Japan will rise from its death bed

IT WAS a neat coincidence. Just as Ryutaro Hashimoto, the Japanese Prime Minister, was saying in London that he thought the worst of Asia's financial crisis was over, back in Tokyo the threat of a downgrade of Japan's credit status by Moody's, the US credit-rating agency, sent the yen to a new six-year low against the dollar.

"The worst," said Mr Hashimoto, "has come and gone and we are now seeing new steps forward." But Moody's said: "The change [in the credit outlook] reflects uncertainty about the ability of the authorities to achieve a policy consensus that would help promote a return to economic growth and fiscal balance."

Um. The credit-rating agencies do have a record of being absurdly slow to respond to changes in the economic state of the countries they rate, so in a way the threat of a downgrade for Japan merely tells us what we knew already. But there is no doubt that the Asia-Europe summit in London at the weekend coincided with a new bout of concern about the health of the economies of the East Asian zone.

This was, after all, the week that the value of the shares quoted on the London stock exchange passed the value of those on the Tokyo exchange - an amazing turnabout from the heady days 10 years ago when the value of the land of the emperor's palace in Tokyo was, in theory at least, worth more than the state of California.

What is actually new here? We have all been aware of the turmoil in East Asia for many months, and there has been no significant new information in recent weeks. Most people have also been aware that Japan was heading back into recession, so again there is nothing terribly new there. So why the new burst of the glooms?

The best way into this tortured subject is to start by separating the different countries. All have problems, but they are different. Japan, in particular, is in a very different position from any other country in the time zone. On the downside, it has been hovering on the brink of recession for six years, though not quite dipping into it until now. By contrast the Asean members (basically the East Asian "tiger" economies) were showing strong growth until the middle of 1996 and decent growth until the middle of last year. As for China, it has been racing along, and growth only started to fall away at the end of the year. As the graph on the left shows, industrial production in all three main segments of the time zone is now heading down, but in Japan the weakness is of much longer standing.

On the other hand, there are fundamental strengths to the Japanese position which the rest of the region does not have: the technological supremacy, of course, but also the fact that Japan is the world's largest creditor nation, a status enhanced every month as its trade surplus piles up further and further. Basket case it is not - whatever the US rating agencies say.

What has gone wrong is a lack of domestic demand, which is a function of failure to make a series of structural reforms which are obvious to anyone outside the country: establishing transparent markets, clear financial accounts of corporations, tax changes to cut the higher rates of income tax and broaden the tax base, changes in land use regulations which inhibit house-building, and so on. None of this is rocket science: all Japan has to do is to apply good practice from countries abroad, including the UK.

The problem is that Japanese officials have found it very hard to confront their problems. You can catch this in Mr Hashimoto's remarks above. Anyone who has had conversations with Japanese officials will have met the same inability to acknowledge the scale of the problem. A few weeks ago a senior Ministry of Finance civil servant told me that Japan would have growth of about 2.5 per cent this year. That seemed absurdly optimistic: it was already clear the country would be struggling to show any growth at all. But it wasn't possible to have a discussion about that possibility.

Now - and this is what seems to be changing - the threat of recession is in the open. The latest "Tankan" survey of business confidence was exceptionally gloomy. The head of Sony, Norio Ohga, said the economy "was on the verge of collapse" and compared Mr Hashimoto to Herbert Hoover, US president at the start of the 1930s Depression. At last the fact that there is a problem is in the open. That is a bull signal, not a bear one. Remember that although Japan may well be moving into recession - I think some months of negative growth are inevitable - the fundamental strengths of the economy are intact.

By contrast, many of the other nations are under great pressure. The forms in which this shows vary from country to country. Some need foreign loans urgently simply to pay for essential imports: Indonesia, for example. Korea and Thailand are under only slightly less intense pressure. Everywhere, slower growth (if they are lucky) or decline (if they are not) will cause social strains. Unemployment rates (see middle graph) are rising and are forecast to rise further. But, whereas in Japan the key problem is slow growth resulting from lack of domestic demand, among the tigers the problem has been the financial strains caused by excessively fast growth.

And then there is China, where yet another set of problems dominates: the position is different again. It is very hard to make any sensible judgement about the Chinese economy, for the data we have may be giving an unreal picture: it may be right but irrelevant. What we do know is that China has embarked on a programme of massive structural reform, in a way doing exactly what people have been urging on Japan. It is, supposedly, sacking half its state employees, which someone calculated means dismissing more people than the entire US workforce. I'm not sure we should take that calculation too seriously, but it does seem that China may be starting a wave of reform analogous in scale, if not in intellectual intent, to the Great Leap Forward or the Cultural Revolution. To say that is not to predict a similar catastrophe; it is simply to point out that China does periodically make giant shifts in economic policy, and it may be making one now.

There is, however, one certainty: that the region will seek to run a large trade surplus with the rest of the world, in practice with North America and Europe. You can see what has been happening in the right-hand chart. That trade surplus will continue to whiz up, fuelled by the devaluation of East Asian currencies, raising the tough question: are we ready to accept it? Could a surge in these exports even threaten the enormous progress that has been made towards greater freedom in international trade?

That is not an immediate cause for concern. We have plenty to worry about meanwhile: a real recession in Japan; three to five years of difficult adjustment for the former tigers; the shock waves from the reforms in China. But in a couple of years' time Japan will be back sowing reasonable growth, and even the more ailing tigers will make progress in their reforms. Reform in China is, of course, the wild card, but we will at least know more what is happening by then.

Come the early years of the next century I don't think we will be worrying about any of these things. Much more likely is that we will be concerned about the flood of East Asian imports into North America and Europe, with all the pressures on world trade that will create.

For me, the most encouraging thing about the communique at the end of the London summit was not the guff about a shared interest in stability, support from the international community, reducing the social impact of the travails, and so on. That is all standard flannel the civil servants write for their political masters. It was the item at the end showing awareness of the protectionist pressures that might result. At least these people are aware that there is a problem.