The world's second largest economy has been reeling like a drunken samurai for the last 10 years, lurching and stumbling into various dead-ends as it tries vainly to find the path to economic recovery. Inebriated by its own post-World War II successes, Japan was for a time the envy of the globe. In the 1970s and '80s, the country dominated such industries as steel, shipbuilding, automobile manufacturing, and electronics. Japanese products were of the highest quality, and manufacturing techniques such as the kanban component of just-in-time production (pioneered by Toyota Motor Corp.) were copied slavishly by companies everywhere. Indeed, Japanese methods and strategies were widely seen as the standards to which all other countries should aspire. Japan's successes even fostered fears of an aggressive "Japan Inc.," a country of 126 million determined and single-minded people who would reject American-style individualism and entrepreneurship, choosing instead to dominate world industries by employing a group ethic that had served them well for four centuries. Today, the fears of a super-dominant Japan look like a child's bad dream. The country's economy has been stagnant since 1990 when a speculative bubble in the real estate market finally burst. Just nine months later, the value of first-tier stocks on the Tokyo Stock Exchange had dropped by more than $2 trillion. The Nikkei stock index, which hit an all-time high of 40,000 at the end of the 1980s, is now hovering in the 11,000 range. Real-estate prices have plummeted 65% since 1991, Japanese banks now find themselves saddled with enormous bad loans to bankrupt or wobbling companies, and unemployment of approximately 5% is a post-war record. An ongoing deflationary trend is further eroding the nation's economic stability. In a country in which a single apple costs the equivalent of nearly $4, a little deflation might be considered a welcome phenomenon. But the current downward spiral also is destroying asset values, lowering wages, and precluding sustained growth in the economy as a whole. Japan's dark decade has devastated the country's industrial sector. Most of the shipbuilding industry, for example, has already been lost to Korea and other low-cost manufacturing centers. More recently, prices for Japanese steel plummeted, and steel companies are now frantically trying to consolidate merely to survive. Nissan Motor Co. Ltd. -- one of the country's Big Five automakers -- continues to exist only because it was rescued in 1999 by a massive cash infusion and partnership with France's Renault SA. And in other industries, many companies are moving substantial portions of their production offshore to countries with lower labor costs -- in particular, to China. Electronics Realigns In electronics, the giant Matsushita Electric Industrial Co. Ltd., best known for its Panasonic brand products, is trying to regain its competitive edge by dismantling its decades-old system of self-contained business units in favor of an entirely new and more flexible structure. On July 31 Matsushita recorded the first quarterly loss in the company's history. Video-game maker Sega Corp. was saved from total collapse earlier this year only because of a $680 million bequest from its late founder. Aiwa Co., a subsidiary of Sony Corp., recently announced that it is closing its last plants in Japan and moving all manufacturing to Indonesia and Malaysia. Even the mighty Sony has realigned its board of directors to more effectively monitor the performance of management and more adequately represent the interests of shareholders. In August semiconductor maker Toshiba Corp. -- which expects that the March 2002 end of its fiscal year will see an operating loss of approximately $1 billion, its highest ever -- announced it would be cutting the jobs of 10% of its 188,000-strong domestic workforce, an unprecedented move in a country where the idea of lifetime employment has always been part of the social contract. Other industrial concerns are following the same path. Fujitsu Ltd. is offering early retirement to 9,000 employees, or 21% of its payroll. Many more corporations are hurting, as well. According to the Tokyo Stock Exchange, the return on equity (ROE) of major Japanese companies went from 8.46% in 1983 to 1.2% in 1999. In the U.S. during the same period, ROE went from 12.36% to 17.88%. The full extent of the problems many companies have faced for nearly a decade is only now becoming clear. Why? Because the group-oriented nature of the society tends to encourage what the Japanese call kotonakareshugi, a word that means willfully ignoring troublesome things that might prove upsetting to oneself or to others. Japanese accounting methods, for example, have for years been a veil of smoke, mirrors, and mumbo-jumbo. It wasn't until 1999 that the country began to adopt international accounting standards, and the process of implementing those standards will be a long and gradual one. Japan has seen 10 different prime ministers in the last 12 years, each promising to turn around the economy, but none willing to propose the structural reforms necessary to ensure stable, long-term growth. The government's primary solution to the stagnant economy has been public spending -- to date, more than $1 trillion in unneeded new highways, "bridges to nowhere," and the like. In addition, in the last three years the government has spent more than $22 billion of public money bailing out the sickly banking system. Unfortunately, that figure represents only a small percentage of what will ultimately be required to clean up the banking sector. Official government estimates of total bad loans outstanding have run as low as $264 billion, but a report issued in July by Goldman Sachs put the figure closer to $1.9 trillion. As a result of so much government spending, Japan's debt is now approximately 130% of gross domestic product (GDP), the largest such ratio ever recorded by a modern industrial state. Yet with all of Japan's troubles, it is easy to forget that this is still one of the world's richest countries. And at street level, one would be hard-pressed to discern any difficulties at all. New housing starts are at an all-time high, and new-car sales grew 3.5 % in fiscal 2000, to more than 4.1 million units. In the better residential areas of major cities like Tokyo, Osaka, and Kyoto, family garages -- although tiny -- are nonetheless big enough to accommodate the BMWs, Mercedes, Jaguars, and other high-status vehicles that the Japanese adore. Although store sales have declined steadily for nearly four years, retail transactions still account for 60% of GDP. Indeed, "Mrs. Watanabe" -- the Japanese version of Jane Q. Public -- can still be found daily in all the smartest stores and boutiques, shopping with single-minded intensity. And cellular phones are ubiquitous, with teenagers routinely running up enormous monthly phone bills that their parents happily pay. It is a triumph of willful blindness, because even more serious problems are brewing beneath the surface. In recent years the Bank of Japan has repeatedly lowered short-term interest rates to near zero to stimulate corporate borrowing and capital expenditure. But rate reduction is a two-edged sword, and the reduced interest earned by individual savers has lowered overall spending power and, consequently, tax receipts. The latter fact has exposed the ticking time bomb of Japan's economic future. Demographic Challenges Japan's birth rate has been in steady decline for years, as women for the first time in the nation's history have begun to delay marriage and childbirth in favor of careers. Thus, the responsibility for repaying the massive government debt that is now being accumulated will eventually fall on the backs of fewer and fewer workers. As is true of many other industrialized countries, the Japanese are facing the hard realities of demographics, with increasing numbers of retirees about to hit the post just as the size of the working population falls. Economists and financial analysts estimate that public and private pension plans are underfinanced by as much as $800 billion, which means the government will have to step in to make up the difference. And that means even more deficit spending. The only solution for Japan's current malaise is broad structural reform. The Japanese must eliminate the country's multifarious barriers to imports and to foreign direct and equity investment. They must allow more flexibility in their labor market. They must overturn the arcane laws that allow for too-cozy relationships between original equipment manufacturers and their suppliers, and between banks and their clients. They must insist on achieving a level of accountability that will make it impossible for both companies and governments to hide their failures. But all of those steps will require political courage of a degree that simply has not existed before in Japan. In April, 59-year-old Junichiro Koizumi was chosen as the new leader of the ruling Liberal Democratic Party (LDP), making him the nation's newest prime minister. Koizumi, a shaggy-haired anomaly in Japanese politics, is an eccentric, self-styled reformer who advocates such changes as privatization of the state-run postal savings system (a part of the country's postal system that functions like a savings bank) to free up funds for investment in industry. But even the quirky Koizumi may not be tough enough to break the stranglehold that old-guard LDP ministers and functionaries have on both the body politic and the economy. During his campaign, for example, Koizumi made no concrete proposals for broad structural reforms, opting instead to deliver vague and nonspecific promises of change that would not frighten off support within the party. His strongest stance -- a vow to tackle the enormous load of bad debt in the banking sector -- has raised fears among many economists that the cure will actually kill the patient, sending the country into a full-fledged depression. And Koizumi can do little to alter the outdated management styles, employment practices, and "sweetheart" board relationships of private Japanese firms. Despite his reformist rhetoric, Koizumi is, like all LDP members, still in the thrall of special-interest groups such as the 8-million-member Japan Agricultural Cooperatives, the powerful national farmers' lobby. And in an insular country with a built-in cultural bias toward conformity, the very idea of proactive leadership -- of advocating the abandonment of old, established ways and the embrace of new, often foreign-born concepts -- is a distinctly hard sell to the rest of the ruling elite. But Koizumi had better do something, and he had better do it quickly. The Asian Development Bank has already reduced its 2001 growth forecast for Japan's neighbors in the region. Additional problems in the Japanese economy would only exacerbate what is widely believed will be a further regional decline. And if Japan begins to sink as a result of its anemic growth and enormous national debt, it could well take the rest of Asia with it. Mark Gottlieb is a contributing writer to IW.