Justin Yifu Lin on Pessimism about the Chinese Economy

"A key reason for weak expectations about the future is a lack of confidence, with claims such as 'there are structural problems' [...] exerting considerable influence on people." — Lin Yifu

Justin Yifu Lin is in many ways the poster-economist of China’s industrial policy. A former chief economist of the World Bank, his worldview of “new structural economics” is based on the simple idea that states should adapt industrial policy according to their changing comparative advantage as the economy develops. In the barest terms, a developing country is endowed with cheap labour, while more developed countries possess abundant capital, more advanced human capital and so on—trends which industrial policy should follow.

But as with most simple theories, there are certain blind spots. Lin does not account for how successful industrial policy might depend on defying, or rather newly defining, an economy’s landscape of comparative advantage through legal and political frameworks that favour certain economic actors over others, or currency intervention that depresses the foreign-currency value of wages and output. This was essentially the criticism made by the South Korean economist Ha-Joon Chang during an exchange with Lin in 2009.

Today, Lin’s success and international visibility have earned him high status within China, and even his own department at Peking University: the Institute of New Structural Economics. He is now the establishment economist par excellence, regularly quoted by the media as a credentialled cheerleader for growth targets and the overall economic direction. Rejecting the charge of structurally entrenched problems in the economy, he argues that the state can push through the current downturn by cutting investment in industries with overcapacity and reallocating it to new growth areas.

The following article is an especially interesting example of the type of “positive energy” he has been exuding in recent years, for the principal reason that he delves with such a high degree of detail into the “pessimistic” arguments that he opposes. Indeed, the arguments that Lin lines up for rebuttal—the idea of a historic transfer of wealth from households to state-backed industry, the looming risks of demographic ageing and the stubborn deflationary pull of systemic debt—have all become fairly commonplace among Chinese economists.

From Lin’s point of view, the spread of such views among influential Chinese economists may itself be treated as a structural comparative disadvantage. The reason public expectations are low, he says, is precisely because people are more willing to buy into this “specious” pessimism than into investments in the Chinese economy. Whether one finds his specific rebuttals convincing, however, is up to the reader to judge.

— James Farquharson

Key Points

1. Three widespread pessimistic narratives—namely those of state-sector overreach, demographic ageing and balance sheet recession—capture phenomena that exist to varying degrees, but misidentify the main cause of China’s slowing growth.

2. In reality, China’s economic slowdown is due mainly to external shocks and the prolonged weakness of global growth and trade following the 2008 financial crisis.

3. This external-demand shock explains the post-2008 turn to state-backed infrastructure investment, which actually benefitted private enterprise through demand and job creation.

4. The charge of state-sector overreach is further challenged by the strong performance of private enterprises in new energy vehicles, solar power and lithium batteries.

5. The narrative of demographic ageing similarly overlooks the role of effective labour, since growth depends not only on labour-force size but also on labour quality, which can rise through higher education levels.

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6. China’s “growing old before getting rich” [未富先老] actually puts it in a better position than countries that “grow old only after getting rich” [先富才老], since it leaves the economy with greater margin for further investment in human capital.

7. Finally, the idea of a “balance sheet recession” does not apply: Japan’s stagnation after the bursting of the housing bubble in the 1990s was due to its abandonment of industrial policy, constraining investment opportunities.

8. The balance sheet recession narrative centres on debt burdens while China’s rising household deposits point to ample savings, suggesting that weak consumption stems more from weak expectations than limited capital.

9. In fact, one of the main reasons for weak expectations is the influence upon people of the pessimistic narratives that many economists propagate.

10. Sustained future growth lies in tailoring policies to local conditions, using each locality’s comparative advantages to combine latecomer advantages in traditional industries with new-track advantages in emerging industries.

Name: Justin Yifu Lin (林毅夫)
Year of birth: 1952 (age: 73)
Position: Dean, Institute of New Structural Economics, Peking University; Dean, Institute of South-South Cooperation, Peking University; Honorary Dean, National School of Development, Peking University
Previously: Senior Vice President and Chief Economist, World Bank (2008-2012); Founding Director and Professor, China Centre for Economic Research, Peking University (1994-2009)
Research focus: New Structural Economics; Agricultural Economics; Development Economics and Economic Reforms in China
Education: MBA, National Chengchi University, Taiwan (1978); MA (Political Economy), Peking University (1982); PhD (Economics), University of Chicago (1986)
Experience Abroad: Postdoctoral Fellow, Yale University (1986-1987); Duke University; Australian National University; University of Minnesota; UCL

LIN YIFU CORRECTS “THREE MAJOR PESSIMISTIC NARRATIVES” IN WUHAN
Justin Yifu Lin (林毅夫)
Published by Hubei Daily’s Guanyixian on 11 June 2026
Adapted from a lecture delivered by Lin Yifu at Tongxin Lecture Hall, a lecture series organised by the Hubei United Front Work Department
Translated and annotated by Cherry Yu
(Illustration by ChatGPT)

I. The “Three Pessimistic Narratives”

China’s economic growth has slowed year by year since 2010: it was 10.6% in 2010 and 5% in 2025, while the 2026 target is 4.5–5%, with efforts to be made in practice to achieve a better outcome.

Why has this slowdown occurred? Some voices in academic and theoretical circles argue that the slowdown stems from China’s own domestic problems. Among devotees of this view, there exist three representative arguments.

The first concerns the widely debated issue of “state sector advance and private sector retreat” [国进民退]: [in other words,] the state-owned economy’s share has risen and its role strengthened while the private economy has found its share declining as it is squeezed out. Some believe that this is the main cause of the downward slide in economic growth.

The second is the problem of “demographic ageing”. This view holds that China’s past rapid development was supported by a large young population and the demographic dividend [人口红利] it generated, while the acceleration of ageing today has left many firms facing recruitment difficulties [“招工难”]. There is a view that this is an important factor behind the economic downturn.

The third is the so-called “balance sheet recession” [“资产负债表衰退”], a concept proposed by Richard Koo, chief economist at Japan’s Nomura Research Institute. It refers to Japan’s experience after the bursting of its real estate bubble in the early 1990s. Highly indebted firms and households focused on repaying debt, leaving firms reluctant to invest and households less willing to consume, with both investment and consumption suffering as a result. There is a school of thought that believes China is now facing a similar situation.

Some argue that these problems are intractable. Indeed, these phenomena and issues do exist to varying degrees, but are they really the main causes of slower economic growth? Only by making a scientific assessment of the nature of these phenomena and the root causes of these problems can we propose effective solutions and accurately assess the outlook for future development.

II. On the charge of “state sector advance and private sector retreat”

On the surface, since 2010, the share of China’s state-owned economy has risen while that of the private economy has declined. State-owned enterprises have received a growing share of bank lending while private enterprises have received a shrinking share. Some have therefore identified “state sector advance and private sector retreat” as the main cause of China’s slowing economic growth, arguing that it is the result of policy choices aimed at making state-owned enterprises larger and stronger. Yet the objective fact is that the policy of upholding and implementing the “two unswervings” [两个毫不动摇] [Note: simultaneous commitment to both the state and non-state sectors] has remained unchanged.

Today, the best-performing sectors are often led by private enterprises, including new energy vehicles, solar power and lithium batteries. From this perspective, the claim of “the advance of the state sector and retreat of the private sector” does not hold up.

In my view, the key reason for the economic downturn lies in the fact that the world economy, especially developed economies, has never truly recovered since the 2008 global financial crisis. Before 2008, global growth was as high as 4.5% or more, compared with only around 3% in recent years. For private enterprises, a greater impact [than the strengthening of state-owned enterprises] stems from [the slowdown in] the growth of trade. Before 2008, global trade grew at more than twice the rate of the world economy, but after 2008 it grew more slowly than the world economy and fell below 3%. Meanwhile, China’s export growth declined from an annual average of around 20% before the crisis to less than 5%.

If a crisis is cyclical, recovery will eventually come within a certain period, giving consumers and entrepreneurs clearer expectations for the future and making them more willing to consume and invest, but nearly two decades have passed since 2008.

Under these circumstances, the government had to stabilise growth and employment by adopting a proactive fiscal policy, mainly through infrastructure investment. In 2008, China had only about 60,000 kilometres of expressways, compared with more than 190,000 kilometres today, and just over 1,000 kilometres of high-speed rail, compared with more than 50,000 kilometres today. The rollout of 4G and 5G was also completed during this period. Since these are all large-scale infrastructure projects, only financially strong state-owned enterprises could participate, relying mainly on bank loans in addition to central government funding. Yet the steel bars, cement, glass and other materials needed for infrastructure construction are mainly produced by private enterprises, while such construction also creates jobs and thereby boosts consumption, making private enterprises the main beneficiaries. Without government-led infrastructure investment, private enterprises would face even greater constraints on their development.

III. On demographic ageing

Is demographic ageing really the root of labour shortages, the disappearance of the demographic dividend and slower economic growth? Some scholars cite Japan as a cautionary example [前车之鉴], arguing that before the 1990s, when ageing was not yet a problem, its economy grew rapidly, whereas after it started experiencing ageing in the 1990s, growth slowed markedly.

However, in fact, many developed countries and regions, including the United States and Europe, have also experienced demographic ageing without facing a situation similar to Japan’s. Based on my own in-depth research, the 53 countries that have now entered an era of demographic ageing can be divided into two types. The first is “growing old before getting rich” [未富先老], where a country enters demographic ageing before its per capita GDP has reached half that of the United States, a category to which China currently belongs. The second is “growing old only after getting rich” [富了才老], where a country enters population ageing only after its per capita GDP has exceeded half that of the United States. Among these 53 ageing countries, 27 fall into the “growing old only after getting rich” category, while 26 fall into the “growing old before getting rich” category.

Media and academic discussions generally assume that “growing old before getting rich” is the more serious problem, yet the data point in the opposite direction. Among the 26 countries that aged before becoming affluent, per capita GDP growth was higher in the decade after they entered population ageing than in the decade before, meaning that GDP growth actually accelerated. By contrast, among countries that aged only after becoming affluent, per capita GDP growth was basically unchanged, while overall GDP growth declined slightly. This differs considerably from what we tend to observe.

The main consequences of population ageing are slower population growth and a shrinking labour force, but it is not a “black swan” event and can be predicted one or two decades before it arrives. When it comes to the factors driving economic growth, what matters is not only the size of the labour force, but more importantly effective labour, or the quality of the workforce, which depends mainly on workers’ level of education. Countries can therefore anticipate population ageing, take measures to address it and increase investment in education in advance.

Therefore, although the size of the labour force declines, the quality of labour will improve, and effective labour may increase accordingly. The lower a country’s starting level of education, the greater the potential increase in effective labour. For countries that “grow old before getting rich”, the lower their level of education, the greater the increases in education investment and in the average years of schooling of the labour force after they enter population ageing, so effective labour actually rises. Moreover, because these countries are still in the catch-up stage, they have greater scope for industrial upgrading, and improvements in education can more effectively support such upgrading, thereby raising both per capita GDP growth and overall GDP growth. However, for countries that experience “growing old only after getting rich”, there is very limited scope to raise workers’ education levels, meaning that per capita GDP growth remains basically unchanged, and as population growth also slows, overall GDP growth will decline to some extent.

For China, the working-age population currently has an average of around 11 years of education, while those retiring at the age of 60 have only about 7 or 8 years, compared with 14 years among young people newly entering the labour market. This suggests that China’s effective labour is still increasing, meaning that population ageing will not cause economic growth to lose momentum.

Why, then, did Japan’s economic growth become stagnant or even turn negative after it entered population ageing? The main reason was that, in seeking to contain Japan, the United States brought about the signing of the Plaza Accord in 1985. Beyond yen appreciation, restrictions on automobile exports and technology transfer, Japan also voluntarily abandoned industrial policy. In the 1980s and 1990s, Japan’s per capita GDP was around 130% of the US level, and its average labour productivity was higher than that of the United States. Apart from military-related industries, whose development was restricted by the United States, Japan was ahead of the United States in other civilian industries, including automobiles and semiconductors. But after abandoning industrial policy, Japan found it difficult to keep generating new quality productive forces, and without further improvements in productivity, economic growth was bound to lose momentum.

IV. On the issue of balance sheet recession

We can see that after Japan’s bubble economy burst, firms became reluctant to invest, household willingness to consume weakened, and economic development slowed as a result. In my view, the main reason firms were reluctant to invest was not high debt, but a lack of investment opportunities. If good investment opportunities exist, firms can obtain financing and invest even if they already carry debt. The same is true of households. If wages do not rise, or if people fear unemployment, their propensity to consume will inevitably be weak. After Japan abandoned industrial policy, technological innovation lost vitality and industrial upgrading faced constraints, reducing investment opportunities and weakening firms’ willingness to invest. As productivity failed to improve, wages did not rise, leaving households with little willingness to consume.

In China’s case, most firms have not followed the path taken by Japanese firms in the 1980s, when large-scale bank financing was channelled into real estate investment. Although some households have mortgage loans, their debt ratio is significantly lower than Japan’s [was]. The main reason for weak household willingness and propensity to consume is not a lack of savings, but the issue of future expectations. In 2024, household savings in China increased by RMB 14.26 trillion, equivalent to more than 10% of GDP. In 2025, household savings increased by RMB 14.64 trillion, bringing total household savings to more than RMB 160 trillion. This shows that household savings are relatively ample. [Note: BIS data put China’s household debt at around 58% of GDP in late 2025, compared with Japan at around 61% of GDP today, or 35% in the 1990s. A BIS report notes on the basis of comparative data that Japanese households did not have particularly high rates of mortgage borrowing even during the bubble period and maintained relatively high savings in the form of safe bank deposits. As such, the authors suggest that the root of the balance sheet recession phenomenon was not primarily weak household finances, but rather credit risks in the banking sector.] A key reason for weak expectations about the future is a lack of confidence, with claims such as “there are structural problems”, “the economic downturn is caused by our country’s domestic problems” and “these issues are intractable” exerting considerable influence on people, even though they are in fact specious.

The main causes of the current economic slowdown are external shocks and the global cycle. New structural economics holds that, since China’s per capita GDP is only one-quarter of the US level, it still has latecomer advantages in traditional industries and enormous scope for technological catch-up. In the emerging and future industries of the Fourth Industrial Revolution, China also enjoys favourable conditions, including an ultra-large domestic market, complete industrial chains and an engineering talent dividend. With an effective market [有效市场] working in tandem with a proactive government [有为政府], China can tailor development strategies to local conditions [因地制宜], following the comparative advantages determined by each locality’s endowments, industrial base and technological conditions. By making good use of the latecomer advantages of traditional industries and the new-track advantages [新道优势] of emerging industries to develop new quality productive forces, China remains the country with the greatest number of development opportunities, even in an unfavourable external environment.

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