Bank Of Japan On Rebalancing The Chinese Economy13 November, 2011, 3:19. Posted by Zarathustra
Most keep on talking about the similarities between present days China and Japan in the late 1980s at the height of the bubble. Surely, there are a lot of similarities between today’s China and late 1980s Japan: real estate bubbles are apparently in both cases; both countries run trade surpluses and are both large creditor nations; demographically, China today is at the similar spot as late 1980s Japan in that the proportion of working population to total population reached the peaks and started to fall.
A paper from the Bank of Japan, interestingly, examines the Japan’s economy in the 1970s and compared that to present day China. Tomoyuki Fukumoto and Ichiro Muto wrote a paper titled “Rebalancing China’s Economic Growth: Some Insights from Japan’s Experience” (which is very interesting so you should read). In their views, China is, in many ways, similar to Japan in the 1970s (emphasis mine):
From 1955 to 1970, Japan achieved high economic growth with an average GDP growth rate of 9.7 percent. Similar to present-day China, the high growth during this period was initiated by vigorous investment. The investment/GDP ratio trended upward, while the consumption/GDP ratio decreased. However, the decline in the consumption/GDP ratio and the rising trend in the investment/GDP ratio clearly halted in the ﬁrst half of the 1970s. In retrospect, it is apparent that the early 1970s was the period when Japan achieved its rebalancing.
What were the main factors behind this rebalancing? The most apparent one is the decline in the return on capital… The decline in the return on capital was basically caused by the slowdown in the productivity growth of capital. There are a number of reasons for this slowdown. On the supply side, the process of catching up to advanced foreign technology, which was a major driving force during Japan’s high-growth period, was virtually complete around the early 1970s (Kosai ). On the demand side, the consumption boom in durable goods, brought about by massive population inﬂows into urban areas, also concluded as urbanization drew to a close (Yoshikawa ). Consequently, in the early 1970s the return on capital decreased substantially, and this signiﬁcantly reduced ﬁrms’ incentives to maintain high investment. This was the basic background for the decline in the investment/GDP ratio in the early 1970s.
However, we can point out two other important elements that played crucial roles in Japan’s rebalancing. The ﬁrst is the rise in the labor share of income… The second important element in Japan’s rebalancing was the narrowing of the difference between the return on capital and the cost of capital. Because Japanese ﬁrms typically raise funds through bank lending, the cost of capital can be approximated by the bank lending rate. Since the ﬁnancial liberalization was not accomplished before the 1980s, the bank lending rate was highly regulated until the 1970s, as is the present-day China. A comparison of the return on capital and the bank lending rate in the period before the 1970s shows that the latter was set far below the former. This suggests that the low cost of capital was one of the key causes of the investment boom during the high-growth period. However, the monetary tightening during the period of the oil shock and the aforementioned decline in the return on capital signiﬁcantly reduced the diﬀerence between the return on capital and the lending rate in the ﬁrst half of the 1970s. This means that the cost of capital rapidly approached the return on capital during the period.
And of course, there are some differences (emphasis mine):
(1) Public Spending on Education, Health Care, Housing, and Pensions
As discussed earlier, the investment/GDP ratio in China is much larger than that in Japan in the 1970s. We believe the diﬀerence stems in part from the institutional reforms that China implemented in the late 1990s. The reform of state-owned enterprises (SOEs) began in the late 1990s, when the SOEs laid oﬀ a massive number of employees. SOEs were freed substantially from the burden of paying for employees’ housing, education, health care, and pensions. As a consequence, the labor share declined. At the same time, the consumption/GDP ratio dropped partly because the laid-oﬀ employees spent less and partly because workers needed to save money for future expenses such as housing, education, health care, and pensions. Chamon and Prasad (2010) ﬁnd that the household saving rate rose because the expenses of education, health care, and housing became a new burden on households after the SOE reform. To boost the labor share and thus raise consumption, therefore, beefing up only the bargaining power of workers may be insuﬃcient. The government should expand public spending on housing, education, and health care and devise a sustainable reform of public pensions.
(2) The Hukou System and the Government Land Purchase System
During the high-growth period in Japan, many rural migrant workers settled in urban areas and started families. This movement boosted consumption in urban areas. Moreover, rural farmers near urban areas obtained generous amounts of money by selling their land to real estate developers. In these ways, the urbanization process increased Japanese households’ income signiﬁcantly and supported strong growth in consumption. However, urbanization in China has diﬀered greatly from Japan in this regard, in that it has not added substantially to the wealth of households. Key factors behind this result are the Hukou system, China’s unique registration system, and the government’s land purchase system.
Under the stringent Hukou system, Chinese rural migrants enjoy little public support for education, health care, and pensions in the urban areas where they live. Accordingly, very few rural migrants are able to settle in urban areas and start families. Huang (2010) found that China’s urbanization has improved the income position of rural migrant workers substantially but may have increased their precautionary saving motivation, because the public support they receive in cities is quite limited.
In addition, because of the government’s land purchase system, the current urbanization process is unfavorable to rural households. Local governments typically earn income through real estate development by expropriating land from farmers at a cost approximating the land’s agricultural productive value, and then selling it to real estate developers at the value of an urban district. Thus, the beneﬁt of urbanization accrues much more to local governments and developers than to farmers.
Reform of the Hukou system and the government’s land purchase system will enable household income and consumption to grow more vigorously.