Look to Japanese experience for a costly lesson in rebalancing

Japan has undergone exactly the kind of rebalancing after 1990 that many expect from China today.

This does not mean China will have as difficult a process as Japan did, but it is worth looking at Japan's history to understand the different ways in which rebalancing can occur.

For Japan in the 1980s and China today, high investment rates and even higher savings rates meant economic growth was heavily dependent on investment and net exports, and not nearly dependent enough on domestic private consumption. Rebalancing meant private consumption had to become a larger source of growth for the economy.

Japan's initial response to the 1987 stock market crash in the United States, which brought with it a sharp contraction in the US trade deficit, was to counteract the trade effect by increasing investment from an already high 28 per cent to nearly 33 per cent three years later. This kept economic growth rates high for two more years but almost certainly at the cost of exacerbating the underlying imbalance in Japan's economy.

Higher investment was likely also to mean more misallocated investment and higher debt levels, and these ultimately had to be paid for directly or indirectly by Japanese households. But increasing the future burden on households would also necessarily prevent household consumption from surging. In fact this was what happened. Consumption growth declined after 1990.