In the 1980s most pundits thought Japan would surpass Europe and the US in economic strength within a decade. But Japan used its newly found wealth inappropriately by failing to implement and enforce adequate regulatory checks and balances, overpaying for overseas assets, and refusing to address its financial crisis in a meaningful way. Japan continues to pay the price for this mistake – its stock market remains depressed by 75% from its all time high in 1989.
Although “Pax Japanica” never materialized, few observers today doubt that “Pax China” will ultimately materialize. Not only is this a reflection of China’s size and scope, but also the fact that it is better positioned to achieve more than Japan was able to achieve in the 1980s. A comparison of Japan’s economic performance over the past 20 years and China’s performance this decade provides some insight into why this is the case.
Japan initially managed the 1970s extremely well, establishing a form of corporatism that merged top private firms and the government into a quasi-symbiotic relationship. The government implicitly backed corporate initiatives, using public money to supplement and subsidize expansion overseas – a practice that continues today. This policy helped Japan evolve from an economy that focused on manufacturing basic electronics and plastics to one that produced advanced technologies and biotechnologies.
The country experienced rapid growth through the 1970s and 1980s based primarily on its ability to establish a virtual global monopoly on mass-produced electronics and emerging technologies. With this growth came a hyper-inflated market, driven by inflated prices, risky lending and speculation. Japan’s credit and real estate bubble ultimately burst in 1989, yet the country’s per capita GDP continued to grow apace, and its economy continued to expand.
Japan had some advantages China did not and does not have. As a fully industrialized nation, it didn’t have to devote substantial financial resources toward alleviating poverty or building infrastructure. By contrast, China’s long march toward industrialization has resulted in large income disparities, a large gap in productivity between the manufacturing and agricultural sectors, and virtually unchecked urban migration.
Nevertheless, China has either surpassed or sidestepped these contradictions to become Asia’s economic hegemon. It still trails Japan by GDP based on purchasing power parity, but has been the leader vis-à-vis real GDP growth since the early 1990s. China’s export revenue surpassed that of Japan in 2004 and by 2008 it stood at US$1.3 trillion compared to its neighbor’s US$807 billion.
Beijing has done a number of things right. By gradually privatizing key industries and diversifying the economy, the government has slowly shifted the economy away from an over-dependence on exports toward being more oriented toward domestic demand – something Japan failed to do. This has not only allowed the country to sustain strong economic growth while other nations combat recession, but has also helped unlock an entrepreneurialism that was thought to be non-existent prior to the 1990s.
China has also proven itself to be less nationalistic and more open to foreign direct investment (FDI) than Japan was in the 1990s. During that period, Japan received just US$39 billion in FDI to China’s US$309 billion. This international openness has worked both ways, with Beijing sending tens of thousands of its students abroad to receive an education. The majority of these students return to China to contribute what they have learned to the economic transformation process. Japan did this in the Meiji era and learned from other countries’ success, but failed to do so during its crisis in the 1980s.
Both Japan and China remain over-regulated, but while China once had 10 ministries running the economy, the number has since been significantly reduced. That kind of change is inconceivable in Japan. Whereas the Chinese Communist Party realized that a failure to reform would see it go the way of the Soviet communists, Japan has long been hamstrung by linkages between the Liberal Democratic Party (which essentially ran a one-party state for more than 50 years until September) and big business. There is in essence a built in disincentive for Japan to engage in meaningful reform. We will in due course find out whether the newly elected Democratic Party of Japan will dance to a different tune.
Japan remains a wealthier, better developed, better educated, and more technologically savvy country, but China has the advantage in terms of geographical and population size, as well as the ability to manage itself more effectively.
Going forward, Beijing faces numerous challenges. It must maintain growth of at least 8% to generate enough new jobs to accommodate its growing work force. The country’s debt-to-GDP ratio of 18%also understates the weight of its debt burden, as it excludes such variables as local government borrowing, the debt of state-owned-enterprises, and non-performing loans made to state-owned financial institutions. Meanwhile, its fiscal deficit could rise to as much as 10% of GDP this year. Government revenue, which drives the bulk of fiscal expenditure, fell by 2.4% in the first half of 2009, well off an officially planned 8% increase.
There are plenty of pundits who warn of collapse, whether it is the negative long-term consequences of Beijing pumping more liquidity into the financial system to prolong the current boom in equities and real estate, or social unrest arising from a failure to sustain high growth and create jobs. But the Chinese government has proven adept in foreseeing what needs to be done.
If China were like Japan, it would have neglected to take action to minimize the impact of the global recession, its economy would have endured substantially lower growth rates, and the impact of its actions on the global economy would be notably diminished. Fortunately, China today bears little resemblance to Japan of the 1980s, or even today. And it will stay that way.
Daniel Wagner is managing director of Country Risk Solutions, a consultancy. C.J. Redfern is an analyst at the same company.