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Print Edition> World
UPDATED: May 17, 2010 NO. 20 MAY 20, 2010
Lessons From Japan
Japan's decade-long recession may be as a cautionary tale for China, but there are important differences between their economies

Major differences

There are several important distinctions between the economies in 1980s Japan and present-day China.

First, they are at different levels of development.

By the mid-1980s, the Japanese had entered the post-industrial phase, in which the domestic market, being saturated, had little room for further development and there was almost no gap between urban and rural areas. But China is still in the initial and middle stages of industrialization, and great disparities remain between urban and rural areas. China therefore boasts a large domestic market and great development potential.

Second, the degree of financial liberalization is different.

The Japanese yen became a freely convertible currency as the government implemented financial liberalization, while China still controls the capital account.

Foreign investment in the Chinese stock and real estate markets is restricted. For its renminbi, or yuan, China adopts a managed floating exchange rate, so the yuan, with its low degree of internationalization, has limited influence in the world economy.

The Chinese currency has also appreciated much more slowly than the Japanese yen did in the 1980s. Since China began its exchange rate reform in 2005, the renminbi has appreciated less than 20 percent against the U.S. dollar. In contrast, the Japanese yen appreciated more than 70 percent within four years of the Plaza Accord, in which all major industrial countries agreed to depreciate the U.S. dollar.

Third, the two countries have different approaches to dealing with their respective economic bubbles.

In the late 1980s, Japan entered a record-breaking economic heyday. Everyone, from politicians to ordinary people, ignored the bubbles that were developing. When the property market became overheated, Japan decided on a "hard landing" approach that led to the rapid burst of the economic bubbles.

In contrast, the Chinese Government has been alert for possible bubbles, repeatedly affirming its commitment to preventing the economy from overheating. The government frequently rolls out new policies to keep property prices from rising too fast, while maintaining the stability of its fiscal, monetary and exchange rate policies.

Finally, economic trends in the two countries are completely different.

China is unlikely to follow Japan's suit, because the latter in the 1980s had limited potential and space to grow its economy, which doomed its economy to enter a period of recession after economic bubbles burst.

In China, however, economic bubbles have only developed to a lesser degree. Rising property prices occur when the economy is growing, so China's bubbles are structural, affecting only part of the economy as opposed to the whole.

China has fairly large potential for economic growth and plenty of room for adjustment. Even if economic bubbles deal a blow to China's economy, the recession will be mild as long as there are no big mistakes in policymaking. But China should not ignore the issue of asset bubbles.

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