TOKYO – Japan lost its 42-year ranking as the world's second-biggest economy to China in 2010, with data on Monday showing a contraction in the last quarter due to weak consumer spending and a strong yen.
While Japan was expected to fall behind a surging China in the year, the data underlined the weak state of a Japanese economy burdened by deflation, soft domestic demand and pressured by the industrialised world's biggest debt.
"It is difficult for the deflation-plagued Japanese economy to achieve self-sustained growth," said Naoki Murakami, chief economist at Monex Securities.
While China's leap forward reflects a shift in economic power as the country transforms itself from poverty-hit communist state to global heavyweight, it highlights the need for shrinking Japan to energise its economy, analysts said.
Japan's post-war "economic miracle" put it at number two behind the United States for more than four decades, but stagnation after the Japanese property bubble burst in the 1990s helped put China on course to supplant its neighbour.
However, Japan remains around 10 times richer on a per-capita basis, noted top government spokesman Yukio Edano. GDP per head in Japan is around $40,000, say economists.
Predictions vary as to when China may overtake the United States as number one economy, but it should happen by 2025, according to estimates by the World Bank, Goldman Sachs and others.
Most Americans already believe China is the world's leading economy, a poll said Monday.
Some 52 percent of Americans said China was the "leading economic power in the world today," against 32 percent who said their own country, the Gallup poll said. The percentage who said China has soared over recent years.
Seven percent identified Japan as the leading economic power, according to the poll, which surveyed 1,015 US adults this month.
Japan's real gross domestic product slipped by an annualised 1.1 percent in the December quarter as the expiration of auto subsidies hit car sales, a new tobacco tax sapped cigarette demand and a strong yen hurt exports.
In contrast, China grew nearly 10 percent in the same period.
While Japan's first contraction in five quarters was not as severe as forecasts of a 2.4 percent slide, the preliminary data is subject to revision.
The economy grew 3.9 percent in 2010, its first annual growth in three years. But this was not enough to keep it ahead of surging China.
Nominal GDP of $5.474 trillion in 2010 put Japan behind China's $5.879 trillion, the data showed. China first eclipsed Japan in the second quarter.
Despite Japan crawling out of a severe year-long recession in 2009, its recovery remains fragile with deflation, high public debt, an ageing population and a strong yen all concerns for policymakers.
Pressure is on Prime Minister Naoto Kan, who has seen his approval ratings tumble as his government looks to boost the economy without deepening the debt amid a legislative impasse over a $1.1 trillion budget for next fiscal year.
Last month Standard & Poor's cut Japan's credit rating one notch to "AA-" from "AA", saying the government lacked a "coherent strategy" to ease a debt running near 200 percent of GDP, the highest of any developed nation.
Nearly a third of government spending is being swallowed up by a social security system catering to a rapidly greying society, Standard & Poor's warned, with that ratio set to rise without reforms as Japan continues to age.
Private consumption, accounting for about 60 percent of Japan's GDP, slid by 0.7 percent quarter-on-quarter in October-December as the car subsidies expired and cigarette sales were dented by Japan's biggest ever tobacco tax hike.
Exports slipped in the quarter as the yen surged to 15-year highs against the dollar, making Japanese goods more expensive overseas and eroding repatriated profits.
But many analysts expect the economy to rebound in the March quarter as the rising tide of global recovery lifts Japan, amid a recent pick-up in corporate spending and exports.
"The contraction will not last long," said Murakami. "Companies' manufacturing activities are recovering rapidly in January-March this year from their bottom in October 2010."
The government played down Japan's slide to third biggest economy and said it would benefit from having a booming neighbour.
"We welcome, as a neighbouring nation, that China's economy is advancing rapidly," said Kaoru Yosano, minister for fiscal policy.
The Bank of Japan is expected to leave its key rate near zero Tuesday in its ongoing battle with deflation