China is showing worrying parallels with previous economic miracles where growth collapsed following a bursting of the bubble. In the wake of excessive investment and huge credit expansion, many fear a crash in China. However, the case of Japan in the 1990s shows that there is another – and more likely – option: huge state intervention and the artificial resuscitation of near-bankrupt institutions (“zombification”) could prevent a major recession. The likely price would be a long phase of comparatively low growth.
China: Crash … For a long time, China was the growth star of the global economy; today some see it as the problem child. China’s very high investment rate (chart 1) suggests that overcapacity is increasing. Furthermore, the loan portfolio has been expanding at a much faster rate than the overall economy for some years (chart 2). This also suggests that many unprofitable investment projects have been financed. Moreover, house prices are falling after a long and sharp rise, which will reduce the quality of many loans. Many such imbalances or bubbles have ended in a crash. The most extreme example is the global economic crisis at the beginning of the 1930s when the sharp rises in loans and asset prices in the US were followed by a deep economic slump. … or the Japanese solution?
However, the example of Japan in the 1990s shows that there is an alternate outcome. The burst of the bubble was comparable to the USA a good 60 years earlier. At the end of the 1980s, Japan accounted for half of global property assets by valuation. The impact that followed on the financial markets was substantial: the equity market peaked in Q4 1989 and then plunged 60% by mid-1992, with the trough only occurring in 2003 following a total loss of 80%. House prices have fallen steadily since their peak in 1991 and were recently 51% lower. The real economy did not slump though. Indeed, it grew at an average rate of around 1% per capita (compared to 4% in the 1980s) and only towards the end of the decade did real GDP marginally fall (chart 3, page 3).
