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The past year saw Japan’s economy continue to wallow in a quagmire of deflation. The problem was compounded by the bad-debt crisis in the banking sector. The recurring afterthought is that the economy is still paying a heavy price for the 1980s bubble. Even more dismaying is the realization that there is no effective cure for the deflation and that it will likely persist for some time.

The common remedy of the past — boosting domestic demand through increased public spending — is no longer a viable option, given the crushing government debt. Probably the only way out is to put the country’s fiscal house in order and create a leaner economic system. Structural reform may sound like a hackneyed slogan, but the need for drastic and painful change cannot be overemphasized.

Deflation — a continuous decline in the prices of goods and services — has caused a staggering loss in asset value over the past decade or more. Stock and land prices have dropped by more than 1,158 trillion yen since the bubble burst in 1990. Moreover, the influx of cheaper imports from developing countries has accelerated price declines.

Particularly, the stock market remains depressed, reflecting not only the twin problems of deflation and bad debt but also a host of negative factors abroad, notably the deterioration of the U.S. economy and the possibility of a war in Iraq. As things stand, market prospects for the year ahead are anything but encouraging.

Prospects for bank reform are also dim. Although banks have been stepping up efforts to write off their bad loans over the past several years, the debt burden has continued to rise. With asset prices in a deep freeze, new problem loans crop up as quickly as old ones are cleared, so banks are tightening their lending standards. They are also calling in more loans from risky borrowers. All of this is exacerbating the credit crunch.

The number of business bankruptcies for last year reached nearly 20,000 — the third highest since the end of World War II, after the figures for 1984 and 2001. With sales slumping, many businesses are holding down capital spending. Analysts say business failures will increase at a faster pace as the economy continues to stagnate.

That is bad for debt-burdened banks as well, leaving them with no choice but to speed up writeoffs. The vicious circle already in motion — debt cleanup driving more businesses out of the market and thus prolonging the slump — will likely accelerate.

The depressed Nikkei index, which closed slightly above 8,700 points last Friday, is indicative of the chronic economic disease. The blue-chip average began the year at the 10,800-point level and climbed past 11,900 in May, posting a record for the year. After that, though, it hit the skids, falling to the 8,300-point level in November, the lowest since March 1983.

Some pundits argue that stock prices do not indicate the real strength of the Japanese economy. That may or may not be true, but foreign investors are taking a hard look; they see Japan as a “selloff.” With bank-held shares also under selling pressure, a strong recovery in the stock market seems unlikely for the time being.

Many Japanese must feel nostalgia for the 1980s when Japan was hailed as “No. 1,” surpassing the United States in key aspects of international competitiveness. Now Japan is ranked 30th, a few steps behind South Korea (ranked 27th) and just one step ahead of China (31st), according to the IMD, a Swiss think tank.

High unemployment is a poignant reminder of the “Japanese disease.” The jobless rate reached 5.5 percent in October, the same as the all-time high reached in December of last year. Although it dipped to 5.3 percent in November, it will almost certainly start rising again as banks forsake more of their deadbeat clients.

While pessimism abounds, it is not darkness all around. The 1990s may have been a “lost decade,” as pundits like to say, but some economic fundamentals remain remarkably strong. For example, consumer spending is basically firm, supported by more than 1,400 trillion yen in personal savings. There is pent-up demand for products better tailored to consumer needs, as illustrated by the boom in fuel-efficient small cars. Overseas tourist spots continue to beckon some 17 million Japanese each year.

It cannot be forgotten, however, that Japan’s economy is no longer what it was and that it is now headed, as it should be, for a new period of development. Those who still believe that ever higher growth is the only way to save the economy are chasing a mirage. The new belief to be embraced is that we must build an economy that does not depend too much on the constant, simultaneous growth of all economic sectors.

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