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Why China's economy is still lagging Japan

Brent Lewin | Bloomberg | Getty Images

China's economy overtook Japan's in 2010 to become the world's second largest, but analysts told CNBC China still lags Japan in terms of the quality of its growth.

The Japanese economy expanded 0.7 percent on year in the final quarter of 2013, substantially slower than China's 7.7 percent expansion. While growth in the mainland economy has slowed from double-digit levels in recent years it remains on course to overtake the U.S. as the world's largest economy as early as 2019 according to the Economist Intelligence Unit.

Yet, the quality of growth in China's economy is questionable, which becomes evident when comparing it with Japan, analysts at Standard & Poors pointed out in a note.

"There is more to the Asian financial leadership story than just the GDP (gross domestic product) level," S&P said. "When we examine metrics other than the level of GDP, China still lags Japan in many areas, sometimes by a sizable margin - although it is catching up."

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The quality of growth

While China has a labor force advantage over Japan due to its large population as well as a higher overall GDP output, S&P analysts said that when viewed from the perspective of per capita GDP the picture changes dramatically.

As of 2013, China's per capita GDP – often viewed as a broad measure on a country's average living standards or economic well-being – was $9,828, one quarter of Japan's $37,135.

"Despite China's impressive growth run over three decades and having left Japan's economy in its shadow in terms of size in recent years, it is easy to forget that China is still a developing country...hundreds of millions of people on the mainland still live in relative poverty when compared to standards in advanced nations," Frederic Neumann, co-head of Asian economic research at HSBC said.

The value of China's exports also outpaces that of Japan by a long shot; China's exports reached $2.9 trillion in 2012, far above Japan's $1.2 trillion. Yet, S&P says the qualitative progress of Japan's exports has actually outpaced that of China by 15 percent over the past five years.

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Medium and high-tech exports have consistently accounted for 70-80 percent of Japan's exports, S&P said. China has clawed its way up from near zero in the mid-1980s to nearly 60 percent in the mid-2000s.

China's development on the export front has been uneven, HSBC's Neumann said, noting that some areas such as telecommunications and internet gear are relatively sophisticated, while at the same time China still ships T-shirts and sneakers to markets elsewhere.

Other differentiating factors include the two countries' international investment positions, the size of their financial sectors and physical infrastructure.

Furthermore, Japan's financial sector is larger than China's by most metrics including bank assets, bank and financial system deposits and private credit, S&P said, ranking it among the top ten globally on all fronts, while China's rankings range from 15th to 40th.

China only outscores Japan in terms of stock market capitalization, ranking 17th globally, while Japan's ranks 24th, based on the World Economic Forum's Financial Development Index 2012.

Japan also supersedes China in terms of innovation. The Bloomberg Global Innovation Index for 2013 showed that Japan had a considerable lead, ranking sixth globally versus China's 29th position.

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Longer-term developments

While the size of China's economy clearly exceeds that of Japan, and Japan outscores China on various other fronts the longer-term view may be more important.

One analyst pointed out that although Japan was far ahead of China in terms of its more advanced governance system and industrial sector, it is an economy facing a huge number of headwinds.

"Japan's long term economic outlook remains very difficult despite the new impetus for reforms from Abenomics, due to the declining population and very high levels of government debt. This is likely to constrain the Japanese long-term growth rate to around 1 percent per year," said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight.

S&P concluded that improving competitiveness and maintaining high productivity as China transitions from an investment-led to a consumption-based economy will be critical for protecting it against the challenges associated with changing its growth model.

HSBC's Neumann agreed: "Rather than compare the two countries at the current juncture, it's more relevant to ask whether China can sustain its stupendous progress and whether Japan can preserve its hard-acquired wealth. It's by means assured that the answer to both is yes, but the answers will be of relevance not just for these two nations but the world at large."

Contact World Economy

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