Could China Be the Next Japan?

China today is very similar to Japan in 1990, and the world's No. 2 economy should be wary of repeating the policy mistakes of Japan

Tai chi in the Lujiazui district in Shanghai, China.

Tai chi in the Lujiazui district in Shanghai, China.

Photographer: Tomohiro Ohsumi/Bloomberg

It's a tale of two economies.

On the same day that China surprised with better-than-expected GDP, Japan's central bank was forced to lower its growth outlook.

But even as China's economy shows signs of recovering from a sharp slowdown, it remains vulnerable to the type of crash that dragged Japan into decades of falling consumer prices and stagnant growth. That's according to research notes from Oxford Economics Ltd. and HSBC Holdings Plc, which warn of the similarities between China today and Japan in 1990.

While the two reports come to different conclusions, they both agree there is enough in common between the two countries to at least merit caution. Japan enjoyed rapid growth through the 1980s until the bursting of a real-estate and stock-market bubble in 1990. China too, has enjoyed decades of fast debt-fueled growth that created a steep run up in real estate prices and, over the past year, one of the world's biggest ever stock market rallies.

In its analysis, Oxford Economics found forecasters were extremely slow to recognize just how much Japan's growth potential had dropped after the crash and how long lasting the effects were.

Those overly optimistic Japan growth forecasts persisted long after the crash and ignored factors such as an aging population.  Something similar is happening with China watchers. While medium-term forecasts have been mostly lowered in recent years, they still look optimistic when demographics are considered.

"A quarter of a century ago, the Japanese economy had a surprising amount in common with that of China today," lead economist Adam Slater said.  "This should serve as a warning to China observers and investors today, especially as some of the same worrying signals are present in China -- chronic overinvestment, high private sector debt, frothy asset markets and poor demographics."

Here are some similarities between the two:

Japan's economic growth averaged 5 percent per year in 1985-1990 and the nation sucked in 8 percent of world imports, accounted for 12 percent of global GDP and a massive 57 percent of Asia Pacific GDP. China today accounts for 10 percent of world imports, 11.5 percent of global GDP and 38 percent of Asia Pacific GDP.

Another point of comparison - China's epic stock rally. The benchmark Shanghai Composite Index surged 150 percent in the year to a June 12 peak, before plunging in a correction that wiped out almost $4 trillion in value.

To be sure, as both sets of research note, China's economy in 2015 is also very different to Japan's in 1990.  It still has plenty of scope to grow and is starting from a much lower level of development and income levels than Japan in 1990. What's more, the Chinese central bank and government have significant policy ammunition stored away and can ramp up stimulus if needed.

Still, both HSBC and Oxford warn China against repeating the policy mistakes of Japan.

In its take, HSBC says China has already learned some lessons from Japan, but that policy makers will need to take more aggressive action to avoid a deflationary spiral.

"With global demand growth unlikely to be as strong as before 2008 or indeed in the 1980s, China should ease policy further and sooner," according to the analysts led by Chief China Economist Qu Hongbin. "China has adopted some of the lessons from Japan, but there is more work to be done."

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