Japan as Number Three

Beijing’s rise, Tokyo’s fall and the wealth of nations.

Younger readers may find this hard to believe, but a mere 20 years ago America’s political and academic establishments viewed Japan as the world’s ascendant economic power. “Japan as Number One” was the title of an influential book by Harvard’s Ezra Vogel, and the journalistic fashion was to lament that while Japan had lost to America in war it had triumphed over the U.S. as an economic competitor.

That inevitability has turned to irony on the news that China has now supplanted Japan as the world’s second largest economy. Such a result was hard to imagine a generation ago, and Japan still far outstrips China in per capita GDP and standard of living.

But the relative growth trends are undeniable, as the nearby chart shows. From 1990 through 2009, China grew by an average of nearly 10% a year, while Japan endured a sharp growth deceleration from its postwar glory years to well under 2% a year. As one nation rises rapidly out of poverty, another has at best settled into a prosperous stagnation.

It’s worth pondering the reasons for this Asian reversal, and its implications. One obvious, if too often forgotten, lesson is that the wealth of a nation is not a birthright. Prosperity has to be earned year after year, through sound economic policies that unleash the natural talents of a nation’s people.

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For China, the breakthrough event was Deng Xiaoping’s opening to the world and free markets in 1978. First in agriculture, and later in other industries, China became a remarkably entrepreneurial place. As our Hugo Restall wrote in 2008, the government share of GDP shrank to about 11% in the early 2000s from 31% in 1978. China unilaterally cut tariffs, joined the World Trade Organization, and forced state-owned companies to shape up and meet new competition. China is still benefitting from the growth momentum of those decisions.

Japan, meanwhile, was moving in the opposite direction. In 1984, we wrote an editorial, “Japan as No. 21,” which described how Japan ranked 21st at that time out of 23 developed countries in government revenue as a share of GDP: 27%, according to the Organization for Economic Cooperation and Development (OECD). In spending, it was dead last at 26%. No longer. Japan has imposed a value-added tax and government spending as a share of GDP is closer to 40%.

After its property and stock bubbles burst in 1990, Japan also embarked on what may have been the longest and most expensive Keynesian policy experiment in world history. (See “Barack Obama-san,” Dec. 16, 2008.) This has taken debt as a share of GDP to nearly 200% while doing very little for growth. Japan has also failed to reform its own version of perverse government-sponsored enterprise, the postal savings system, among other domestic barriers to competition.

A visitor to Japan will still see an affluent nation, but its relative decline has been striking. Derek Scissors of the Heritage Foundation notes that Japan now ranks roughly 40th in measures of personal income and that the average Japanese is now poorer than the average citizen of Mississippi. A lost generation of growth has compounding consequences.

Another comparative economic question concerns not merely policy but national will. Emerging from defeat in World War II, the Japanese people were bent on rising again, albeit peacefully. Their social cohesion and corporate discipline built some of the world’s great companies, which still contribute to global well-being.

Tourists stop at a clothing shop in Tokyo Monday, Aug. 16, 2010. Japan lost its place as the world’s No. 2 economy to China in the second quarter as receding global growth sapped momentum and stunted a shaky recovery.

Now Japan’s population is aging, and older countries tend to be more risk-averse. Unlike the U.S. or Australia, Japan has never welcomed immigrants who could supply a younger generation of workers. Its political system seems unable to return to a pro-growth agenda.

Today, China is the more dynamic, confident nation, its people striving to make up for lost centuries and reassert themselves as the dominant regional power. China has its own problems with an aging population (thanks to its one-child policy), but the migration of tens of millions from countryside to cities gives it plenty of youthful talent.

The question is whether China can maintain its fantastic rate of growth as it runs up against the limits of one-party rule. Especially since the financial panic tarnished the U.S. economic model, the Chinese are increasingly touting their version of “state-directed” global business champions.

In a recent report for the U.S. Chamber of Commerce, old China hand James McGregor of APCO Worldwide shows how China is moving away from free market policies by sheltering domestic companies in seven key areas from competition. This will lead to less domestic efficiency and innovation, while courting a global trade backlash. Politically directed capital can flourish for a time but it inevitably founders on the lack of market discipline.

The economic rise of China has nevertheless been a great and welcome contribution to global prosperity, much as Japan’s rise was in the postwar decades. By contrast, Japan’s 20-year stagnation has been a tragedy for the world as well as for the Japanese people. Global prosperity is not a zero-sum game, and each nation needs to make its contribution.

Americans can take some comfort that at least through 2008 the U.S. had retained its global economic standing even as other nations rose and fell. The U.S. remains far and away the world’s largest economy, though China is gaining. The way to avoid Japan’s fate is to avoid the same policy mistakes, which means returning to the policies of the 1980s that revived the U.S. after the last Great Recession.

Editorial, Wall Street Journal

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Full article and photos: http://online.wsj.com/article/SB10001424052748704868604575433212314778700.html