After 42 years as the world’s second biggest economy, Japan officially fell behind neighboring China in 2010.  Many projections indicate that China will go on to surpass the United States as the world’s largest economy by the year 2025.

It is hardly surprising that the world’s most populated country would pass its tenth largest.  Japan maintains a significant lead on China when population is accounted for in per-capita measures of wealth.  Regardless, this does draw attention to recent economic struggles in Japan.  Several indicators of the nation’s economic well-being have recently fallen and Standard & Poor’s went as far as to downgrade the Japanese credit rating from AA to AA-. 

Why did Japan’s real GDP decrease by 1.1% in December as China’s increased by 10%?  Some factors attributed to these recent struggles include an aging population, deflation, and disappearing incentives for major industries.

With the second highest median age in the world (behind Monaco), Japan’s population is rapidly growing older.  This has caused nearly one third of all government spending to be devoted to the social security system.  Once thriving manufacturing businesses now face a decreased supply of skilled labor as their employees retire.

At nearly 200% of GDP, Japan’s public debt is above any other developed economy.  The yen is currently at a 15-year high when compared to the dollar, making Japanese exports very expensive for global consumers.  The Bank of Japan is committed to fighting deflation, but with interest rates at nearly 0% there are very few options for them to do so.

Expiring automotive subsidies have hurt sales in one of Japan’s largest global industries.  Increased tobacco taxes have also dramatically decreased demand for Japanese cigarettes.  Consumers apparently have not reallocated spending from these industries to other aspects of the economy, as private consumption decreased by roughly 1%.

While the Japanese government publicly states that it is happy to have a thriving neighbor in China, there still must be fears about economic conditions at home.  The workforce will not get younger overnight, and deflation problems will take years to overcome.  An anticipated global recovery from the recent recession would help Japan, but the country’s leaders can only hope that it will be enough to reverse this negative trend.

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