Beneath the gleaming skyline of Shanghai and the global dominance of China’s electric vehicle supply chains, a deeper unease is spreading across the world’s second-largest economy. Economists and policymakers alike are increasingly gripped by a sense of déjà vu — the uncomfortable recognition that China may be approaching the same economic precipice that derailed Japan’s miracle growth three decades ago.
If Japan’s collapse in the early 1990s was a tragedy of an Asian titan undone by excess and policy hesitation, China’s unfolding drama carries far higher stakes. In a globalized economy deeply intertwined with Chinese manufacturing, trade and finance, the consequences of a prolonged Chinese stagnation would ripple far beyond Asia.
To understand why Beijing must tread carefully, it is instructive to revisit the anatomy of Japan’s crisis — not merely as a historical episode, but as a living cautionary tale examined by some of the world’s most influential economic thinkers.
When Japan’s asset bubble burst in 1989, the country’s economic engine stalled in ways few had anticipated. Nobel laureate Paul Krugman famously described Japan as trapped in a “liquidity trap” — a condition in which monetary policy loses its potency.
After the bubble collapsed, the Bank of Japan slashed interest rates to near zero. Yet despite cheap credit and aggressive easing, growth refused to revive. Households and businesses, traumatized by collapsing asset prices, chose to hoard cash rather than spend or invest.
Krugman’s insight was psychological as much as financial. When deflationary expectations take hold — when people believe prices tomorrow will be lower than today — even zero interest rates fail to stimulate borrowing. Liquidity floods the banking system, but economic nerves remain numb.
Today, China is confronting similar warning signs. Consumer prices have hovered near stagnation, and producer prices have fallen for extended periods. If deflationary psychology becomes entrenched, Beijing could find itself battling the same invisible foe that paralyzed Japan.
A deeper structural interpretation comes from economist Richard Koo, who coined the term “balance sheet recession.” In his analysis, Japan’s crisis was not simply about weak demand but about damaged corporate balance sheets.
Consider a Japanese firm in 1990 with land assets worth 100 billion yen and liabilities of 80 billion yen. When land prices collapsed to 20 billion yen, the company became technically insolvent. Even if operations remained profitable, profits were diverted toward debt repayment rather than expansion.
According to Koo, this private-sector deleveraging strangled Japan’s recovery. Businesses prioritized repairing balance sheets over pursuing growth. The result was years of stagnation.
China’s predicament bears resemblance. Its property sector — long the locomotive of growth — is now a brake. Developer giants such as China Evergrande Group have become symbols of excess. Evergrande’s implosion was not an isolated corporate failure; it signaled the bursting of a real estate bubble that had inflated for two decades.
Middle-class Chinese households have roughly 70 percent of their wealth tied to property. As housing prices fall, families feel poorer. Consumption slows. The balance sheet stress that once afflicted Japanese firms now weighs heavily on Chinese households and local governments alike.
Another provocative perspective comes from Richard Werner, author of Princes of the Yen. Werner argued that Japan’s central bank used “window guidance” — direct control over bank lending — to steer credit toward speculative sectors, inflating the bubble and then allowing it to burst to force structural change.
Werner’s critique highlights a recurring theme: misallocated credit can be as damaging as insufficient credit.
China’s financial system, tightly controlled by the state, gives Beijing significant influence over lending patterns. In theory, this centralization is an advantage. Unlike Japan in the 1990s, China can direct state-owned banks to support strategic industries and prevent cascading failures.
But the risk is that credit may continue flowing into unproductive sectors — propping up “zombie” developers or financing infrastructure projects with limited economic returns.
Japanese economist Yukio Noguchi emphasized the role of structural rigidities in Japan’s crisis, including a land taxation system that encouraged speculation and inflated asset values.
China’s own structural rigidities are different but equally challenging. Local governments rely heavily on land sales for revenue. This created powerful incentives to sustain rising property prices, leading to overbuilding and ghost cities.
The convergence of asset greed, hidden debt burdens and delayed policy responses ultimately defined Japan’s lost decades. China must now decide whether it can break that pattern.
Yet China’s situation is not a simple replay. It carries distinct and potentially more dangerous burdens.
Japan entered its crisis as a high-income country. China remains a middle-income economy facing the risk of “getting old before getting rich.” Its demographic decline is accelerating, and its social safety net remains fragile.
Moreover, Japan in 1990 was a close ally of the United States. China faces a far more contentious geopolitical landscape. Trade tensions escalated during the administration of Donald Trump, whose tariffs targeted Chinese exports. Technology restrictions and rising Western trade barriers now limit Beijing’s ability to rely on exports as a release valve.
The global environment is less forgiving. China’s slowdown would reverberate through commodity exporters, supply chains and financial markets worldwide.
Looking toward 2026, President Xi Jinping has promised a more “proactive” macroeconomic stance.
Beijing has unveiled large-scale stimulus funded by government bonds, including consumption trade-in schemes and infrastructure investments worth hundreds of billions of yuan. The strategy reflects lessons drawn from economic theory.
From Krugman’s perspective, boosting demand directly may help break deflationary psychology. From Koo’s standpoint, the government must act as “borrower of last resort” when the private sector retreats.
Consumption subsidies aim to encourage households to spend. Infrastructure projects are designed to sustain employment and stabilize growth.
The central question is whether these measures represent a cure or merely painkillers.
If stimulus funds flow primarily into unproductive projects — bridges to nowhere, underused high-speed rail lines, or white elephant developments — China risks piling new bad debt onto old. The problem then becomes one of compounding liabilities.
Werner would likely argue that without reforming credit allocation toward innovative and productive sectors, stimulus may degenerate into “zombie credit.”
There are signs Beijing understands the urgency. Policymakers have discussed expanding social safety nets to reduce precautionary savings and encourage consumption. Strengthening health care, pensions and unemployment benefits could shift the growth model from investment-heavy to consumption-led.
But such reforms require redistributing resources — politically sensitive territory in a system accustomed to top-down control.
The global economy has a profound interest in China succeeding where Japan stumbled.
China is deeply embedded in global supply chains. Its dominance in electric vehicles, renewable energy equipment and critical minerals processing underpins the green transition worldwide. A prolonged stagnation would depress commodity prices, disrupt trade and unsettle financial markets.
For developing countries dependent on Chinese demand, the consequences could be severe. For advanced economies, deflationary spillovers and financial contagion are real risks.
The question increasingly posed in economic circles is whether Beijing should be bolder in redistributing wealth directly to households through cash transfers, rather than doubling down on infrastructure.
Direct transfers could boost consumption more effectively than another highway or industrial park. But they challenge entrenched policy instincts.
Japan’s most valuable lesson is not how to prevent a bubble from bursting — that moment has already passed — but how to acknowledge losses quickly and distribute them transparently.
Japan’s delay in recognizing bad loans prolonged stagnation. China faces similar choices regarding property debt and local government liabilities.
Continued liquidity injections into what critics describe as a black hole of property debt risk transforming the specter of “lost decades” from possibility to probability.
Yet China retains advantages Japan lacked. Its centralized governance enables rapid policy shifts. It still has urbanization potential and technological ambitions in artificial intelligence, semiconductors and green energy.
The coming years will test whether these strengths can offset structural weaknesses.
Three decades ago, Japan’s rising sun dimmed under the weight of excess and hesitation. Today, China’s dragon faces its own storm.
The stakes are immeasurably higher. A Japan-style stagnation in China would not remain confined within its borders. It would reshape trade flows, investment patterns and geopolitical balances.
The world is watching one of the most consequential economic dramas of the century unfold. Can China engineer a soft landing through bold structural reform and targeted redistribution? Or will incremental stimulus merely prolong adjustment?
As President Xi charts a “proactive” course toward 2026, Beijing must decide whether to confront structural imbalances head-on or continue navigating cautiously.
History does not repeat exactly, but it often rhymes. For China, the echoes of Japan’s lost decades are growing louder. The dragon must choose wisely if it hopes to fly through a storm that once sank the rising sun.
