Japan Is Fading

Japan is heading into a landmark election in a state of freefall. Stagnant since the early 1990s, Japan's economy fell off a cliff in the last quarter, dropping 15.2 percent in the worst collapse of any industrial nation in decades. Automakers—Toyota, Nissan, and Honda, once the heart of the Japanese industrial miracle—saw exports fall 70 percent in April, and were forced to shutter factories to clear inventory. Since pocketbook issues decide elections, it's not surprising that Japanese voters appeared poised to toss out the ruling Liberal Democratic Party (LDP), only the second time it has lost power in half a century.

Meanwhile, China is launching direct challenges to Japan's position as the leading economy in Asia. Beijing recently launched an official campaign to build a green car industry, a field in which Japan still holds a commanding lead. Some Japan watchers compare China's green car project to Sputnik, the Soviet satellite that trumped American preeminence in science and technology in the 1950s. Just as alarming, China has been making noises about replacing the dollar as the sole international reserve currency, and has begun conducting regional financing deals in Chinese yuan instead, a push Japanese officials see as a direct threat to the yen as well. "It brought home the fact that the yen is not used in this way by others," notes Yasuo Ota, an editorial writer for Nikkei. The worry grew in July, when top Chinese officials flew to Washington, D.C., to continue their high-level "strategic dialogue": "That caused concern, because the Japanese feel that we need to be involved in any conversation about security in the region," notes Shinzo Kobori of the Institute for International Policy Studies in Tokyo.

So Japan is preparing to usher in a new government against a backdrop of worry that the nation is already Asia's political and economic also-ran, prematurely playing No. 2 to China. It's all happened fast. When this decade opened, Japan's economy was still almost four times the size of China's, but in recent years China looked set to surpass Japan by 2010 or shortly thereafter. Now, with China still growing at 8 percent a year and Japan shrinking, commentators in Japan have been forced to admit that the switch will likely come even sooner. "It's nonsense for us to continue talking about competing with China [for sole leadership in Asia] when their economy will surpass ours by next year," says Kobori, echoing the sentiments of other academics, writers, intellectuals, and even younger politicians within Japan.

There's a growing, reluctant consensus that Japan will have to find a new role. From the Meiji Restoration—the great flowering of Japanese innovation and reform in the 1860s—until recently, Japan "had basically one goal: catch up with the West and be accepted as a great power. They achieved that in the '80s, but they've never figured out what to do for an encore," says Columbia professor and Japan expert Gerald Curtis. "Japan today is a tired country." The old model—work hard and save to finance exports to the West—is clearly broken. (The other top developed export power, Germany, has also been particularly hard hit by the global recession, as all the rich consuming nations of the West enter what looks to be a long period of slow growth and weak demand.) With Asia emerging as "the center of the global economy, its new growth engine, Japan now has to figure out how to put itself at the center of that center," says Curtis.

The opposition Democratic Party of Japan (DPJ) clearly sees Japan as a regional Asian power, and no longer a nation tied only to the West. DPJ leader Yukio Hatoyama has denounced the global free-market consensus, of which Japan was once a happy member, blaming "globalism" and "U.S.-led free-market fundamentalism" for the current crisis. His vision amounts to a retreat inward, beefing up "fraternity" at home with a stronger welfare state, and more generous pensions and child support, while refocusing Japan's trade and investment strategies on East Asia. Alarmingly, however, the DPJ manifesto did not even mention "growth" until it was attacked by the LDP, suggesting that the DPJ doesn't quite get its predicament. Maintaining Japan's comfortable standard of living won't be possible without growth.

American and Japanese intellectuals have compared Japan's new position to Canada's, or Switzerland's—rich, content powers that have learned to thrive alongside giant neighbors. The problem, says MIT Japan expert Richard Samuels, is that it would be a painful "deep dive" for Japan to go the way of Canada, which has an economy more than three times smaller, and smoother relations with the U.S. than Japan has with China. The Asian powers have a rough history dating to the Japanese occupation of China in World War II, and often competing interests in trade and security. Japan is still protected by the U.S. nuclear umbrella, now primarily against possible future threats from China.

Others have suggested that a more fitting model could be found in France, the wealthy co-leader with Germany of a powerful regional bloc. Japan and China might play this role together in Asia. The DPJ has even proposed French-style child subsidies to boost the country's birthrate, which would revive some of the economic dynamism Japan has lost as a result of having the world's most rapidly aging population. Of course, the EU started as the European Coal and Steel Community, a postwar French-German alliance to share resources; China and Japan are still fighting over offshore oil rights and atrocities from World War II. The huge gap in average yearly incomes—$34,080 in Japan and $2,000 in China—will make it difficult for them to work together as regional leaders, the way Germany and France do.

Yet the benefits of an aggressive regional strategy are clear—France, for example, has boosted its per capita income by 42 percent since the formation of the European Union in 1993, and no one doubts that it has gained greatly by leveraging the common market. Japan could do the same. Goldman Sachs predicts that the major emerging markets, led by China and India, will overtake the combined GDP of the G7 by 2027, a decade faster than previously thought. By 2010 China will account for an amazing 30 percent of global consumption growth, more than the G3 and double that of the U.S. The Japanese, who have hitherto focused more on economic ties to the U.S. and Europe, are slowly beginning to realize that they would do well to ride this train.