Is China going Japan way?


Is the China story similar to the 1980s Japanese bubble? …asks Vatsal Srivastava in his Currency Corner column for Asian Lite News

A visitor takes a photo of oil-paper umbrellas at an exhibition  in Luzhou, southwest China's Sichuan Province
A visitor takes a photo of oil-paper umbrellas at an exhibition in Luzhou, southwest China’s Sichuan Province

When China sneezes, the world catches a cold. It follows that a long-lasting serious illness within China’s economy has the potential to derail the entire post-crisis global economic recovery.

Fears of a real estate bubble burst, coupled with collapsing stock prices from seven year highs have led many to question whether China stands at the same juncture as its economic superpower neighbour, Japan, did in the late 1980s. There certainly seem to be many economic variables which would strengthen the above case: high and less efficient investment, current account surpluses, deteriorating demographic trends, deflation and parabolic increases in asset prices of housing and equities.

However, today China is at a very different stage of its economic development than Japan was in the 1980s. It is unlikely that China will go through any “lost decades”. By the late 1980s, Japan was already a highly advanced economy whereas today China’s potential for catch-up growth has not been exhausted (although it is growing at its slowest pace in 25 years.) Although China’s GDP is huge in absolute terms, it is still a middle-income country in per capita terms.

The main argument towards predicting an imminent collapse of the dragon is the outrageously high investment rate as a proportion of its GDP which many believe to be unsustainable. The bears argue that the Chinese are “building bridges to nowhere”. This is blamed for current overcapacity and build-up of bad debt.

There cannot be any dispute over China’s high investment rate which is 10 percentage points higher than Japan’s peak in the 1970s. But China has an even higher savings rate of 49 percent of GDP. Further, China’s much lower capital stock per capita implies that it still stands to gain significantly from investment. China’s total factor productivity (TFP), which measures how well inputs of labour and capital combine to produce output, has been on an upward trend since the reforms began in the late 1970s.

TFP can also be looked as a measure of the degree of “technology” in the economy. Considering that China’s markets are much less modern than those in the developed world, we can expect the TFP to grow over time and assume that there is plenty of capacity for reforms to drive efficiency. This would be similar to Japan’s productivity miracle of the 1960s.

China’s urbanisation rate is only 55 percent, the same as that of Japan in 1955! Currently, the urbanisation rate in Japan is 93 percent. Thus, the further driver of investment in infrastructure will be urbanisation and it is wrong to conclude that China has run out of “useful” investment opportunities.

From the markets point of view, the capitulation seen in the last few weeks represents a buying opportunity for secular China bulls. The size of of the stock market relative to the size of the economy still remains small. China’s total stock market capitalisation is around 40 percent of its GDP, compared with 140 percent in Japan at its peak. Further, domestic Chinese households hold 10 percent of their assets in shares compared with 20 percent in Japan at the start of the 1990s according to HSBC.

China seems to be be where Japan was in the 1960s: just look back into history on what the Japanese economy achieved between then and the late 1980s. All the bearish arguments over China would be settled.