China Can Avoid Japan’s Lost Decades If It Follows Korea’s Path

As Beijing struggles to contain a nationwide slump in property values, economists have been quick to draw parallels with Japan. Recent data showing China recorded its first contraction in bank lending to businesses and households in nearly two decades, coming after several months of weak retail sales, appeared to confirm that a Japan-style “balance-sheet recession” is underway. (The term, popularized by Richard Koo, an expert on the Japanese economy, refers to a situation in which consumers and companies prioritize paying down debt over spending and investing, thereby curbing growth.)

There are other unsettling parallels between Asia’s two biggest economies. In China, a broad index of prices has logged five consecutive quarters of declines—the longest stretch of deflation since the 1990s. Stocks traded on the mainland and Hong Kong exchanges have lost a combined $5 trillion in market value in the last three years. When Japan’s property bubble burst in the early 1990s, what followed were several “Lost Decades” of sinking asset prices and anemic growth.

Yet the Japanification argument has one big limitation: China’s per capita gross domestic product and urbanization levels are well below those of Japan in the 1990s, meaning the analogy lumps in a developed economy (Japan) with one still striving to obtain that status (China). By such metrics, China looks a lot more like South Korea, a nation that experienced its own reckoning toward the turn of the century in the form of the Asian financial crisis and came out of it stronger than before.

“Japan in the 1990s was like a middle-aged person,” Shu Jiapei, author of a report titled Japanization or Koreanization? and an analyst at China’s SDIC Securities Co., said at a gathering hosted by Peking University in June. “Korea in 1998 and China today are no longer teenagers, but they’re still in their youth and could still grow a few centimeters taller and become stronger. That’s the biggest difference.”

For China’s policymakers the most pressing challenge now is to find engines of growth to offset the economic drag from the troubled property market—and that’s where South Korea may offer a road map. When decades of red-hot growth ended, South Korea’s post-crisis leaders changed tack. On the financial front, they restructured insolvent businesses and improved corporate governance to guard against future failures. Japan, by contrast, kept its zombie companies on their feet, which came back to bite productivity and growth.

Korea’s leadership also embarked on a push to build out services and knowledge-based industries. Manufacturers responded by shifting into production of higher-tech goods and boosting exports. Japan, in contrast, struggled to achieve similar results, though not for lack of trying. Today you’ll find China President Xi Jinping extolling scientific and technological innovation as the “new quality productive forces” driving a transformation of the country’s economy. China was early to embrace electric vehicles, turning the nation into the biggest EV market in the world and driving its automakers to expand globally. Investment in clean technology also helped it dominate in fields such as solar panels and lithium-ion batteries.

Louis Kuijs, chief Asia-Pacific economist at S&P Global Ratings, is among those who see parallels between post-crisis Korea and present-day China, saying the latter is “relatively well-placed” to achieve further gains in living standards. Yet he also points to two critical differences between the two: Government intervention in the economy is more prevalent in China, and the country, already a huge exporter, is encountering resistance in the US and Europe, where policymakers are hiking tariffs or throwing up other barriers to Chinese shipments. “Our long-term growth and productivity projections for China are in principle benchmarked on the trajectory of Korea and Taiwan. But we ‘penalize’ China for these two factors,” Kuijs says.

Yan Kun, the deputy head of the Institute of Japanese Studies at the Chinese Academy of Social Sciences, a government-affiliated think tank, predicts that China’s long-term economic growth rate will hover from 4% to 6%, vastly better than Japan’s. (Japan, Asia’s No. 2 economy, has averaged growth of less than 0.8% since 2000.) Japan failed to grasp the opportunities presented by the big technological advances of the ’90s—notably the widespread adoption of the internet. Intent on avoiding a similar fate, Beijing unveiled a blueprint called Made in China nearly a decade ago that designated a host of next-generation industries as national priorities. China’s leadership in areas like EVs shows the payoff of such foresight, Yan and her CASS colleagues argue in a book published in April.

Of course, comparing any two economies is problematic, let alone when one of them is a giant like China. “China is much bigger than Korea,” says Larry Hu, head of China economics at Macquarie Group Ltd. “It’s much easier for the world to accommodate the rise of Korea than the rise of China.” —Malcolm Scott with Yujing Liu