One of the most popular frameworks for thinking about China’s economy today is the experience of Japan in the 1990s. The attraction is understandable. Property market activity in China has collapsed, prices across the economy are falling, and interest rates have dropped to record lows. All were features of Japan’s long malaise. But as much as China’s economy faces problems, it is unlikely that “Japanification” is one of them.

Japan’s experience is often compressed into the idea of a balance sheet recession, the process whereby companies and households prioritise debt reduction over spending and investment. That was certainly one of the dynamics that weighed on Japan’s economy. But as made clear by the long report recently produced by the Japanese central bank reviewing the country’s experience over the last 25 years, much more was involved. Indeed, the strong impression from the Bank of Japan’s work is that Japanification was the result of a confluence of factors that was particular in place and time to Japan in the 1990s. 

The BOJ groups those factors into three buckets. Some elements in the first — termed a “chronic shortage of demand” — will be familiar to China watchers, in particular a fall in asset prices and signs of banking sector fragility. In Japan, these were the starting points for a chain of events that led to lower lending, cuts in investment, and ultimately the corporate sector shifting from its usual position of net borrower to become a net saver — in other words, the so-called balance sheet recession. 

In China, that feedthrough is much less obvious. Real estate investment has declined, but borrowing and investment by the manufacturing sector has continued to grow. The BOJ notes that Japan from the 1990s was slow to adapt to the “globalization and the rapid IT revolution” then taking place. With the emergence today of companies like BYD and DeepSeek, it is very difficult to argue that China is falling behind in the same way.

The other two buckets of factors identified by the BOJ involve first, the supply side of the economy, and second, the “deflationary mindset” — the change in behaviour of companies and households as they started to believe that inflation wasn’t coming back. Both can be traced to a particular feature of Japan’s economy in the 1990s: a domestic cost base that was much higher than elsewhere. 

Both the cyclical shortage of demand, and the structural risks associated with ageing, argue for much bolder policy action to change consumer behaviour.

Regulation and currency movements pushed up costs in Japan. It is well understood that the Plaza Accord of 1985 triggered a sharp appreciation of the Japanese yen in the second half of the 1980s. It is less appreciated that despite the bursting of Japan’s growth bubble in 1989, the yen continued to rise, strengthening by a further 65 percent in the first half of the 1990s. A cost base that was already high when the economy was booming rose even further after the cycle had already turned.

That prices rose so far above the rest of the world meant they then had a long way to fall. That process of deflation was in turn enabled by deregulation, while imports of cheaper foreign products began to increase into a country that had been relatively closed before 1989. In the labor market, companies chopped away at the expensive lifetime employment model of the 1980s by employing many more part-time and temporary workers.

Once the process of falling prices began, companies and households started to believe it would never stop. This phenomenon resulted, in part, from a strong societal preference for employment. Firms, facing weak demand and increased competition, could only fulfil that desire by cutting wages — but with salaries being cut, it then became difficult for firms to raise prices, leading to further downwards pressure on corporate revenues and the inflation expectations of employees.

Little of this has any parallels with China today. There, import penetration is falling. Employees in the state sector do have stronger tenure rights. However, there are also 300 million migrant workers who enjoy very little protection at all, as shown by the waves of layoffs in 2008, or the more recent rounds of redundancies in the Chinese tech sector. 

China’s lightly regulated labor market helps keep manufacturing costs down, and far from facing excessive appreciation, the big challenge for the People’s Bank of China has been to prevent the renminbi from weakening too much. While Japan’s real effective exchange rate continued to register new record highs through the first half of the 1990s, China’s today is cheaper than at any time since 2014. 

Being a central bank, the ultimate aim of the BOJ’s recent report was to think about monetary policy. As the Japanese economy deteriorated during the 1990s, so the natural rate of interest — the underlying real rate of return — became negative. Given the usual zero bound for nominal interest rates, that made monetary policy ineffective, and in turn, prolonged the deflationary and economic malaise that Japan was experiencing.

It is unlikely this is what is happening in China today. The reality might not be as strong as the 5 percent growth indicated by the official government data, but there is enough evidence to think that the economy is at least expanding. While the property market is a mess, exports have been strong, and cyclically, consumption is not nearly as weak as is often portrayed. Interest rates haven’t yet been effective in turning around the property market, but monetary policy likely retains some of its potency.

There are reasonable grounds, then, to argue that Japanification is unlikely in China. One consequence is that the dive in Chinese interest rates at the end of last year was overdone.

The over-arching framework of Japanification isn’t a good fit for China today. However, there are still lessons that can be learnt from Japan’s experience over the last thirty years. The sudden stop of China’s property market is contributing to a shortage of aggregate demand. Combined with the expansion in supply resulting from the continued rise in manufacturing investment, the result is a price deflation that erodes corporate profitability. Investor confidence that China isn’t caught in Japanification is unlikely to emerge at least until prices start to rise.

In addition, there is one area where China, and indeed the other economies of East Asia, look very similar to Japan indeed: demographics. While not playing a direct role in the chain of events that caused Japan’s problems, the BOJ did identify ageing as one of the factors that may have contributed to the shortage of demand. That’s because rather than retiring and spending down their savings, households in Japan started to save more to prepare for longer life expectancy — a dynamic that has also been seen in Korea.

Both the cyclical shortage of demand, and the structural risks associated with ageing, argue for much bolder policy action to change consumer behaviour. Beijing does seem to be recognising the need for a structural rise in consumption, but so far, the welfare spending needed to finance that change has been lacking. Similarly, while it was encouraging that Beijing did last year announce an increase in the retirement age, the changes — between three and five years — are far too small relative to the rise in longevity. In both cases, much bigger changes are likely still needed to ensure China’s economy is on the right path to fulfil its potential.

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