China powers past stagnant Japan

GDP figures for the second quarter of 2010 show that China has ousted Japan as the world's second-largest economy.

Nominal GDP in China in Q2 was $1.34trn, compared with $1.29trn for Japan, and it looks likely that China will also be ahead when full-year figures for 2010 come in early in 2011. In 2009, Chinese GDP was $4.9trn, versus $5.1trn for Japan.

Although the US is still comfortably the world's biggest economy, with 2009 GDP of $14.3trn, Paul Niven, head of asset allocation at F&C Investments, says China is widely expected to overtake the US by 2030.

The past decade has seen significant change in the world's economic powerbase, with both China and India overtaking Germany and the UK, for many years the third and fourth-biggest economies, on a purchasing power parity basis (source: CIA World Factbook). Brazil and Russia, the other two ‘Bric' countries, are closing in fast.

Niven points out that the bald figures are not the only important gauge. "Japan has been stagnating for 20 years while China has been averaging annual GDP growth rates of around 8% for several decades," he says.

Parallels between China and Japan

In spite of their geographical proximity, China and Japan are very different creatures: the one a vast land mass and the world's most populous nation; the other an archipelago with a population smaller than that of Nigeria.

Yet China's development in recent years resembles Japan's post-war ‘economic miracle', according to Niven. "China has followed a model of export-driven growth as well as building out infrastructure in order to spur the phenomenal growth seen in the past 30 years. A similar model was adopted in Japan post-war," he says.

But Niven points out that Japan's boom years from the 1950s have been followed by two decades of difficult conditions. "Japan was the high growth area until the bubble burst in the late 1980s," he says. "It became a pre-eminent economic power, had the largest stockmarket capitalisation in the world, the most expensive stock of real estate and so on, but the bubble spectacularly burst and the economy now languishes with periodic bouts of deflation, interest rates have been close to zero for more than a decade, government debt/GDP is at extremely high levels, the population is ageing, domestic demand is deficient and the country is highly dependent on exogenous factors to drive growth."

China's stockmarket capitalisation may well also surpass that of Japan, says Niven. "This has happened before, in both 2008 and 2009 but, at present levels, there is about 10% gap between the overall market value of Japanese and Chinese stocks."

However, Niven says the future is not without risks for China, and hence for the rest of the world, for which China's economic ascendancy has been a significant source of growth.

Headwinds for China

"The current state of the world, with heavily indebted western nations, risks to global growth (and Chinese export markets) and a need to prevent domestic overheating and overcapacity by renewed infrastructure spending, poses significant challenges to the Chinese authorities," he says. "Growth needs to be rebalanced towards domestic consumption and authorities face a difficult balancing act to ensure sufficient external momentum, without triggering trade disputes, while looking to inject improved momentum to consumers."

However, domestic consumption growth may be hard to achieve in a country that is ranked a lowly 128th in the world - one place above Namibia - in GDP per capita terms. (Source: CIA World Factbook, 2009 figures.)

"China's share of domestic consumption to GDP stands around half to two thirds that of developed economies and has actually been on a declining trend. Going forward, the key will be how China adapts to an environment where reliance on developed economies to fuel exports will be significantly less than in the past and where consumption growth will have to, for the first time, outstrip growth in the broader economy," Niven concludes.