Japanese Experience, Our "Stepping Stones"? - Huxiu#
#Omnivore
Highlights#
First, seek supply-side reforms, such as deregulation and tax cuts, to improve domestic capital returns. ⤴️ ^042e7738
Second, increase labor market flexibility, reduce wage rigidity and the fixed nature of employment relationships, so that businesses can adjust labor costs to cope with competition from catching-up economies. ⤴️ ^02d4a71d
Japan's seniority system has hindered this process, while the situation in China is different now; the fixed employment system is slowly changing, and gig work is beginning to flourish. Japan has also done part of this through part-time work.
Third, reform the education system to address the increasing demand for human capital and inequality specific to catching-up economies.
For catching-up economies, the key consideration regarding the most important human capital is how to maximize the number of people who can generate new ideas and businesses, and how to motivate them to focus on creative work. ⤴️ ^b53f2f1a
Decoupling from Western markets means that Chinese companies may have to sell to less affluent regions. As shown in Figure 5-4, Western economies account for 56.8% of global GDP, while Russia, Africa, and other regions account for only 25.3%. ⤴️ ^50a539e6
Domestic capital returns ⤴️ ^cf97cf4f
Japanese Experience, Our "Stepping Stones"?#
This article discusses the real lessons from the Japanese economy and the genuine problems facing China. The author points out Japan's experience with balance sheet recessions and explains why balance sheet recessions can lead to economic stagnation. Additionally, the author introduces the concept of "catching-up economies," exploring the challenges and development paths facing China.
• 💡 Japan's balance sheet recession is a key factor leading to economic stagnation.
• 💡 The concept of "catching-up economies" helps understand the stages and challenges of economic development.
• 💡 China faces challenges such as deteriorating demographic structure and the middle-income trap, necessitating the search for new growth drivers.
Post-war Japan is like a "5-Year College Entrance Examination, 3-Year Simulation" filled with answers, with high-scoring experiences in areas such as industrial rise, cultural export, basic science, and income distribution, as well as lessons on real estate bubbles, population decline, and monetary policy errors. For East Asian countries with highly overlapping development paths, Japan serves as a "stepping stone" reference, a stone that has already been smoothed out, with clear reflective value.
"Why did Japan's entire economy change dramatically around 1990?"
The "aging population, structural economic issues, zombie banks, fiscal stimulus fallacies, and excessive government debt" proposed by Western economists fail to explain the situation coherently. Ultimately, the name that cannot be avoided when discussing the Japanese economy and the Great Recession is Gu Zhaoming.
Gu Zhaoming became the chief economist at Nomura Research Institute in 1997, ranking first for three consecutive years in the "Top 100 Economists in Japan" list, and has provided policy advice to several Japanese prime ministers.
In his new book "Catching-Up Economies," Gu Zhaoming introduces the concept of "catching-up economies," layering it with the theory of "balance sheet recession," attempting to explain a question—why does a powerful and vibrant economy lose its growth momentum and fall into long-term stagnation? Why do policies that were effective in the past fail today, and why does nostalgia for better days not help solve future problems?
- The True Lesson from Japan: When the Balance Sheet Doesn't Want to Strive
25 years ago, seven years after the collapse of Japan's economic bubble, Gu Zhaoming proposed the concept of "balance sheet recession" to explain why economies fall into years of stagnation after a bubble bursts and why traditional monetary policy prescriptions are largely ineffective during this recession.
The basic principle of "balance sheet recession" is as follows: During the economic bubble, people tend to leverage, borrow money, and then use borrowed money to make profits. After the bubble bursts, asset prices collapse, but liabilities remain, so their balance sheets fall into distress.
Once the balance sheet is in distress, it essentially means bankruptcy. However, bankruptcy can be divided into two situations: if cash flow is decent, debts can be repaid with cash flow; if there is no cash flow, it means the business has reached its end, with no other options.
The key to this viewpoint is recognizing that the private sector does not always pursue "profit maximization" as assumed in economic textbooks; rather, when facing severe balance sheet challenges, it chooses to pursue "debt minimization."
Why didn't economists consider that the pursuit of debt minimization by the private sector could lead to economic recession when establishing theories? Because they believed the private sector always tries to achieve profit maximization. However, to achieve profit maximization, the private sector must meet two conditions: one is to have a clean balance sheet, and the other is to discover attractive investment opportunities.
After the Great Depression, Japan was the first developed country where balance sheet issues led the private sector to shift towards debt minimization.
Japan's asset bubble was enormous; at its peak, it was said that the circumference of the Imperial Palace in central Tokyo, about 5,000 meters, was worth as much as the entire state of California in the United States. After the collapse of Japan's asset bubble in 1990, the value of commercial real estate nationwide fell by 87%, returning to levels seen in 1973, devastating the balance sheets of national enterprises and financial institutions. The wealth loss in Japan after 1990 accounted for three times the proportion of GDP lost during the Great Depression in the United States.
Gu Zhaoming calculated that the asset price crash after 1989 caused Japan to lose 150 trillion yen in wealth, and the resulting gap led enterprises and households to engage in at least 15 years of net debt repayment, which in turn eliminated total demand equivalent to 20% of GDP, completely dragging Japan into the quagmire of depression.
From 1985 to 1990, when Japan's asset bubble rapidly expanded, these enterprises borrowed funds on a large scale, leveraging investments in various assets. The Bank of Japan recognized the existence of a bubble and economic overheating, steadily raising short-term interest rates to 8% in an attempt to curb excessive prosperity.
When the bubble finally burst in 1990, the demand for borrowing rapidly shrank. The Bank of Japan noticed that the economy was also slowing sharply, and by 1995, interest rates had fallen from the peak of 8% to nearly zero. However, the demand for loans not only did not recover but even turned negative that year. In other words, the entire non-financial corporate sector in Japan was repaying debts under zero interest rate conditions.
Thirty years after the bubble burst, under negative interest rates, Japan's corporate sector's savings still exceeded 4.3% of GDP. It is precisely this disappearance of corporate borrowers that has led the Japanese economy to stagnate over the past 30 years. The culprit of the "Japanization" phenomenon is corporate debt minimization.
This is a world that economic departments or business schools have never imagined. Traditional theory holds that at such low interest rates, companies should borrow heavily, but in reality, Japanese companies not only stopped borrowing but also began repaying debts, a trend that continued for over a decade.
The question is, what happens to the national economy when all companies do this simultaneously? In a national economy, if someone saves or repays debt, someone else must spend or borrow. In normal economic conditions, the savings of depositors flow through financial institutions to those in need of funds in the form of loans, thus sustaining economic development. If there are too many borrowers, the central bank will raise interest rates; if there are too few borrowers, the central bank will lower interest rates to ensure the lending cycle continues.
However, when everyone is simultaneously repairing their balance sheets, even if interest rates drop to zero, everyone will still choose to continue repaying debts, and no one will borrow money, leading the economy toward depression, falling into a deflationary spiral of $1,000—$900—$810—$730.
Specifically, suppose I have an income of $1,000, and after spending $900, this $900 becomes someone else's income. The remaining $100 is saved and then lent out through financial institutions, turning into consumption by borrowers, so $1,000 becomes consumption, driving the economy forward.
However, when a balance sheet recession occurs, due to the lack of borrowers, the saved $100 gets stuck in the financial system and cannot flow out, causing the economy to shrink from $1,000 to $900. Then, after this $900 becomes another person's income, this person will also save 10% of it, meaning their consumption will only be $810, leaving the remaining $90 stuck in the bank, as repairing balance sheets takes a long time; Japan took nearly 20 years.
- A New Concept: "Catching-Up Economies"
While the concept of balance sheet recession helps explain many phenomena observed in the West since 2008 and in Japan since 1990, it cannot explain all phenomena. Some occurrences in these countries predate 2008 or occurred after their balance sheet recessions, making it difficult to attribute them solely to balance sheet recessions.
Another reason why the private sector pursues debt minimization or is even unwilling to borrow in an environment of extremely low interest rates is that enterprises cannot find sufficiently attractive investment opportunities, making borrowing and investing unprofitable. There are two possible reasons for insufficient investment opportunities:
The first reason is a lack of technological innovation and scientific breakthroughs, making feasible investment projects hard to find. This explains the centuries-long economic stagnation before the Industrial Revolution in the 1860s.
The second reason is that overseas capital returns are higher, prompting enterprises to choose to invest abroad rather than domestically. Japan in the 1970s and emerging economies in the 1990s rose in succession, with most investments no longer occurring in domestic markets.
No one can guarantee the availability of investment opportunities. It depends on various factors, including the pace of technological innovation and scientific breakthroughs, the ability of entrepreneurs to assess investment opportunities and their willingness to borrow, the costs of labor and other inputs, the availability of reasonably priced financing, the protection of intellectual property rights, and the state of the economy and world trade.
The importance of each factor depends on a country's stage of economic development. For countries at the technological frontier, the pace of technological innovation and scientific breakthroughs is more crucial. For emerging economies, the availability of reasonably priced financing and the protection of intellectual property rights are equally important.
To understand how these factors change over time, the concept of "catching-up economies" divides economies into three stages based on different levels of industrialization: the urbanization stage before the Lewis turning point, the golden age crossing the Lewis turning point, and the catching-up stage.
- The First Stage of Industrialization: Urbanized Economies Before the Lewis Turning Point
In the urbanization stage before the Lewis turning point, which is the early stage of industrialization, labor supply is unlimited, and the wealth gap is significant. The share of capital income grows faster than that of labor income, and enterprises continuously increase investments to earn more income.
The sustained high investment rate means rapid domestic capital accumulation and urbanization, marking the take-off period of an economy's growth. With workers' wages suppressed, inflation is not a major issue. At this time, fiscal policy can play a significant role, providing infrastructure that allows private sector investment to flourish.
- The Second Stage of Industrialization: The Golden Age Crossing the Lewis Turning Point
During the golden age of crossing the Lewis turning point, urbanization is essentially complete, and the demand for labor will push up wages, self-correcting the income gap. The purchasing power of ordinary citizens continues to grow, and enterprises are motivated to expand capacity and increase profits, leading to growth in investment-related borrowing. At this time, the economy's supply and demand, consumption and investment are relatively strong.
Throughout the golden age, the strong demand for borrowing from the private sector will push the monetary multiplier to its highest value, making monetary policy very effective. However, the ability of fiscal policy to stimulate the economy during this stage is limited due to the tendency to "crowd out" private sector investment. Only when a balance sheet recession occurs can fiscal policy play a role.
- The Third Stage of Industrialization: Catching-Up Economies
In the catching-up stage, the capital returns of economies are lower than those of emerging economies, and the wage levels of foreign workers are far below domestic levels. Enterprises no longer have the same motivation to invest domestically and instead begin investing abroad.
The most fundamental macro challenge facing catching-up economies is that enterprises cannot absorb private sector savings due to insufficient investment opportunities domestically. At this stage, monetary policy gradually becomes ineffective, and the absence of borrowers means that no matter how low interest rates drop, the economy cannot be stimulated. In contrast, fiscal policy at this time does not "crowd out" the private sector and can absorb savings to convert them into investments, making fiscal policy more effective.
- "Catching-Up Economies": Two Major Problems & Three-Pronged Approach
Catching-up economies face two problems.
First, low domestic investment returns lead enterprises to shift investments to high-return regions abroad. Under the continuous pressure from shareholders to improve capital returns, enterprises lack the motivation to invest in domestic production and choose to invest overseas or directly purchase low-cost products from abroad, which directly reduces domestic borrowing demand.
Second, the proportion of financing loans gradually increases.
Loans can be divided into operational loans and financing loans, which have significant differences. Operational loans are financing aimed at actual consumption and investment, with funds used to build factories or purchase consumer goods, contributing to GDP growth. This indicator provides insight into enterprise expansion and serves as a leading indicator of future economic activity. Financing loans are for purchasing existing assets, such as buying existing real estate or stocks, only involving the transfer of asset ownership and not directly promoting economic growth, thus contributing nothing to GDP growth, but can be used to gauge future asset prices.
As economies transition from the golden age to the catching-up stage, the proportion of financing loans relative to operational loans gradually increases, which inevitably creates a cycle of bubbles and balance sheet recessions.
Due to capital chasing higher investment returns in foreign markets, catching-up economies see a continuous decrease in demand for operational loans. Meanwhile, the funds from financing loans remain in the domestic financial sector, directed towards existing assets like real estate and stocks, "speculating" on prices, forming asset price bubbles. If asset price bubbles become severe enough, central banks typically reduce the bubbles by raising interest rates. The bursting of the bubble leads to a collapse in asset prices, further plunging the economy into a balance sheet recession.
To address the above issues, catching-up economies need to tackle them from both long-term and short-term perspectives.
In the short term, the government must continue borrowing and use the excess savings of the private sector for public projects that can balance budgets until domestic investment returns improve in the long term.
In the long term, the solution to the lack of investment opportunities in catching-up economies is to improve domestic capital returns through structural reforms, which typically take ten years or longer to yield macroeconomic effects.
To stay ahead, catching-up economies have limited low-cost investment opportunities, and with an aging population, policymakers driving growth need to adopt a three-pronged approach to structural reform.
==First, seek supply-side reforms, such as deregulation and tax cuts, to improve domestic capital returns.==
With the arrival of competition from Japan, the United States entered the catching-up stage in the 1970s. The U.S. was losing many industries and good job opportunities, creating a sense of urgency to break the past. Former President Ronald Reagan initiated supply-side reforms, significantly cutting taxes and deregulating from the early 1980s, addressing the first of the three challenges faced by catching-up economies by improving domestic capital returns. These policies encouraged innovators and entrepreneurs to generate new ideas and products, particularly in the information technology sector.
==Second, increase labor market flexibility, reduce wage rigidity and the fixed nature of employment relationships, so that businesses can adjust labor costs to cope with competition from catching-up economies.==
Once a country enters the catching-up stage, the entire economy must become more flexible so that its enterprises can take evasive actions to withstand competitors. Foreign competitors may suddenly emerge from certain places, often with entirely different cost structures. In the face of such competition, enterprises must cut back or abandon unprofitable product lines and shift resources to still-profitable areas.
These difficult decisions must be made without hesitation, making it hard for enterprises to maintain seniority-based wages and lifetime employment systems, as both effectively turn labor into fixed costs and weaken management's ability to take evasive actions. Achieving this flexibility is a new challenge unique to the catching-up era.
==Third, reform the education system to address the increasing demand for human capital and inequality specific to catching-up economies.==
==For catching-up economies, the key consideration regarding the most important human capital is how to maximize the number of people who can generate new ideas and businesses, and how to motivate them to focus on creative work.==
This may require a new consensus, helping those who cannot think outside the box to understand and accept the fact that their well-being depends on those who can. In fact, during the catching-up stage, society as a whole must recognize that such thinkers are crucial for generating new investment opportunities domestically, preventing the economy from falling into long-term stagnation.
These three challenges are unique to economies in the catching-up stage, and these three policies are necessary conditions for maintaining their status as developed economies.
- China's True Problem: The Easiest Story Has Been Told
The golden age of the United States and Western Europe lasted about 40 years, ending in the mid-1970s; Japan's golden age lasted about 30 years, ending in the mid-1990s; the golden age of Taiwan and South Korea among the "Four Asian Tigers" lasted about 20 years, ending around 2005; so how long can the golden age of mainland China last?
Through the free trade system, China has successfully transformed from an extremely poor agricultural country with over 1 billion people into the world's second-largest economy in just 30 years. The 30 years following China's reform and opening up in 1978 may be the fastest and largest period of economic growth in history, with per capita GDP for over 1 billion people rising from over $300 to over $10,000 in 2019. China quickly integrated into the global economy, attracting a large amount of foreign direct investment, initially from Hong Kong and Taiwan, and soon expanding to all developed economies.
Around 2012, China crossed the Lewis turning point, experiencing rapid wage growth. This means China is in the golden age after the Lewis turning point. As wages rise in China, both domestic and foreign companies are moving factories to lower-wage countries like Vietnam and Bangladesh. In fact, the globalization and free trade system that allowed China to benefit as the lowest-cost producer is currently facing challenges.
This also means that the easier parts of China's economic growth story have come to an end.
- Challenges Facing China: "Decoupling," Demographic Characteristics, and the Middle-Income Trap
China has been the fastest-growing economy over the past 40 years, providing a good real-world example, with the middle-income trap and deteriorating demographic structure being urgent issues.
China's per capita GDP is slightly above $10,000, currently positioned in the middle of the trap, while its working-age population has been shrinking since 2012. The 2020 census data indicates that China's total population may begin to decline as early as 2022. Therefore, economists worry that before China fully escapes the middle-income trap and joins the ranks of developed economies, it may lose growth momentum due to unfavorable demographic structures.
For an export-oriented growth model to succeed, two necessary conditions must be met: the ability to manufacture competitive products and access to foreign markets where these products can be sold. There is no doubt that China has made tremendous progress in meeting the first condition. Today, China can manufacture almost everything at high quality and competitive prices.
Regarding the second condition, in the context of rising protectionism, Chinese economists need to focus more on who will buy Chinese products. After all, it is these people who will drive the expansion necessary for China's continued economic growth.
In recent years, ongoing trade frictions between China and the U.S. have prompted China to rely more on domestic demand for economic growth, referred to as the domestic circulation or dual circulation economic cycle. This has also led to many discussions about "decoupling."
So far, China's economic growth has largely depended on its competitive export prices. At the peak of the export boom in 2006, exports accounted for nearly 35% of China's GDP. Today, this figure is still around 18%. As long as export prices remain competitive, foreign consumers will expand for China, leading to rapid export growth.
Because export products can be sold, Chinese manufacturers have made significant contributions to employment and economic growth by continuously expanding domestic investments. In other words, China is in a golden age, with ample reasons for expansion, as they export to regions wealthier than themselves.
==Decoupling from Western markets means that Chinese companies may have to sell to less affluent regions.====As shown in Figure 5-4, Western economies account for 56.8% of global GDP, while Russia, Africa, and other regions account for only 25.3%.==
The per capita GDP of Western economies is 4.5 times that of other economies. Given that China's per capita GDP has only recently surpassed the $10,000 mark, this could sharply reduce the market size available for Chinese companies to sell their products. The Chinese market is certainly important to the West, but it is essential to recognize that in global GDP, Western economies account for 56.8%, while China only accounts for 17.9%.
- Future Economic Growth Requires Strong Expansion of Enterprises and Consumption
Fundamentally, for an economy to grow, some people's spending must exceed their income. If enterprises and households behave cautiously, only spending what they earn at each period, the economy may stabilize but will not grow. For economic growth to occur, the real economy must expand—either by borrowing money or reducing savings.
Thus, economic growth requires a continuous and sufficient number of opportunities to attract enterprises to borrow money for investment, or exciting new products to emerge that entice consumers to want to purchase, even if it means increasing debt or reducing savings. Many factors influence the availability of investment opportunities and "must-have" products, with population and productivity being just two of them. Whether such opportunities exist depends on the stage of economic development and the unpredictable pace of technological innovation, which generates new products or new methods of manufacturing existing products more efficiently.
For China's economy to develop in the current external environment, domestic enterprises and consumers must expand. To achieve this, enterprises need to continuously launch new products that can amaze and excite consumers. However, the key question facing policymakers is whether there are enough companies to support the economy of 1.4 billion people and drive its development.
Despite China's remarkable economic growth over the past 40 years, there are still 600 million people with a monthly income of 1,000 yuan or less, and 900 million people with an income of 2,000 yuan or less. Therefore, China can still leverage foreign markets and develop manufacturing to provide well-paid jobs for these 900 million people, thereby improving their living standards.
For Chinese companies to develop new products, the government must also protect intellectual property rights—without intellectual property rights, companies will not confidently invest resources in R&D. Since product innovation is riskier than product manufacturing, the financial system will need to reform to ensure these companies can access more venture capital.
While these policy reforms may indeed occur, the environment of "fewer and less affluent consumers" is more challenging than what Chinese companies have become accustomed to. Therefore, as "decoupling" progresses, economic growth may slow down.
Few countries have turned to more challenging product innovation while their per capita GDP remains low after the war, and no country has successfully achieved sustained economic growth, indicating that China faces significant challenges.
Moreover, when foreign companies that set up factories in China begin to scale back operations in response to lower wages elsewhere or face higher tariffs on Chinese-made products abroad, there must be companies to replace them to maintain output and employment.
Although an increasing number of capable Chinese companies can produce domestically and sell products abroad, the question remains the same: after foreign companies leave, are there enough companies to provide well-paid jobs for the populace?
A country in the middle-income trap should consciously strive to improve ==domestic capital returns== so that foreign and domestic companies continue to invest. Only by keeping entrepreneurs expanding can the economy avoid being dragged down.
In the short term, the government can maintain economic stability through expansion. However, unless the social return rate of these public works is high enough to break even, the growing budget deficit and the financing burden of maintaining new project costs will ultimately force the government to reduce fiscal stimulus. Once these fiscal supports are withdrawn, economic growth will slow unless enterprises continuously succeed in launching exciting new products.
As mentioned earlier, China's working-age population began to shrink in 2012, the year China crossed the Lewis turning point. From a demographic perspective, it is quite unusual for the entire labor supply curve to shift left when an economy reaches the Lewis turning point. Both Japan and South Korea enjoyed about 30 years of labor growth after reaching the Lewis turning point.
The guiding significance of the Japanese example lies in the expectation that the total population decline, which is expected to begin as early as 2022, will drag down the portion of economic growth driven by population growth. If China cannot escape the middle-income trap before the momentum for economic growth driven by demographic factors disappears, it may struggle to achieve the goal of reaching a per capita GDP of $20,000 by 2035 as an aging country with increasing social burdens.
With the help of fiscal policy, if there are no actual military conflicts, China's economy may continue to grow in the coming years. However, as the population ages and domestic wages reach the threshold level of the middle-income trap, "decoupling" from the West may lead to a significant decline in growth rates.
In this sense, if China wants to achieve the aforementioned living standards by 2035, there is no time to waste and no room for policy errors. Chinese policymakers must understand which enterprises have been expanding so far and which will expand in the future.
Author: [U.S.] Gu Zhaoming
Publisher: CITIC Publishing Group
Subtitle: How Developed Economies Understand and Respond to New Reality Challenges
Original Title: Pursued Economy: Understanding and Overcoming the Challenging New Realities for Advanced Economies
Translators: Xu Zhong / Ren Qing
Publication Year: 2023-8