China is going to end up teaching Asia how to run a capitalist system and replace Japan as the business model that developing countries emulate to drive their economies forward.

Japan instigated the last change, and the economic success it generated led everyone up until a dozen years ago to study the Japanese business model.

The approach helped Japan grow rapidly, but it also created tremendous waste of capital and inflated many bubbles. Unfortunately for countries that were emulating Japan, certain sectors of their economies were also ballooning to bursting point.

Then in 1997, they all burst together because the Japanese banks got into trouble. To save themselves, they started pulling their money out of Asian economies, which sent regional markets into a tailspin.

Just as Japan had created an economic miracle, it had also created an economic disaster. But just over a decade ago, everyone was saying that the 21st century was going to be the Asian century. Japan was going to be the leader and the yen was going to be the currency of region. Asia seemed to have it all, the leadership, the money, the prestige and the drive. Investors and the public are now tired of the lethargy in Japan and it is about to lose its leadership role in Asia.

However, China essentially has the same problems that hobbled Japan: its banks are limping along, lifelong employment is considered a right, bubbles in certain sectors of its economy are approaching bursting point, and its state-owned enterprises are guzzling vast amounts of money.

The difference between China and Japan, however, is that the Chinese government has handled the situation in much the same way a Western government would have handled it.

The Central Government realised its military had to get out of business, its financial sectors need to be reformed, its loss-making SOEs had to be closed down -- which has resulted in 47 million people being laid off -- and it tackled problems early. All these are measures which Japan similarly had to make, but refused to do.

The result is that the Chinese economy works, while the Japanese economy remains stalled, and China is becoming a leader in showing how Asia needs to evolve its market economy, he said.

Rivers of investment flowing into China have made much of this possible, of course, but Mr Overholt said investors are not just going to China because wages are low. It is the ability of the Chinese government to reform its markets, open them to competition and making things work that is attracting investors.

This has led to US$309 billion in foreign direct investment being pumped into China in the 1990s, compared to just US$39 billion in Japan.