Japan surrendered its 42-year ranking as the world's second-biggest economy to China in 2010, after data today showed a fourth-quarter contraction caused by weaker 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.
China's leap forward reflects a shift in economic power as the country transforms itself from poverty-hit communist state to global heavyweight, but it highlights the need for Japan to re-energise its economy, analysts said.
Its post-war 'economic miracle' put it at number two behind the US for 42 years, but stagnation after its property bubble burst in the 1990s helped put booming China on course to supplant it this year.
However, Japan remains around 10 times richer on a per capita basis, according to the International Monetary Fund. Japan's real gross domestic product slipped by an annualised 1.1% in the three months from October to December as the expiration of car subsidies hit car sales, a new tobacco tax sapped cigarette demand and a strong yen hurt exports.
While the first contraction in five quarters was not as severe as analyst expectations of a 2.4% slide, Japanese GDP data is subject to constant revision. The economy grew 3.9% in 2010, government data showed - 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 it behind China's $5.879 trillion, the data showed.
Despite Japan's crawling out of a severe year-long recession in 2009, its recovery remains fragile with deflation, high public debt, weak domestic demand and a strong yen all concerns for policymakers.
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% 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.
Prime Minister Naoto Kan's government has prioritised social security reform and a tax system overhaul, but has seen his approval ratings tumble and the opposition has so far refused to begin talks on the issue.
Private consumption, accounting for about 60% of Japan's GDP, slid by 0.7% in the last quarter of 2010 as subsidies for green car purchases expired and as cigarette sales were dented by Japan's biggest ever tobacco tax hike. Exports slipped in the quarter as the Japanese 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 January-March quarter as the rising tide of global recovery lifts Japan, amid a recent pick up in corporate spending and exports.
Imports surge narrows China surplus
Meanwhile, China's trade surplus fell to its lowest in nine months in January after imports surged, supporting the government's case ahead of a G20 meeting that it is doing enough to boost domestic demand without speeding up currency appreciation.
The trade surplus shrank to $6.5 billion from $13.1 billion in December, well short of forecasts for a $10.7 billion gap.
In the past, a weaker surplus would have caused concern for the Chinese government, but more recently it has been trying to shift the economy towards greater reliance on consumption and less on exports, in part to address critics who say that its success has come at the expense of other countries.
China's imports rose 51% in January from a year earlier, blowing past market forecasts for a 28% rise. Exports rose 37.7%, topping expectations for a 22.4% rise, the customs administration said.
