Australian Financial Review

Japanification Would Be a Good Outcome for China

High debt, lower productivity, and the lack of adequate provisions being made for the aging population are a looming slow-motion financial and social train wreck.

Senior Fellow
The Mingshen Nursing Home in northern Shanghai. (Ryan Pyle/Corbis via Getty Images)
The Mingshen Nursing Home in northern Shanghai. (Ryan Pyle/Corbis via Getty Images)

Last week, Karen Maley presciently warned that China is running out of time to avoid “Japanification” – decades of slow growth due to high debt and declining productivity. Yet there is good evidence to support an even more pessimistic assessment and suggest it would be a good outcome if only China were more like Japan.

China’s GDP surpassed Japan about a decade ago. But a crude measurement of economic activity occurring each year is not the best indicator of material success. Unlike Japan, China will not grow rich on a per capita basis before its irreversible ageing demographics comes into play.

On this issue, China is unique because of the one child policy in place since 1980 and which is only being wound back in recent years. The dynamic of one working member of an extended family looking after two parents and several grandparents is increasingly common.

Moreover, Japan is much better prepared to provide for its ageing population than is China. For example, the estimate is that only around one-third of all urban residents and less than 10 per cent of rural residents have some form of central, provincial, or local government provided pension. In recent times, Beijing has introduced a modest nationwide old age insurance scheme which covers most citizens.

Revenue for the scheme is meant to come from statutory contributions by corporate firms. The problem is that China’s well-known corporate problems of high debt and declining productivity mean such contributions are consistently below what is needed for the old age insurance scheme to work.

There is no way to circumvent this problem. For example, in 2020 the government offered firms relief from the worsening economic conditions by lowering the contribution they had to make.

This led to a decline of about 13 per cent in pension fund revenues, despite a 5.5 per cent increase in expenditures. Government entities were forced to inject billions to plug the immediate gap. The available accounts remain murky.

We do know that at the end of 2019, the pooled surplus from the urban pension plans was about $US790 billion, which was sufficient to sustain only 13 months of benefit payments.

Regarding Chinese pension plans provided for by the state, this is becoming ever more dependent on local government. The problem is that the gap between what the local government receives from the central government and what the former needs to spend to provide public and social goods is estimated to be $US1 trillion ($1.5 trillion) a year.

Previously dependent on land sales and houses being flipped in a buoyant residential property market, local governments are looking to issue more and more bonds to cover the shortfall.

The state of their books and other so-called Local Government Financing Vehicles means their capacity to honour bond payments is questionable, meaning an implicit central government guarantee is needed to attract buyers of these local government bonds.

We then get a rerun of moral hazard issues plaguing the entire Chinese political economy: governments guaranteeing questionable financial debt products to fuel higher demand for them.

Dangerous imbalances

Corporate firms needing to find more money to provide for employee pensions are already suffering declining revenues due to the entrenched slowdown and are issuing corporate bonds to fund the shortfall.

Hence, all this additional financial leverage in the economy to tread water on just one of many social obligations – providing for an ageing population – is occurring at a time when deleveraging is desperately needed.

It is no wonder the lack of adequate provisions being made for China’s ageing population by the state and corporate sectors is rightly described as a slow-motion financial and social train wreck by astute analysts.

And we haven’t even mentioned the broader structural problems with the Chinese economy, why the high debt, high leverage, high turnover and low-cost strategy is no longer working and is creating dangerous imbalances.

Away from economics, there is another reason why Japan is much better placed. When it comes to geostrategy, Xi Jinping has been a disaster for the country over the past decade. He has reversed the grand strategy pursued by his predecessors since Deng Xiaoping, which was to prevent the emergence of grand coalitions against China.

By the time Japan began its years of low economic growth, it was welcomed as a champion of regional stability and widely accepted as a responsible stakeholder in the global order. As China embarks on its period of structurally lower growth, it faces the growing prospect of advanced economy democracies in the Americas, Europe and Asia banding together to constrain its ambition and behaviour.

It seems that China engaging in the most rapid military buildup in peacetime history has not resulted in it becoming more secure externally. That growth in spending on internal security has outpaced and exceeds expenditure on the People’s Liberation Army suggests the Chinese Communist Party is becoming less secure internally as well.

Which leads to the conclusion that rather than avoid Japanification, China might do better to follow and emulate its island neighbour.

Read in Australian Financial Times.