China's Economy Will Surpass Japan's This Year

During a recent trip to Japan, New York University economist Edward Lincoln was surprised to find executives at Toyota wringing their hands─not about sales, which were down 27 percent since the beginning of the year thanks to the global recession, but about their new position as the No. 1 automaker in the world. They nabbed the top spot last year after GM imploded. But Lincoln says that the Japanese automaker has come to realize that being the top dog means that you have to set the agenda for the rest of the industry, and also fend off all the people trying to knock you off the podium─a tough spot to be in.

It's a position that Japan as a country has come to know well. These days, the Japanese population as a whole is hand-wringing over the fact that they will probably loose their spot as the No. 2 economy in the world (and the No. 1 player in Asia) to China by the end of the year. The Japanese have been in decline for ages─they only just came through their "lost decade" of the '90s and early part of this century. Yet this year has proven that they have further to fall. The second-quarter GDP figures, out at the end of May, were truly terrible─the country declined 15.2 percent on an annualized basis. Meanwhile, the Chinese continue their seemingly endless upward trajectory, with a likely 8 percent growth this year─in the middle of the worst economic period since the Great Depression. No wonder world leaders can't make it to Beijing fast enough to mug with Hu Jintao and Wen Jiabao. Last week's U.S.-China Economic Dialogue just made clear what we already knew: Japan is now an also-ran in Asia, and China is taking the dominant position, not only economically but politically too.

The rise of China wasn't new, either, of course. But the speed at which the shift is taking place, and the fact that China has remained so stable and prosperous while the financial crisis and recession has called into question Japan's entire high-savings, export model is a huge blow to the Japanese. China is moving up the food chain faster than anyone thought possible, and even beginning to challenge Japan at the very core of its economy: high-end manufacturing. True, China mostly still exports cheap goods to the West. But the government has made it clear that they want to go for higher-end goods and, to that end, have been offering subsidies to more innovative companies, payments for patent filings, and all sorts of tax breaks and supports to entrepreneurs in areas like green technology and energy-efficient cars and fuels.

That's the area that Japan currently leads. Yet the demise of the auto industry (sales in the U.S., still the world's largest market by revenue, have been halved in the last year) is another reason that this is the bleakest economic moment in what has been for Japan a very bleak two decades. In one month late last winter, sales at all the major automakers were down 50 to 90 percent; the entire industry basically shut production for two weeks to clear out inventories. Meanwhile, green cars have become Japan's Sputnik; the Chinese have fast-tracked this sector, and aim to make the Middle Kingdom home to the clean Detroit of the future. "People aren't buying cars and China's rise is inexorable. It's no wonder the Japanese are depressed," notes MIT Japan expert professor Richard Samuels. That double hit at the heart of their much-lauded manufacturing industry, from their historic rival, is one reason that the Japanese seem to be taking their backward economic move lying down. On a recent trip to Japan, I found very little fire in the belly among politicians or businesspeople. Cliché as it is, many simply wanted to apologize for how dismal their situation was. So much for Japan As Number One (the title of now infamous Ezra Vogel book about how the world would come to emulate Japan).

So, what does it all mean for the U.S.? Politically, it means that we'll move ever closer to China; they'll be necessary for securing Asia in the future (Japan's military budget has been flat for 20 years). Economically, it means that the Japanese, who've realized that they are overreliant on the American consumer, will start nurturing closer ties with not only China, but the rest of Asia and the developing world. Consumers there won't replace Americans immediately, but the Japanese are starting to realize that while they may not be able to be No. 1 on their own, they have the fastest-growing market in the world on their doorstep. And countries, like companies, can sometimes do pretty well in the No. 2 slot.