In a recent post, Brad Setser analyzes the World Bank's latest China Quarterly. Setser discusses a number of issues raised in the World Bank's research, but one item that jumped out at me was the idea that China is increasing its volume of parts/component production relative to the previous driver of export growth which has been final assembly of components produced elsewhere(likely a large volume from Japan). I think it is clear that China has the labor pool and cost advantage to undercut Japanese exporters. For the time being, Japan still has an edge in terms of branding of their hard goods, but I don't see any reason that Chinese firms will not develop marketing skills to penetrate the US and European markets more directly than they have to date.
Since Japan's GDP growth is almost wholly dependent on exports, if Chinese firms gain significant share in finished goods manufacturing another long term deflation/recession could be in the offing for Japan.