Japan's approaches wouldn't necessarily work in China

In a speech at Soochow Securities' forum in Hong Kong in June, Richard Koo, chief economist at the Nomura Research Institute, highlighted the similarities between China's current economic situation and Japan's balance sheet recession, suggesting that instead of focusing on monetary policy or structural reforms, China should allocate all its resources toward fiscal stimulus to sustain economic activity. This viewpoint warrants measured discussion.

Prudent stand needed

Koo's speech shed light on the economic challenges China now faces, reminiscent of Japan's experience in the 1990s when the bursting of the real estate bubble led to a decline in asset values and an increase in liabilities for both businesses and individuals. As a result, companies and individuals refrained from taking out loans and instead, focused on saving and debt repayment, which finally led to an economic recession. In such a scenario, Koo argues for implementing macroeconomic fiscal stimulus policies, wherein the government lends out savings to ensure sufficient liquidity, maintain economic growth and smoothen the yield curve signaling recession. This would enable some people to resume borrowing, investing and consuming, and help restore normal economic growth once they have successfully repaired their balance sheets.

Koo's theory, which advocates fiscal borrowing stimulus measures as a means to inject liquidity and resumption of economic growth once balance sheets are repaired, undoubtedly offered innovative and logically sound solutions to Japan's economic downturns at that time. With limited knowledge of Japan's economic situation, this writer will not comment on the rationale and comprehensiveness of Koo's depiction of Japan's economic recession mechanism or the application and effectiveness of the proposed measures. Instead, the major concern of this article is that it may not be a good idea to apply Koo's theory in China.

In fact, market economies have been witness to various transitions — from pre-capitalist laissez-faire policies to Keynesian stimulus measures during the 1929-39 Great Depression, followed by post-war socialist welfare programs, active monetary policies during periods of severe inflation, and the emergence of supply-side measures during times of stagflation, emphasizing tax cuts and reforms. Currently, the majority of market economies, including transition economies from the socialist system in recent years, have already shifted away from direct planning regulations. Macroeconomic regulations they adopted are based on the operation of micro market economies and utilize a combination of Keynesian, monetary and supply-side policies, either in rotation, prioritization or mixed approaches.

Fiscal stimulus inadvisable?

In the Chinese context, it is highly inadvisable to solely rely on a single fiscal stimulus approach without considering other factors. This is due to several differences — to be discussed below — between China's current economic situation and that of Japan in the past, even though they hold some common issues such as low population growth, shrinking labor supply and real estate bubbles.

First, Japan was basically a market economy during that period, while China is currently transitioning from planned incremental reforms toward a socialist market economy. This fundamental difference determines whether China should prioritize policy-driven initiatives or mainly leverage reforms. There are significant institutional disparities between the two countries.

Most countries utilizing fiscal stimulus measures as a major tool for economic regulation over a certain period of time can be classified as a combination of "Keynesian policies at the macro level and market economy at the micro level". Japan's economic measures and structure represent a typical model of this combination. Although China faces similar economic problems to Japan's experience, it is important to note that China is adopting a socialist market economy system. Applying a singular strong fiscal stimulus plan, therefore, would lead to a situation of "pure Keynesian policies plus a transitioning market economy", which is fundamentally different from the nature of Japan's case.

Second, differences also lie in the formation of problems and their underlying causes. In Japan, asset bubble bursts resulted from market speculation under hard constraint from balance sheets. The need to repay debt placed strict requirements on savings, leading to an economic recession. However, in China's case, certain local governments, State-owned enterprises and even private enterprises lack awareness of financial balancing acts, and excessively borrow against existing assets. As a result, the soft constraints on financial balances have fueled and inflated the bubble. Amid the turmoil of balance sheet insolvency, certain debtors may even don a cloak of secrecy, clandestinely shifting assets and eluding their debts.

For instance, some private enterprises, particularly those in the real estate sector, exhibit speculative intentions, prioritizing scale and borrowing, disregarding risks and holding out expectations that lenders will always come to their rescue. State-owned financial institutions and capital markets also provide loans, bond issuances and debt purchases to local governments and enterprises, thus benefiting them from soft constraints on balance sheets due to factors such as government endorsement and high interest rates offered by the real estate market.

Another major difference in underlying characteristics comes from the structure of the two countries' balance sheets. Japan's post-war market economy system allowed individuals and corporate entities to own land and properties. However, in China, people have only land-use rights, unable to trade land or determine prices. As a result, they are unable to utilize financing methods such as mortgages, investments and equity sharing, leading to inherent liquidity constraints within the system.

Consequently, Japan has been able to achieve balance sheet repair for businesses and households, while China faces an absence of immovable assets such as land and housing in their balance sheets and urgently needs to fill this gap and set up its own sheets by aligning with characteristics of its socialist market economy.

Lastly, Japan has gradually established a relatively comprehensive modern fiscal system, characterized by strict institutional design and supervisory constraints in terms of government revenue sources, deficits, borrowing, debt repayment, risk control, expenditure programs and administrative cost efficiency. Moreover, the majority of businesses in Japan are non-state-owned entities, generally operating without fiscal subsidies.

In contrast, China's fiscal system exhibits varying degrees of soft constraints, inefficiencies and structural imbalances. For example, the country strives to allocate significant financial resources to technology research and development, but it often faces challenges such as overestimation and fraudulent practices. Furthermore, although it has carried out an ample amount of fiscal deficit pushes, a substantial portion has been directed toward public infrastructure projects and SOEs, leading to internal circulation and failure of smooth fund flows among and between various businesses and households. In this sense, macroeconomic policy stimulus moves and market-based investments and consumption can come apart at the seams.

Overall, the differences between China and Japan, including the ongoing transition in China's market economy and the varied nature related to balance sheets and debt, make it unlikely that China will successfully adopt a one-size-fits-all potent fiscal stimulus approach without considering other factors necessary along the road to sustainable economic growth.

The writer is the head of the National Economic Engineering Laboratory of the Dongbei University of Finance and Economics. The views don't necessarily reflect those of China Daily.