What Happens If China Becomes Japan?

By all normal indicators, China should be headed for a massive setback. The last couple of decades have been characterized by amazing, double-digit growth. It has also been characterized, especially in recent years, by a credit boom and massive overinvestment as the Chinese government has leaned on bank loans to keep growth on target.

A few years ago, I visited a “third tier” Chinese city, where my group saw evidence of a boom everywhere we looked. But all the trucks were carrying construction materials, not goods. At the workshop-level factory we visited, one of my fellow travelers, who spoke Chinese, learned that the owners were trying to sell it because they could get more from the land than they could from making farm equipment.

This didn’t sound like sustainable development to me, and from all I hear, this characterizes a lot of the growth in the last few years — driven by government directive, rather than supply and demand. Now China seems to be slowing down. Not “stalling out” — its “slow” growth rates would still be matters of envy and amazement in the developed world. But industrial production in August showed its worst numbers since the financial crisis, and other economic data also seem muted. In the context of the previous amazing expansion, as I said, all normal indicators would point to a coming crash. But China is not like any other place. So I’m hesitant to predict a crash, because what would a crash in China even look like? Can its banking system even have a run?

My colleague William Pesek makes a convincing argument that a Chinese crash would look a lot like Japan’s. Threatened with a massive financial panic when its overinvestment bubble burst, Japan’s government poured vast sums into propping up bad banks and the companies it had loaned money to.

Japan managed to avoid something like the Great Depression. But many have argued that what it got instead was decades of stagnation. Banks avoided writing down bad loans by funneling more money into bloated, stagnant businesses. That capital could not be used to fund new enterprises and projects that might have driven economic growth. It avoided large losses, but it also avoided large potential gains, trading risk for a steady but certain slow decline. Japan now has a two-tier economy in which the insiders of 20 years ago still enjoy their lifetime employment, but young workers increasingly end up in unstable temporary jobs.

If China follows a similar course, this will have major implications for the rest of the world — so major that I cannot possibly chart them all out here, even if I could correctly foresee the future, which I certainly can’t. But let me suggest two that are particularly worth thinking about: What are the geopolitical implications of the world’s largest country entering a period of Japan-like stagnation without Japan-like wealth? And what are the potential costs and benefits for other countries that consume Chinese goods — and compete with Chinese workers?

Of the two, the former is by far the scariest question. But in the short term, the answers to the latter will probably be more apparent — and more disruptive.

Megan McArdle is a Bloomberg View columnist who writes on economics, business and public policy. She is the author of “The Up Side of Down.”