The world today is witnessing an unsettling sense of economic deja vu. Beneath the gleaming skyline of Shanghai and the global dominance of China’s electric vehicle industry, the Chinese economy is on a precipice, similar to the one that dashed Japan’s economic miracle three decades ago.
The parallels are increasingly striking. If Japan’s story was a tragedy of an Asian economic giant undone by its own excesses, then China is writing an eerily similar drama, albeit with far higher stakes for global economic stability.
To understand why China must tread carefully, it is instructive to revisit the anatomy of Japan’s economic crisis as seen by major thinkers who have examined the collapse from various angles.
Nobel laureate and commentator Paul Krugman, through his theory of the “liquidity trap,” described Japan as a patient whose economic nervous system had gone numb.
After the asset bubble burst, the Bank of Japan cut interest rates to zero, yet the economy remained stubbornly stagnant. Traumatized by the collapse of property prices, Japanese households chose to hoard cash rather than spend or invest.
Krugman argued that once deflationary expectations become entrenched, when people believe prices tomorrow will be lower than today, even the most aggressive monetary stimulus loses its effectiveness. Liquidity may flood the system, but it fails to spark the real economy.
Richard Koo offers a deeper structural explanation through his concept of the “balance sheet recession.” According to Koo, Japan’s core problem was not a lack of willingness to spend, but firms’ inability to act dynamically. Consider a company with land assets worth 100 billion yen and liabilities of 80 billion yen.
When land prices collapse to 20 billion yen, the firm becomes technically insolvent, even if its operations remain profitable. In such a situation, profits are diverted toward debt repayment rather than expansion. Koo argued that this private-sector aversion to borrowing ultimately strangled Japan’s growth.
A more provocative view comes from Richard Werner in his “Princes of the Yen”, in which he blames the Bank of Japan’s credit control mechanisms, known as “window guidance.”
Werner suggests the central bank exercised tight control over commercial lending, directing credit toward speculative sectors, inflating a bubble, and then deliberately allowing it to burst to force structural reform.
Japanese economists have added further nuance. Yukio Noguchi, for instance, highlights the rigidity and obsolescence of Japan’s land taxation system, which fueled rampant speculation.
Taken together, these perspectives converge on a single conclusion: Japan’s crisis was triggered by a toxic mix of asset greed, hidden debt burdens and delayed or misguided policy responses.
Striking resemblance
Fast forward to today’s China. Whether acknowledged or not, what is unfolding in China today bears a striking resemblance to Japan in 1989.
China’s property sector, which served as the primary engine of growth for two decades, has become a heavy drag on the economy. Developer giants such as Evergrande are not merely failed corporations; they symbolize the bursting of an asset bubble far larger than anything Japan experienced.
China is also beginning to show symptoms of Richard Koo’s balance sheet recession, this time at the household level. Middle-class families, with roughly 70% of their wealth tied to property, feel poorer as housing prices fall. Consumption slows accordingly.
At the same time, deflationary pressures are intensifying across the economy. Should China slide into a deflationary spiral of the kind Krugman describes, massive private and local government debts will become even more burdensome as the real value of debt rises while prices fall.
Yet China holds trump cards Japan lacked back in the 1990s. For one, its centrally managed economic system gives Beijing firm control over the banking sector. Unlike Japan, where banks were allowed to fail in succession, China can instruct state-owned banks to keep strategic sectors on life support. Moreover, China still has room to urbanize, unlike Japan, which had already reached saturation by the time its crisis hit.
Even so, China carries unique and potentially more dangerous burdens. Chief among them is the risk of “getting old before getting rich.” Japan entered its crisis as a high-income country; China remains a middle-income economy with a fragile social safety net. Rising geopolitical pressures, not least Donald Trump’s tariffs, further complicate the picture.
Japan in 1990 was a close US ally. China today faces technology restrictions and rising trade barriers from the West, limiting its ability to rely on exports as a release valve, as Japan once did.
Proactive stance
Looking ahead to 2026, President Xi Jinping has promised a more “proactive” macroeconomic stance.
Large-scale stimulus funded by government bonds, including consumption trade-in schemes and massive infrastructure investments worth hundreds of billions of yuan, signals that Beijing recognizes the alarm bells are ringing. The question is whether these measures will be sufficient.
From a theoretical standpoint, Xi’s approach represents a classic attempt to avoid Krugman’s liquidity trap by forcibly boosting demand. Consumption subsidies are designed to break deflationary psychology, while big infrastructure spending aligns with Koo’s prescription that the government act as the “borrower of last resort” when the private sector retreats.
The risk, however, lies in execution. If stimulus funds are channeled primarily into unproductive physical projects, bridges to nowhere or white elephant buildings, China may simply be piling new bad debt onto old.
Werner would likely warn that without deep reform of credit allocation toward genuinely productive and innovative sectors, such stimulus risks degenerating into “zombie credit” that generates little real value.
As such, Xi’s current measures are functioning as painkillers, not a cure. They may help China avoid a sudden, Japan-style collapse in the near term. But without bold structural reforms, strengthening social safety nets to encourage consumption and transparently resolving local government debt, China may merely be taking a slower path to crisis.
Beijing should recognize that Tokyo’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 so the economy can reset gradually.
Continued liquidity injections into the black hole of property debt risk turning China’s version of Japan’s “lost decades” from a possibility into an increasingly likely outcome.
The global economy has a strong interest in China succeeding where Japan stumbled. If this giant were to fall in the same manner, the shock would not be confined to Beijing or Tokyo; it would send shock waves through markets and livelihoods worldwide.
We are witnessing one of the most consequential economic dramas of the century: Can the dragon fly through the storm that once sank the rising sun? Should Beijing be bolder in redistributing wealth directly to households through cash transfers, rather than continuing to build road, trains and bridges?
Beijing must choose wisely to avoid a repeat of Japan’s rise and fall.