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China's rise creates a moment of introspection, too

BEIJING – As news spread this week that after decades of growth, China had officially passed Japan to become the world’s second-largest economy, behind the United States, I was on the outskirts of western Beijing for the unveiling of the third generation of China’s “pod houses.”

Huang Rixin, a spritely 78-year-old former engineer turned Beijing landlord, has made a name for himself in recent months producing cage-like, 21.5-square-foot living spaces dubbed “capsule apartments” for the capital’s burgeoning class of jobless and underemployed college graduates.

Photo by Wang Yish/Imaginechina

Two Chinese men sit in their own small spaces in capsule apartments in Beijing, China, in a photo taken June 12, 2010.

Taking Japan’s famous capsule hotels for inspiration, Huang has improved on previous iterations of his pod houses by doubling the size of the rooms and including more shelf space. Huang views his pods, with rent of about $51 a month, as a cost-effective way to house the estimated 3 million recent university graduates seeking employment or earning less than the average starting salary of approximately $400 a month.

In many ways his capsule apartments highlight the social and economic problems that belie China’s gaudy GDP numbers.

Even as the national economy surges, China’s per-capita income has simply not kept pace, and millions of people have been left out of the nation’s economic miracle.

China’s per-capita income, at around $6,600, is closer to that of Turkmenistan or El Salvador, rather than to the U.S.’s $46,000 or even Japan’s $33,000.

While China’s liberalized economic policy has certainly pulled hundreds of millions of people out of poverty and transformed the country into an industrial dynamo, little of that prosperity has trickled down to the majority of would-be Chinese consumers – the very people who many economic experts insist will fuel China’s growth well into the 21st century.

One such expert is economist and Peking University professor Michael Pettis. In an excellent blog post this week, Pettis, succinctly summed up this point, writing, “In order to reduce China’s excessive dependence on export surpluses and investment, it is vitally important that household consumption, which in China represents probably the lowest share of GDP ever recorded, rise significantly.”

Not enough ‘Made in China’ consumed there
For better or for worse, China’s Communist Party has tied the legitimacy of its power to elevating the economic situation of its people. So far, this approach has paid off, as Chinese citizens over the years have enjoyed healthier incomes and lifestyles.

However, as time has gone by, China’s economic model – modeled on the Japanese system of subsidizing growth through heavy capital investment, easy low interest government loans and an undervalued currency – has proven to be too successful, essentially starving domestic consumption in favor of national growth through export.

In short: Too little of what China produces ends up consumed by the Chinese themselves.

The government has tried a variety of strategies to curtail this trend and boost consumption. This summer has seen a rash of labor unrest as the government allowed Chinese workers to agitate for higher wages. It also introduced government subsidies on a number of products ranging from cars to household appliances in a bid to generate domestic consumer spending.

Both proved successful, yet as Pettis noted, consumer consumption in 2009 was still less than 36 percent of GDP, which is an almost unheard of number for such a massive economy.

In essence, China is still the largest market in the world for virtually everything, and despite claims otherwise, Chinese consumers are very willing spenders. However, Chinese wages are currently so low that consumers simply are unable to contribute to domestic consumption unless serious wealth redistribution or salary adjustment occurs.

Tokyo’s take
Meanwhile in Japan, the government’s reaction to being surpassed by their Asian neighbor was so calm, it set off alarm bells.

Japan's economic minister Satoshi Arai said, “It doesn't matter who comes out at the top or bottom. It simply represents each country's current economic health.”

But that thought was not shared by the rest of the country. Practically all of the major Japanese newspapers had editorials warning that Japan was in desperate need of serious change.

In particular, the Nikkei, the largest business daily, lashed out at Prime Minister Naoto Kan’s administration, writing: “The current policies of the Japanese government are not only marked by underestimating fiscal analysis, but they're also extremely ill-equipped to deal with any crisis both in terms of posture and structure."

Hiromichi Shirakawa, chief economist for Credit Suisse explained why he believes Japan is in it's current predicament. "The biggest problem for Japan right now is that there is a significant lack of demand, and also whether they're individuals or corporations, everyone here is exercising 'precautionary saving' against an unpredictable future.”

"It was just a matter of time,” said Shirakawa. “Japan's economy has been contracting while China has been expanding. Japan has already lost in terms of ‘quantity’ and now it's time to look at the aspect of ‘quality’ such as people's personal income and purchasing power.”

Social unrest concerns lead to subdued announcement
Back in China, in the past, a seminal moment like the nation’s elevation to the No. 2 spot would have been heavily played up in state media as proof of increased Chinese prosperity and global relevance.

However, while local news reports have noted the event, they were quick to note the country’s low per capita income and the need for continued gradual economic progress.

The Chinese coverage seemed to be low key in comparison to Western coverage, which highlighted the milestone as front page news and analyzed its implications for the broader global economy.

But it seems that concerns over class friction and social unrest led to the subdued way the announcement was made domestically in China. In the year alone, the central government that has found itself enmeshed in a host of social class issues that run the gamut from dating shows and local government corruption to the rights of household pets.

Whatever their concerns, China has earned its moment in the sun. Deep economic, environmental and social issues lurk, and only time will tell whether China’s status is sleight of hand or real. However, there is no denying that in only 30 years, China has transformed itself into one of the greatest economic power houses in world history.

Whether that economic stature is fleeting – as it was for the Japan – or relatively more long-term, as it has been for the U.S., will bear close watching.

NBC News' Arata Yamamoto contributed to this report from Tokyo.