China overtakes Japan as world's second-biggest economy

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Media captionChina's growth has been powering ahead while the wheels have come off Japan's economy

China has overtaken Japan as the world's second-biggest economy.

Japan's economy was worth $5.474 trillion (£3.414 trillion) at the end of 2010, figures from Tokyo have shown. China's economy was closer to $5.8 trillion in the same period.

Japan has been hit by a drop in exports and consumer demand, while China has enjoyed a manufacturing boom.

At its current rate of growth, analysts see China replacing the US as the world's top economy in about a decade.

"It's realistic to say that within 10 years China will be roughly the same size as the US economy," said Tom Miller of GK Dragonomics, a Beijing-based economic consultancy.

The US economy is currently almost three times the size of the Chinese economy in dollar terms. The UK's economy is estimated to be the world's sixth largest.

Overseas risk

Japan played down the significance of the shift in the economic league table, and the fact that it has been replaced as the second-largest economy for the first time in more than four decades.

"As an economy, we are not competing for rankings but working to improve citizens' lives," said Economics Minister Kaoru Yosano.

The minister added that China's booming economy was welcome news for Japan as a neighbouring country.

China is now Japan's main trading partner and is increasingly important to companies such as electronics firm Sony and carmakers like Honda and Toyota.

However, Mr Yosano said that Japan needed to watch closely "risks from overseas economies and currency moves".

Negative demand

The yen has been strengthening against other currencies, recently touching a 15-year high against the dollar, and the fear is that the currency's gains may hurt foreign demand for Japanese products.

Overtaking Japan

By the late 1980s Japan's economy was a powerhouse, with growth peaking at 7.1%. It was being driven by booming electronics and auto industries, and billions of dollars invested in the financial markets. Japanese manufacturers benefited from a relatively cheap labour force.
China's economic success began in the 1980s. At the start of the decade the household responsibility system was changed to allow families to keep their surplus grain. In 1994, the pricing system was changed to allow freer price movements. These steps and others started opening up China's economy.
Bar chart illustrating percentage change in japanese land prices 1984 to 2004
By the 1990s, Japanese land was severely overvalued. Property prices were unrealistically high and there was lots of speculation in the stock and property markets. Then the bubble burst, causing a massive market collapse. Investment started to flow out and brand Japan took a beating.
Graphic showing the growth in the chinese economy and how it has now overtaken Japan as second largest world economy
By the mid 1990s China was well on the path of opening up its economy. Exports were flooding out and China was given the title of "the world's factory". Taking advantage of its huge population, China began to move up in the rankings of the world's top economies.
Graphic comparing the relative size of America and Chinas wealth gap
China's growth is forecast to slow, but even so economists say it is on track to overtake the US as the world's No.1 economy in about 10 years. And while it needs to control inflation and prevent asset bubbles, most economists agree the economy's underlying structure is sound, and growth sustainable.
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According to the latest figures from Tokyo, Japan's economy contracted at an annualised rate of 1.1% in the final three months of 2010. Growth declined 0.3% from the previous quarter.

It was the first time in five quarters that the economy had contracted and it was caused by a dip in domestic and export demand, analysts said.

Consumer spending fell 0.7% in the final three months of 2010, the figures showed.

Analysts said that while demand had been picking up since the start of the year, there would not be a sudden revival in Japan's economic fortunes.

Not least because government plans to boost consumer spending by giving incentives to buy products such as consumer durables had either finished or were about to end.

"The main reasons for the contraction are the expiry of government stimulus measures and negative external demand," said Takeshi Minami, chief economist at Norinchukin Research Institute.

"It is going to be difficult for the economy to emerge from a lull in the January-March period.

"We are unlikely to see the economy worsen, but the recovery will not be strong enough for people to actually feel it is happening."

'Lost decade'

Japan has been struggling to come to terms with what many analysts call the "lost decade" of the 1990s when a property market and asset crash turned the economy on its head.

Domestic demand tumbled and exports also dropped as consumers looked for cheaper products from other emerging markets, and China in particular.

Today, Japan's biggest headaches are an ageing population that is spending less, and a workforce that is relatively expensive and inflexible to operate.

By contrast, the majority of China's growth has been funded by a long-running manufacturing boom and the subsequent expansion of its domestic industries and infrastructure.

"There was an emphasis on infrastructure," said Duncan Innes-Ker of the Economist Intelligence Unit (EIU) in Beijing.

"They were building way ahead of where people thought the demand would be. And because the infrastructure was there, companies went there."

Whole picture

Most economists agree that while China as a whole is growing, and the average person is getting wealthier, comparing only the size of its economy to Japan's does not paint an accurate enough picture.

"Most people in China are still poor, more people live in the countryside than in cities," said Mr Miller of GK Dragonomics.

"The average Japanese person is much much richer than the average Chinese person."

The International Monetary Fund estimates that GDP per head of the population is almost $34,000 in Japan, while in the People's Republic of China it is just over $7,500.