Why China Could Follow Japan’s Economic Fate

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These days in China, people are looking for cheap eats. That’s because many are feeling financially strained. Discount delicacies like these have gone viral, especially at affordable spots like the Japanese restaurant Saizeriya.

However, meal deals aren’t the only thing China has picked up from Japan. The entire economy is starting to resemble Japan’s in concerning ways. Many in China today are worried they might be repeating what happened to Japan over 30 years ago. This includes stagnant growth, a burst real estate bubble, falling bond yields, a sluggish credit market, and an aging population—not to mention price growth that is close to zero.

China has reported its longest deflationary streak of the century, pushing ordinary Chinese citizens to be frugal at a time when policymakers desperately need them to spend. If consumers continue to save instead of spend, companies will make less money, leading to lower wages for workers. This cycle could continue unless Beijing learns from Japan’s devastating lost decades before it’s too late.

Japan’s Lost Decades

Tokyo, the world’s largest and most rapidly growing city, saw Japan’s economy skyrocket after World War II, peaking in the 1980s. Credit was cheap, the yen was strong, and the economy was booming. Confident consumers borrowed heavily to purchase property and stocks, whose values were surging. Japanese corporations also spent extravagantly, both domestically and on high-profile purchases abroad.

But as the 1980s ended, so did many fortunes. On the first day of the 1990s, the Japanese market began collapsing. The yen continued to hit new lows, causing frustration on the Tokyo currency exchange. This marked the beginning of Japan’s "lost decades," characterized by a property bubble burst, a debt crisis, and a rush to the safety of government debt.

Balance Sheet Recession

Japan entered what’s known as a balance sheet recession. To understand this, imagine buying a house as an investment. You take out a loan, expecting its value to rise. But suddenly, property prices start dropping. While your household income remains the same, you feel poorer by the day. This leads you to cut back on spending, focus on paying down debt, and save for the future.

While saving is generally good, in a situation like this, it can be harmful to the economy. If everyone is saving and no one is borrowing, the economy contracts. Central banks typically lower interest rates to encourage borrowing and spending, which Japan did for a long time. However, if people and businesses believe the economy will decline further, they may continue to save instead of spend.

For monetary policy to work, there must be borrowers. If there are none, monetary policy becomes ineffective. This leads to another issue: financial institutions, which receive these funds, need to invest them somewhere. If the private sector is not borrowing, the only borrower left is the government. As a result, investors begin buying government bonds, driving bond yields lower and lower.

Ultra-low bond yields negatively impact bank earnings, distort pension savings returns, and reduce investment income.

China’s Similarities

These same patterns are now playing out in parts of China. Bond yields have been declining, reaching record lows at the start of this year. In July 2024, new loans in China were actually negative for the first time in 19 years. More loans were paid off than were taken out, signaling a serious lack of borrowing.

Like Japan in the 1990s, China’s crisis is deeply tied to real estate. For years, property was considered a safe investment, with around 75% of household wealth stored in real estate. As housing prices fall, consumer confidence plummets. People see their home values declining and feel poorer, further reducing spending.

This situation is worsened by China’s demographic challenges. Its population is shrinking and aging—just like Japan’s did. This highlights the psychological aspect of economic downturns, where fear and uncertainty drive behavior.

Molly Shao, a 25-year-old professional in Shanghai, exemplifies this shift. She uses apps like Dianping and Meituan to find restaurant discounts, a habit that has become a way of life for millions of Chinese consumers.

China’s Differences

Despite these similarities, there are key differences that suggest China may avoid Japan’s fate. For instance, lending is still growing in some areas. In 2024, industry loans increased by over 12%, infrastructure spending rose, and real estate development remained positive. This indicates that China’s private sector is still borrowing.

China also has more room for urbanization compared to 1990s Japan, as well as a larger domestic market to support economic growth. Additionally, China is a global leader in technology, with companies like Alibaba and Tencent at the forefront. The country has more software developers than the U.S. by a ratio of approximately three to one.

While a technological revolution isn’t guaranteed, recent developments suggest that China has the potential for major innovations that could change its economic trajectory.

Lessons from Japan

Finally, China has the advantage of learning from Japan’s mistakes. Japan lost a generation because policymakers didn’t fully understand the crisis at the time. Today, Chinese policymakers have Japan’s experience as a playbook to study.

In a recession where individuals make rational choices—such as saving money—but collectively these actions harm the economy, the government must step in to sustain economic activity. If China can apply these lessons effectively, it may be able to avoid repeating Japan’s lost decades.