What Can China Learn from Japan's Policy Mistakes that Worsened the...
Title：What Can China Learn from Japan's Policy Mistakes that Worsened the "Lost Decades"?
Starting from 1990, with the bursting of the economic bubble, the Japanese economy fell into a "balance sheet recession" characterized by low growth, low employment, low inflation, low wealth, and low leverage, lasting for 30 years, also known as Japan's "Lost Decades". The "Lost Decades" were not inevitable and were marked by profound policy mistakes, especially in the first decade when policy responses lacked coordination, consistency and continuity. From the standpoint of China's current economic development, these past policy errors in Japan offer significant lessons.
Lesson 1: Actively burst the bubble but severely underestimate the impact of the bubble's collapse.
In order to control the continuous expansion of the stock and real estate bubbles, Japan's decision-makers took proactive measures, implementing five consecutive interest rate hikes starting from May 1989, raising the discount rate from 3.25% to 6.0% by August 1990. Additionally, in 1990, the introduction of financing quota control on the real estate industry in Japan led to a rapid decline in the growth rate of real estate loans balance from 15.3% in March 1990 to 0.3% in March 1991. Furthermore, starting from 1991, Japan also began to implement land tax reform, tightening land taxes.
Under continuous pressure from interest rate hikes, credit restrictions, and tax reforms, Japan’s stock market and housing prices experienced severe declines. In 1990, the Nikkei 225 index plummeted by 33%, and in March 1992, it fell below the 20,000 points, only half of its peak value in 1989. Japanese land prices also declined by approximately 8% in 1991.
However, Japanese policymakers made a significant miscalculation about the consequences of the bursting asset bubble. In 1991 and 1992, the Japanese government believed that the collapse of the bubble economy would have a minimal negative impact on personal consumption and corporate investment, and expected it to dissipate after 1993. They also downplayed the severity of the non-performing loan issue in financial institutions. It was not until 1993 that the Japanese government realized that the "bursting of the economic bubble had a significant impact on the real economy."
The significant impact mainly affected the balance sheets of businesses and households. Following the bursting of the asset bubble in Japan, real estate prices, a crucial asset allocation for Japanese businesses and households, dropped by more than 70% from their peak in the 1990s, while equity assets fell by more than 80%, causing a wealth loss of over 150 trillion yen for Japanese businesses and households.
Lesson 2: Lack of policy coordination resulted in a "liquidity trap" in monetary policy.
After the bubble burst, the absence of a unified policy response and targeted measures led to a lack of clarity in the market about the future prospects. During the 1991-1998 period, Japan saw 7 changes in prime ministers, and the country's economic development strategies were continuously adjusted, with inadequate focus on addressing the bubble burst.
At this time, Japan also fell into a "liquidity trap". The Bank of Japan lowered the benchmark lending rate 9 times, from 6% in 1991 to 0.5% in 1996, but it did not reverse the continuous decline in loan and money supply growth. Japan's M2 growth rate dropped from around 12% in 1990 to near zero in 1993, while inflation continued to decline, eventually leading to long-term deflation.
The underlying reasons behind this are twofold: on the one hand, banks faced rising non-performing loans and declining capital adequacy ratios, leading to a trend of "reluctant lending". On the other hand, corporate balance sheets contracted, incomes significantly decreased, and residents' expectations for employment and income declined, resulting in a trend of "reluctant borrowing”, causing a weakness in both the supply and demand sides of monetary credit.
The tightening measures on land value tax in 1991 exacerbated property owners' inclination to sell, leading to a sustained decline in the real estate market. It was not until 1998 that Japan's land policy began to shift comprehensively. By that time, Tokyo’s housing price index had dropped nearly 50% from its peak in 1991. In 2004, Japanese real estate prices finally hit rock bottom, with the index showing a decline of nearly 60%.
Lesson 3: Fiscal policy emphasizes "heavy investment and light consumption¡±, leading to sustained low levels of consumer spending.
Japan's fiscal policy of "emphasizing investment over consumption" has led to an economic recovery hampered by a "disrupted supply and demand cycle".
After the bubble burst, Japan implemented expansionary fiscal policies with a focus on boosting public investment. Since 1992, the Japanese government has consistently increased the budget for public works expenditures, with increases of 8.6 trillion yen in 1992, 11.6 trillion yen in 1993, and 7.2 trillion yen in 1994. In 1995, a comprehensive emergency economic package totalling 18.8 trillion yen was launched, still focusing mainly on the increasing public works expenditure and expanding public investment.
While the decline in the employment and consumption of residents has not received sufficient attention. Only in 1994 was a one-time "special tax cut" implemented for personal income tax, but its effectiveness was limited. Increased public investment has not led to growth in employment and consumption. In 1990, Japan's job availability ratio was 1.4, meaning there were 1.4 job openings for every job seeker in the labor market, but it then declined sharply and did not exceed 1 until 2005. As a result, Japan's private consumption growth rate dropped rapidly from 4.8% in 1990 and remained below 3% for the next decade, even falling to -0.6% in 1998.
The contractionary consumption tax policy has stifled Japan’s nascent recovery. Japan's expansionary fiscal policy lacked a focus on household consumption, leading to ineffective stimulus to the economy and instead to a widening fiscal deficit. In response, the Japanese government enacted the Fiscal Structure Reform Law in 1997, which set a target of reducing the fiscal deficit as a percentage of GDP to within 3% by 2003, discontinuing the issuance of deficit bonds, raising the consumption tax rate from 3% to 5%, terminating certain tax reduction measures, and increasing the proportion of individual burdens in medical expenses.
As a result, the consumption tax policy has increased the burden on residents, further weakening personal consumption and hampering economic recovery. In addition to the compounded impact of the Southeast Asian financial crisis, the Japanese economy, which showed some signs of improvement in 1996 (at a growth rate of 4.4%), once again fell into recession, with the growth rate plummeting to around 0%.
Lesson 4: The inadequate resolution of financial risks has led to a growing accumulation of non-performing assets.
Japan has implemented the Main Bank System, and the authorities have overlooked the negative feedback loop between "asset price declines, business operational difficulties, and bank non-performing loans". The government's approach to disposing of non-performing assets relied solely on the expectation that economic recovery and rising asset prices would drive down the level of non-performing assets.
However, as asset prices continued to decline, balance sheet deterioration became evident, and corporate bankruptcies continued to rise. By fiscal year 1991, the number of corporate bankruptcies in Japan had surged to approximately 13,578, an increase of 48% over 1990. Subsequently, over the next decade, the number of corporate bankruptcies in Japan remained consistently high.
Correspondingly, non-performing loans in Japan also grew increasingly large. By the end of 1992, the total amount of non-performing debts in the Japanese banking sector was approximately 40 trillion yen, and by the end of September 1998, it had risen to 87.5 trillion yen. If the non-performing assets concealed by financial institutions are taken into account, the actual scale is even larger.
Therefore, the financial system is seriously at risk with weak risk resistance capability. Under the impact of the Southeast Asian financial crisis, Japan’s major financial institutions also collapsed. At the end of 1997, Hokkaido Takushoku Bank and Yamaichi Securities went bankrupt, and in the latter half of 1998, Long-Term Credit Bank of Japan and Nippon Credit Bank experienced poor operations and were nationalized. To that end, the Japanese government determined to inject government funds into financial institutions to address the risk issue.
However, the delay in resolving the risk led the Japanese government investing enormous rescue funds. In March 1998, the Japanese government injected 1.0156 trillion yen of fiscal funds into 21 banks, and in October 1998, the government launched a reconstruction finance plan totaling 60 trillion yen, with 25 trillion yen allocated for bank recapitalization. If risk management had been strongly promoted in the early stages of the bubble burst, such massive injections of government funding might not have been necessary.
Insights on China's Current Policies
In 2023, China's real GDP grew by 5.2% year-on-year, successfully meeting the annual growth target. However, the quarter-on-quarter GDP growth rate dropped to 1.0% in the fourth quarter, indicating a slowdown in the recovery momentum. Additionally, China faces challenges such as continued sluggish in the real estate and capital markets, insufficient effective demand, weak social expectations, and various risks.
After the bursting of the stock and real estate bubbles in 1990, Japan's policy responses were uncoordinated, inconsistent, and discontinuous, leading to a continuous decline in asset prices, high risks for financial institutions, contraction in corporate financing and household consumption. This in turn triggered a negative feedback loop of long-term deflation and low economic growth. These experiences provide valuable insights into China's current policy responses.
First, pay attention to the impact of simultaneous declines in real estate and stock prices, in order to avoid a sustained contraction of balance sheets. In recent years, China has seen a continuous decline in real estate prices, with sales price indices of newly constructed commercial residential buildings in 70 large and medium-sized cities dropping for 22 consecutive months as of January 2024. The Shanghai Stock Exchange Composite Index has been continuously declining since the second half of 2023, and once approaching 2600 points.
Under these circumstances, real estate development investment continued to decline, with a 9.6% year-on-year decrease in 2023. While new deposits from residents increased from 9.7 trillion yuan in 2019 to 16.7 trillion yuan in 2023, new loans decreased from 7.4 trillion yuan to 4.3 trillion yuan. It is apparent that the decline in asset prices has caused significant impact on corporate investment and household consumption, leading to a slowdown in economic recovery momentum. Effective growth stabilization policies must be implemented quickly to avoid a sustained contraction of the balance sheet.
Second, it is important to coordinate fiscal and monetary policy to further enhance the effectiveness of stimulus policy. In recent times, monetary policy has continuously increased its countercyclical adjustment efforts. Since December 2023, deposit rates, rediscount rates, reserve requirement ratios, and LPR have been continuously lowered. Driven by loose monetary policy, the weighted average interest rate on loans by financial institutions dropped to 3.83% in December 2023, reaching an all-time low.
However, in January 2024, new medium and long-term (MLT) loans to enterprises decreased, and new medium and long-term loans to residents were lower than the same period in 2021 and 2022, indicating relatively limited policy effects. In December 2023, total social retail sales increased by only 0.42% on a month-on-month basis, while consumer confidence index remained low at 87.6 points. Private investment also showed relatively weak performance, declining by 0.4% year-on-year for the year as a whole. Insufficient demand has made it difficult for the effectiveness of monetary policy to be fully realized, and stable growth still requires the central government's additional efforts to cooperate.
Third, there is a need to increase stimulus to household consumption to drive the recovery. While the momentum of consumption recovery is slowing, there are signs of " quantity increase and price decrease " in consumption. During the 2024 Spring Festival holiday, various indicators such as the number of outbound tourists, travel expenses, and service consumption income reached historical highs, but "per capita spending" only recovered to 91% of the same period in 2019. By contrast, in December 2023, the year-on-year growth rate of industrial added value continued to rise to 6.8%.
It is evident that the main problem facing stable growth lies in consumption rather than production. In the next step, the central government should intensify the stimulus to consumption through fiscal measures, such as distributing consumption vouchers nationwide, implementing policies of exchanging old cars and home appliances for new ones and providing subsidies, to accelerate consumption recovery and drive supply and demand into a virtuous cycle.
SHEN Jianguang is the Chief Economist of JD.COM