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China overtakes Japan – so what?

Economies of Asia | China overtakes Japan – so what? Anthony Harrington

At the end of July, in the height of the usual summer news famine, the business media leapt with delight on the fact that Chinese economy had, as the story put it, “overtaken the Japanese economy as the world’s second largest economy”. Few of the headline writers bothered to note that if ever there was a case of comparing apples with oranges, this was it. One has an ageing population and has struggled with a stagnant economy and incipient deflation for two decades. The other has a burgeoning population, three decades of rapid growth and is wrestling with incipient inflation.

What the two economies do have in common, however, is that they are both exporters. That said, one is a master at the game and is at the top of the value added curve. The other is still transitioning from low value to high value exports, though this point can be overcooked. In a report presented to the US China Economic and Security Review way back in January 2005, Robert Scott, from the US Economic Policy Institute, warned that people who thought China’s main exports were cheap textiles and easily fabricated goods were barking up the wrong tree. He told the committee:

“Everyone knew that we would lose jobs in labor intensive industries like textiles and apparel, but we thought we could hold our own in the capital-intensive, high-tech arena. The numbers we’re seeing now put the lie to that hope – as China expands its share even in core industries such as autos and aerospace.”

A later presentation by Zhi Wang from the US International Trade Commission’s Office of Economics, which cites Scott’s comments, showed that China’s export of Advanced Technology Products (ATP) was on the march upwards, and was being orchestrated by foreign-invested enterprises that had moved into China following its accession to the World Trade Organisation.

The chief categories of Chinese ATP shipments to the US are information and communications technologies. These exports still tend to be at the low end of the ATP value added chain, but the trend is clearly upwards.

For the media, none of this detail mattered particularly. What the press was chiefly keen on was highlighting the significance of China’s leapfrogging Japan as a milestone on its road to overtaking the US as the world’s premier economic engine. Predictions as to when this is likely to happen range from 2025 to 2035 or even 2050.

Clearly, however, if the Chinese economy suffers a major crash over the next few years, as some commentators deem likely (see for example Ian Fraser’s blog, "Betting on Chinese equities as short-sellers predict Sino armageddon"), then all bets are off and anything can happen.

In fact, the way media reporting has moved on since the “China-overtakes-Japan” story first broke has been revealing. China is now widely seen as likely to achieve 10 – 11% growth for 2010 (except by those who think that the country is likely to suffer an asset bubble implosion), while Japan seems to give more cause for concern with each month that passes. The flavour of this is splendidly conveyed by Emma Wall’s Telegraph article "Is it time for investors to give up on Japan?"   

Wall was reacting to a message from a leading UK broker, Hargreaves Lansdown, that now is a great time to invest in Japanese equities! Against this Wall points out that the average Japan fund has had negative returns for 12 out of the past 20 years, losing 39% in 1990, 21% in 1995, 30% in 1999 and 14% in 2005.

In fact a £2,000 investment in a Japan fund twenty years ago would now be worth just £2,320, by comparison with a 100% or more return from a plain vanilla FTSE passive tracker fund. Moreover, this, she points out, is an idealised position. Of the 35 Japan funds that you could have invested in 20 years ago, none of them would have delivered you a positive return today.

Wall’s point is that as far as investors are concerned, with Japan, today’s small gains are tomorrow’s losses and the cycle of zero returns just goes round and round. However, against this counsel of despair one should point out, just to round out our Japan/China story, that China is currently investing massively in Japanese government bonds as an alternative line to US Treasuries. Ironic, isn’t it? Investors and their advisors in the West may have mixed views on Japan. China, apparently, doesn’t.

Further reading on the economies of Asia and Japan:

Tags: China , deflation , demographics , exports , inflation , Japan , value add
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