From Japanification to anti-involution: what’s different this time?

As China’s economic momentum slows and structural challenges intensify, a familiar spectre re-emerges: Japanification.

Much like Japan in the 1990s, China now grapples with the aftermath of a real estate crisis, mounting debt, an ageing population and industrial overcapacity.

Is history repeating itself, setting China on a path toward decades of stagnation?

Parallels with Japan: debt, demographics and deflation

China and Japan share several socio-economic traits. Both pursued debt-fuelled growth: high savings rates and low borrowing costs led to unchecked investment booms. Japan became Asia’s most indebted economy, and China’s government debt – when including local government financing vehicles (LGFVs) – reached an estimated 117% of GDP in 2023, far above the official figure of 69%.[1] This towering debt burden dampens risk appetite and constrains growth.

Demographics add to the pressure. China’s birth rate has fallen to multi-decade lows, and urbanisation has plateaued. Like Japan, China is ageing fast. These trends suppress consumption and contribute to persistent deflationary pressure.

Industrial overinvestment, also driven by ambitions for self-sufficiency and global manufacturing dominance, has created excess capacity. With domestic demand under strain, competition intensifies, margins shrink and corporates lose the appetite – or ability – to reinvest and grow.

A strategic pivot towards a new growth model

Studying history isn’t about revisiting the past – it’s about understanding change.

While echoes of Japan’s experience are undeniable, China has several levers to avoid a similar fate. Unlike Japan, China still enjoys substantial fiscal flexibility. Central government debt stands at 88% of GDP in 2024[2], compared with Japan’s 230%, meaning China doesn’t necessarily need ultra-low interest rates just to service its debt. LGFV liabilities can be restructured, and local governments hold vast assets – utilities, transport infrastructure and more – that can be better monetised to support obligations.

Encouragingly, many provinces are revising prices for basic services like water, electricity and transport for the first time in decades – a sign that local governments are actively working to improve cash flow.

Japan struggled to identify new growth engines after its property bubble burst. China, by contrast, still maintains GDP growth around 5% annually. More importantly, it is pivoting from quantity-driven expansion to a model focusing on high-quality growth.

This shift is not just rhetorical. Policymakers are prioritising debt management and de-risking over further credit expansion. For the first time in modern history, China appears willing to accept slower growth in exchange for quality.

This marks an important shift in China’s economic strategy, which has the potential to reshape the Chinese economy and unlock new productivity gains if executed well. China’s potential growth drivers are compelling: artificial intelligence, green energy and broader innovation ecosystems.

These are the opportunities Japan didn’t have in its stagnation days.

Anti-involution: a new chapter?

This pivot also marks the beginning of China’s ‘anti-involution’ efforts – an attempt to break free from the cycle of excessive competition and diminishing returns.

Critics argue that anti-involution will be ineffective, because policy controls tend to be short term and China’s inefficient state-led capital allocation system is unlikely to go away.

These concerns are valid. China’s political and regulatory environment will remain opaque and hard to interpret. However, we believe that anti-involution is part of the strategic pivot rather than temporary administrative controls, and will therefore be more structural than cyclical.

Moreover, industrial policy is not unique to China. Globally, state-driven capital allocation is rising as national security concerns increasingly override market-based decision-making. In this post-globalisation, post-liberalism era, China’s approach may be more aligned with emerging global norms than previously thought.

Transitioning towards a risk-based model

The end of debt-driven growth is behind the anti-involution push. Cheap financing and risk-blind lending once led to a proliferation of low-quality projects. State-owned banks operated under mandates for aggressive loan growth at low rates. But regulators are shifting course. They’ve begun phasing out ‘window guidance’ and encouraging risk-based loan pricing.

Notably, the Loan Prime Rate was recently held steady in September 2025 despite expectations of further cuts – a signal that regulators recognise the unsustainable pressure on bank margins and are more receptive to risk-based approach.

A more selective, risk-aware financing framework will help channel capital into high-quality projects. China also needs a multi-tiered financing system that goes beyond bank lending. Capital markets offer a viable alternative, and policymakers are now encouraging a gradual rotation of savings into equities.

Changes are also happening at local government level. Local governments, once flush with land sale revenues, must now invest wisely. In the past, officials were incentivised to pursue growth targets regardless of project quality, leading to redundant capacity.

Today, officials are focused on monetising existing assets and selecting high-quality projects with limited resources. The central government has introduced the concept of national markets and passed legislation to protect private enterprises – dismantling local protectionism and discriminatory practices. It will take time to play out, but the re-defined investment discipline could generate long-term benefits.

A market in transition

China’s economy is in transition. Years of rapid GDP growth didn’t translate into corporate profitability. Now, the reverse may be unfolding.

A more disciplined, quality-focused growth strategy could, in our view, spark a long-term earnings upcycle.

 

[1] Source: International Monetary Fund. “People’s Republic of China: 2024 Article IV. Consultation.” IMF Staff Country Reports 2024, 258 (2024), https://doi.org/10.5089/9798400284281.002

[2] Source: https://www.imf.org/external/datamapper/GDD/2024%20Global%20Debt%20Monitor.pdf