Decades after Japan’s 1990 asset bubble collapse left a legacy of unprofitable “zombie” firms propped up by cheap bank lending, mounting economic data suggests China could be walking down a very similar path after its 2021 real estate slowdown. While broad comparisons between 1990s Japan and 2020s China often overlook critical structural differences between the two economies, experts say the pattern of debt evergreening that dragged Japan into decades of stagnation is now visible in China’s financial system.
The case of Japan’s Daiei, once the nation’s top retail giant, illustrates how the zombie company cycle plays out. After the bubble burst, Daiei slipped into sustained unprofitability, but Japanese major banks including UFJ kept the firm afloat with repeated below-market-rate loans. This practice, dubbed “evergreening”, let banks avoid classifying outstanding debt as non-performing (NPL), hiding bad assets from regulators and the public to meet capital requirements and avoid public backlash. Eventually acquired by rival Aeon, Daiei’s brand is set to be fully phased out in the coming years, decades after it first became insolvent.
A landmark 2008 paper by economists Caballero, Hoshi, and Kashyap found that this widespread evergreening dragged down Japan’s entire economy for decades. When the bubble burst, hundreds of profitable firms across construction, retail, and trade became unprofitable. Rather than force these firms into bankruptcy and accept their own losses, banks extended new cheap loans to let unprofitable firms pay off old debt, reclassifying bad debt as performing. This locked up scarce capital, labor, and other resources in unproductive firms, blocking healthy new companies from accessing the resources they needed to grow. Even with government backing to keep lending alive, the misallocation of resources left Japan stuck in long-term productivity stagnation.
Japanese policymakers chose this path for clear sociopolitical reasons: at the time, the country had a strong norm of lifetime job security, and widespread corporate failures would have thrown millions out of work, raising the risk of social unrest. Bank bailouts were also deeply unpopular, so regulators chose regulatory forbearance and capital injections for banks rather than forcing them to clean up their balance sheets by cutting off zombie borrowers.
Today, China faces a similar post-bubble moment. After the 2021 correction in its overheated real estate sector, the country has seen a broad economic slowdown that is deeper than official figures indicate, and a sharp rise in the share of loss-making firms across real estate-linked sectors. Multiple independent analyses show signs of widespread debt evergreening that mirror 1990s Japan.
Data from the Rhodium Group shows that despite a rising share of unprofitable firms since 2021, the official share of non-performing loans has actually fallen. A 2025 audit from China’s National Audit Office found that 16 out of 43 audited Chinese banks had actual non-performing loan levels double their officially reported figures. Loan rollovers to avoid NPL classification are pervasive, with the Chinese financial system acting as a shock absorber to keep unprofitable firms afloat and prevent widespread defaults. Rhodium Group data also shows the share of bank loans issued below benchmark interest rates has risen sharply since 2021, even as benchmark rates have fallen, and analysis from the Federal Reserve Bank of Dallas confirms that a growing share of Chinese firms, particularly in real estate, do not earn enough to cover their loan interest payments.
Critics argue that unlike market-based Japan, China’s state-directed banking system can avoid the downsides of zombie lending, since bad debt is effectively backed by the central government, which can order banks to keep lending indefinitely. But analysts point out this does not solve the core resource misallocation problem that hurt Japan, and China’s own government already took similar actions to Japan’s in the wake of the bust: supporting banks and encouraging them to keep lending to unprofitable firms to avoid unrest.
Even if the government can avoid a financial crisis, zombie firms still lock up critical resources that healthy firms could use. They compete for skilled labor, raw materials, land, and energy, driving up costs and crowding out innovative new entrants. For example, 1990s Japan’s Daiei was able to underprice new competitors thanks to cheap bank loans, blocking retail sector innovation for decades. In China today, this dynamic may be driving widespread industrial involution: after the real estate slowdown, the Chinese government directed banks to increase lending to manufacturing and green tech sectors as part of its industrial policy strategy. While many of these firms are efficient and globally competitive, as much as 30% of listed firms in high-priority sectors including electric vehicles, solar panels, and batteries are zombies that cannot service their debt, kept alive by loan rollovers and local government subsidies to preserve jobs and tax revenue. These unprofitable firms cut prices to below production cost to hold market share, crushing profit margins across the entire sector for even the most efficient competitors.
While this flood of cheap exports has helped China gain global market share in key industrial sectors, it comes at a long-term cost to domestic productivity growth. Over time, persistent resource misallocation could erode China’s long-term competitiveness, rather than strengthen it. The practice may also be adding to fiscal risks: just as Japan’s zombie lending left the country with unsustainable government debt that is now causing currency weakness and inflation, China’s evergreening practice pushes the cost of unproductive firms onto taxpayers and domestic bondholders, creating long-term fiscal pressures that the government will eventually have to address.
In an update addressing reader questions about geopolitical differences between Japan and China, author Noah Smith notes that China’s government shares Japan’s core motivation for zombie lending: fear of social unrest from widespread unemployment, which has remained a top policy priority in China after the end of rapid growth. While China’s goal of reshaping global supply chains means it will continue to support unprofitable firms in strategic sectors, this will only deepen the productivity trap over time. Ultimately, while many structural differences separate the two economies, the parallel of zombie lending and debt evergreening is clear — and so far, China’s government appears to be stepping into the same long-term trap that stunted Japan’s growth for decades.