. Although China's largest pharmaceutical company, China National Pharmaceutical Group Corporation (Sinopharm), has a larger revenue scale (500 billion yuan, about 70 billion U.S. dollars), if we tease apart the irrelevant bits, its pure pharmaceutical business should be inferior to Takeda.

In the semiconductor industry, Japan once held a 50 percent global market share in the 1980s and 1990s. The Chinese mainland today is definitely far behind.

We need to acknowledge the gap, because there lies China's future growth. If China's leading companies in various industries reached the level of Japan's in the 1980s and 1990s, then without a doubt, backed by China's huge market, China's GDP will surpass that of the United States.

China currently produces the largest amount of physical goods in many categories globally. Yet when calculated per capita, not only is China's production power inferior to the United States, it also falls short of Japan. Taking the automotive industry as an example. Japan, with a population of 126 million, sells over 4 million cars annually, so that makes 3-3.5 cars sold per hundred people. In China, 23 million cars are sold annually, with less than 2 cars sold per hundred people. Even using Japan, a country with a large population but limited land, as a benchmark, China's automotive sales still have the potential to double.

5

Back then, Japan lost its ambition to catch up with the United States. Does China still have that drive today?

Such an ambitious spirit is too mysterious to grasp. However, it is truly a major driving factor for an organization to make or break. Taking the e-commerce industry as an example, the decline of Alibaba and the rise of Pinduoduo are largely due to the difference in ambition between the two companies. A country's ambitious spirit comes from the sum of the ambition of its government, enterprises, and individuals.

If asked whether China will go down the same slippery slope as Japan, I believe it depends on whether China still has the aspiring, indomitable, and ever-striving spirit. In other words, whether the country, government, enterprises, and individuals are willing to stand up against oppression and failure?

In recent years, there have been many pessimistic opinions on the internet about choosing to skate by and become a couch potato to reject the rat race. It seems like everyone has lost their ambition, but I don't see it that way.

As mentioned earlier, the ambition of a country is the sum of the ambition of the government, enterprises, and individuals. From the perspective of the government, the top level of the Chinese government definitely still has the ambition to surpass the United States and compete with them. The middle and lower levels of the government may not be as ambitious as before, but from my own observations, local government officials still have the motivation to develop the economy and strive for progress.

For the ambitious spirit of enterprises, there are three aspects to consider: 1) whether Chinese people are still aspiring to start up businesses and whether newly-developing enterprises continue to spring up; 2) whether Chinese companies can seize opportunities in emerging or reforming industries; and 3) whether Chinese companies in traditional mature industries dare to challenge the global industry leaders.

Today, China can still give a positive answer to these three questions. In the past thirty years, two new industries emerged from scratch: the internet and new energy. Chinese companies have captured the majority of the domestic market in these two fields and have also gained certain market share globally.

Recently, there has been a breakthrough in the LLM (Large Language Model) by OpenAI. Overnight, countless Chinese companies have started developing LLMs of their own, and a large number of startups have emerged. Of course, there are mixed intentions, and some are just trying to manipulate stock prices. However, Chinese companies still maintain a high sensitivity to emerging opportunities and are willing to take risks to catch up.

Chinese companies also have the determination and ability to challenge industry leaders in traditional mature industries. Emerging Chinese companies are trying to enter markets that have already been highly monopolized by global industry giants such as PCs, smartphones, home appliances, LCD panels, medical devices, daily chemicals, beverages, and sports brands.

From an individual perspective, most Chinese people still hope to change their fate through their own efforts. Compared with developing countries like India and developed countries like Japan and those in Europe, there are far fewer Chinese people who choose to go goblin mode.

There are indeed many people complaining today, but most of them do so because they can't achieve what they desire, not because they truly desire nothing。

6

It is not easy for a country to maintain a positive and upward ambition continuously.

For enterprises, an ambitious and upbeat spirit can not be maintained when you set a development ceiling over their heads. In 1990, Japanese entrepreneurs realized that the United States was an unbreakable ceiling for Japan, and they lost their spirit. Today's Chinese entrepreneurs do not necessarily see the United States as a ceiling, but in some industries, such as the internet industry, some entrepreneurs may feel that they have encountered some limits, and they are uncertain where the boundary lies between unregulated and orderly expansion.

If entrepreneurs believe that they will hit a ceiling when their business expands, their ambition will diminish. We must ensure that mainstream entrepreneurs do not feel an invisible ceiling above them. Fortunately, not all industries in China currently have an invisible ceiling. The internet industry is an exception because of its deep association with ideology. Companies like BYD and Huawei do not feel an invisible ceiling above them.

For ordinary people, maintaining a positive and upward spirit requires providing individuals with hope and the belief that they can achieve social mobility through their own abilities. Reducing wealth inequality, limiting the inheritance of wealth, promoting social mobility, and preventing the emergence of monopolistic groups are all necessary conditions for maintaining the fighting spirit of people.

Maintaining the positive spirit of the people and maintaining that of enterprises are contradictory in a sense. If companies are allowed to monopolize indefinitely and expand disorderly, it becomes challenging for ordinary people to maintain their fighting spirit. On the other hand, if an egalitarian approach is adopted, it becomes difficult for enterprises to maintain their ambition. Ultimately, a balance needs to be struck.

It is not easy to keep this balance. But no matter what, as long as China maintains a positive and upward spirit, strives for the top, and never gives up, it will not go down the same slippery slope as Japan. Although both the Soviet Union and Japan yielded to the United States by choice in their former competition, whatever the outcome, this time China will not give in.

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