Germany spurs EU recovery as China leapfrogs Japan

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China has overtaken Japan to become the second-largest economy in the world after the United States. While things are looking up for a German-fuelled recovery in Europe, China's progress has caught the attention of the US, where the economy continues to flounder.

Based on figures for the second quarter of 2010, China's fast-growing economy leapfrogged Japan, something analysts had forecast even before the global economic downturn.

In recent years China has overtaken Germany, France and the UK and could surpass the US by 2030.

The news cements China's position as a global economic powerhouse, and while the noises coming from Beijing are modest, getting one over on Japan – an historic local rival – will be a source of great pride for ordinary Chinese citizens.

Japanese officials say it would be fairer to compare the figures at the end of the year rather than relying on the results of a single quarter, but with China's economy growing quickly and Japan in the economic doldrums, it is almost certain that Japan will find itself in third place at the end of the year.

Meanwhile, the EU economy grew at its fastest pace in three years in the second quarter of the year, thanks in no small part to Germany's 2.2% growth.

Challenges remain in China

Per capita income in China is still a fraction what Europeans, Americans or Japanese workers earn and quality of life issues – notably environmental challenges and social inequality – remain major headaches for Beijing.

The EU and US have been heaping pressure on China to allow its currency to appreciate, with Western leaders arguing that Beijing has kept the renminbi artificially low in order to boost exports.

There has also been criticism of China's intellectual property regime and allegedly protectionist policies designed to favour domestic firms.

Nonetheless, the economic crisis has hit Western capitals harder than Beijing, which has been a major source of credit, particularly for the US. Despite holding billions of dollars in its foreign currency fund, China has argued that the world should abandon the greenback as a global reserve currency.

The news that China is now the world's second-largest economy merely confirms its status as a major geopolitical player.

Yi Gang, vice governor of the People's Bank of China and also the head of the State Administration of Foreign Exchange (SAFE), said energy and environmental protection are the major challenges facing China despite its economic success.

"China, in fact, is now already the world's second-largest economy. The restrictions caused by environmental factors have been unprecedented, such as underground water, air and carbon emissions. Another restriction is caused by resources, including energy exports," he said.

"This has enormous significance. It reconfirms what’s been happening for the better part of a decade: China has been eclipsing Japan economically. For everyone in China’s region, they’re now the biggest trading partner rather than the U.S. or Japan," Nicholas R. Lardy, an economist at the Peterson Institute for International Economics, told the New York Times.

"China is already the primary determiner of the price of virtually every major commodity. And the Chinese government can be much more decisive in allocating resources in a way that other governments of this level of per capita income cannot," he said.

China has achieved a dramatic transformation of its economy since it began the process of 'Reform and Opening Up' at the end of the 1970s. The reforms lifted hundreds of millions of people out of poverty and have made China an economic powerhouse.

However, the pace of change has made Western powers uneasy as economic and political power shifts to Beijing. China has enjoyed a growing role in the G20 and international diplomacy, including climate change talks.

China has responded to the global economic downturn with a massive stimulus package, much of which is focused on green industries. This has helped contain the impact of the international crisis on China and is a major driver in the fledgling global recovery.

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