China Drifts Closer to Its Own Lost Decade
Beijing has the chance to learn from Japan’s errors in the ’90s, but that would take dramatic rethinking.
By Joseph C. Sternberg
The question has become unavoidable: Are we witnessing the Japanification of China’s economy?
The analogy is straightforward.
Japan in the 1970s and ’80s and China in the 2000s and ’10s experienced rapid economic growth, fueled by astounding credit expansion feeding into an export-dependent economic model.
Among the most obvious manifestations of growth in both places was a huge run-up in property values.
The collapse of that property market presaged Japan’s lost decades (we’re now well into the fourth).
So why not expect a similar awful fate to afflict China as the aftershocks of its 2020 real-estate crash reverberate?
Optimists can point out that China entered into this correction with several advantages relative to Japan’s experience of the early 1990s.
The most important, counterintuitively, is that China is much, much poorer.
In 1990 Japan’s per capita income was roughly 108% of America’s.
In 2020 China’s per capita income was 17% of America’s.
Beijing has ample scope to achieve growth simply by encouraging a catch-up of the large segments of the economy that remain impoverished.
Chinese officials also benefit—cough, cough—from the opportunity to learn from Japan’s example.
Yet heading into 2026 there’s growing reason to doubt those advantages will save China.
The property market clearly hasn’t found its bottom.
Fixed-asset investment keeps falling.
Consumer confidence remains tenuous.
Worse, fears of deflation now stalk the land. Beijing for the past year or so has worried about “involution,” a situation in which overproduction leads to “too much” domestic price competition.
Officials fear this could cause falling household consumption (as individuals anticipate lower prices if they wait until tomorrow to buy) and rising financial distress among indebted companies.
Deflation per se was never Japan’s biggest economic problem.
But deflation was a symptom of the things that were.
To wit: The entrenchment of a two-track economy in which some industries (primarily export manufacturers) are phenomenally productive while others (mostly domestic service firms) lag badly, combined with the refusal to impose meaningful discipline on the economy via the financial system.
China is missing its opportunity to avoid both traps.
Beijing’s property correction started with some promise.
President Xi Jinping triggered it by tightening mortgage-lending standards.
This was accompanied by a policy of allowing private-sector real-estate developers to go bankrupt.
In time the central government also took steps to clear up the multitrillion-dollar overhang of property-linked debts hidden in local governments’ books.
On the surface, this all looks like financial-system market discipline.
Yet it quickly became apparent that real-estate bankruptcies had less to do with “the market” than with consolidating viable assets in the hands of the state-owned developers.
The cleanup of local-government finances is proceeding haltingly.
Meanwhile, there are too few indications that China’s economic slowdown is leading to the sort of business upheaval that culls lagging businesses in a recession.
Instead, there’s reason to suspect corporate zombies are proliferating.
By one recent estimate, among service-oriented companies the proportion of total corporate assets held by firms that don’t earn enough to cover interest payments has risen to 17%, from around 8% in 2019.
This happens because banks are encouraged by low interest rates (and perhaps a quiet word from regulators) to roll over dubious loans rather than forcing unproductive firms into bankruptcy.
This form of “zombification” has been a hallmark of Japan’s economy throughout the lost decades.
It’s how a two-track economy develops.
Firms that would have succeeded under any circumstances—because they’ve developed fantastic new mousetraps, or because they’re exposed to the discipline of global trade—continue to grow.
But they coexist with an increasingly sluggish zombie economy, and as in any good zombie film the living and the walking dead are locked in a constant battle for resources.
In Japan this manifests in several startling ways, as veteran observer Richard Katz notes.
Unusually for a developed economy, productivity growth is concentrated in a handful of industries, rather than spread across the top-performing companies in each industry.
Japan lacks the market incentives necessary to disperse innovation from the most inventive firms to the rest.
It’s too soon to say for sure that China is falling into this pattern, but early signs aren’t encouraging.
Anecdotally, a pronounced divide is emerging between high-tech industries that benefit from government favoritism, such as electric-vehicle manufacturing and artificial intelligence, and everyone else.
This happens because Mr. Xi has made high-tech innovation an economic priority in its own right, independent of the development of a market economy that could translate innovation into broad-based prosperity.
This tic has been a conspicuous and unhelpful feature of Japanese policymaking in recent decades.
The Japanification of China still isn’t inevitable.
But it’s more than five years since the property correction began.
Absent a dramatic rethink in Beijing, China’s hopes of avoiding a lost decade are fading rapidly.
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