China overtakes Japan as world's number two economy (News Feature)

By Lars Nicolaysen and Andreas Landwehr Aug 16, 2010, 16:50 GMT

Tokyo/Bejing - China overtook Japan as the world's second-largest economy in the second quarter, capping three decades of spectacular growth.

Japan held the number two title behind the United States for more than 40 years, but its economy hit a decade of stagnant growth in the 1990s and has not regained its postwar power. Meanwhile, China's economy is growing at a rate of about 10 per cent annually even as the world emerges from a deep recession.

Although the switch between the world's second and third-largest economies was expected, it is a historic milestone in China's rise as a global economic power.

China earlier replaced Germany as the world's biggest exporter. It also has the most foreign currency reserves by far - 2.45 trillion US dollars - buys the most cars and is the biggest creditor of the highly indebted United States.

Now China wants a greater say in global economic and financial matters, too.

While Japan struggles with a saturated domestic market and rapidly aging population, China has plenty of growth potential remaining. Millions of Chinese are moving from the countryside into cities as the country urbanizes. Living standards can still improve considerably.

In terms of per capita gross domestic product (GDP), however, China, with a population of 1.3 billion, is only about a tenth the size of Japan or the United States, putting it on a level with countries such as Algeria and El Salvador.

'We expect that household incomes will continue to grow steadily, but it will probably take a few more decades for per capita GDP to reach any level similar to developed nations,' said Jinny Yan, a China specialist with London-based Standard Chartered Bank.

China's rise is not tantamount to Japan's fall, though. The Japanese economy is growing, albeit slowly.

Japan is way ahead technologically in industries such as car manufacturing, electronics and machine building. But its gigantic lead will likely diminish faster than the Japanese would like.

Many Japanese bureaucrats once deluded themselves into thinking that their country could successfully produce goods at home and sell them in China. No longer. If Japanese companies want to remain competitive, experts say, they will have to become 'more Chinese' by investing and producing more in China, their top market.

The Chinese, for their part, can learn from Japan - both its successes and mistakes. Japan's growth and infrastructure investment - the expansion of railway and road networks, for example - have served as a model for China.

But Japan's long-standing focus on investment coupled with its heavy dependency on exports have resulted in problems. For a long time it neglected measures to boost domestic consumption, which makes up 60 per cent of GDP.

China attentively watched Japan appreciate the yen and borrow heavily to finance economic stimulus programmes at the urging of Washington. 'I think we should not take this road,' remarked Lu Zhengwei, senior economist at Fuzhou-based Industrial Bank Co.

He said that China's high savings rate made it able to afford large expenditures for infrastructure projects. 'On one hand, we need investment; on the other hand, we have money to invest,' he said, defending Chinese economic policy as 'sustainable.'

Beijing has been unable to spur domestic demand sufficiently, though. Bad loans lurk in banks and local investment companies. The positive effects of China's economic stimulus programme and massive expansion of loans by state banks could prove to be short-lived.

So even as China is hailed as the global economy's new engine, all is not rosy despite the impressive growth figures.

'China's economy is still imbalanced - it relies overly on exports and investment,' said Ben Simpfendorfer, chief China economist for the Royal Bank of Scotland.

'While China is providing some support to global growth, the risk is that the economy might yet slow abruptly because of these imbalances,' he warned. 'And as the world's second-largest economy, China is too big to be bailed out by the IMF (International Monetary Fund) or any other agency.'