In the centre of Tokyo there stands an elegant, wooden shrine to the Emperor Meiji who ruled Japan in the 19th century. It is a monument that now poses a critical challenge to his modern-day political successors. Slightly over a century ago Emperor Meiji gave his name to one of the most dramatic reformations that Japan has ever seen: in a few decades he transformed the country from a closed, feudal, and rigid society into a dynamic, entrepreneurial industrial power.

The question now is whether Japan can surprise its critics by performing the same "modernising" trick again and implement a second major "restoration" to revive the country's flagging fortunes.

The challenge is pressing. A decade ago Japan was viewed as one of the most dynamic and powerful economies in the world. Now, however, it is beset by a sense of malaise and decline. During most of the last two years the economy has been mired in the deepest recession since the second world war.

The corporate sector has suffered rising bankrupcies and watched some of Japan's best-known companies, such as Hitachi, unveil record losses. The industrial sectors in which Japan once aspired to global dominance, such as banking and automotive, are increasingly falling prey to foreign incursions.

Although the country has been free of any overt political turmoil, there are now rising signs of social strain: the unemployment rate recently hit a post-war record of 4.8 per cent, higher than even the US, while suicide rates due to economic problems soared 35 per cent last year.

Some Japanese still regard such woes as simply a short-term, cyclical problem. Others argue that the economy is simply readjusting to the collapse of the 1980s asset price "bubble". And when, last month, data emerged showing that the economy grew at an annualised 7.9 per cent at the start of the year, a few observers declared that the worst was over. "Japan is out of hospital and in convalescence now," claims Eisuke Sakakibara, the former vice-minister of finance for international affairs.

But Japan's problems go deeper than just the post-
bubble asset price collapse, or cyclical downturn. The underlying challenge is also structural: namely, how to transform the system that so effectively built a manufacturing base in the post-war period into a structure that can instead support a mature and dynamic economy that is plagued by an ageing population. What is needed, in other words, is a new social and
economic paradigm.

Exactly what this paradigm might be is unclear. Simply transplanting US-style capitalism into Japan is unlikely to work, but the paternalistic state-dominated system that built the Japanese manufacturing base looks too rigid to support a dynamic, entrepreneurial, high-technology culture.

Japan in the 1990s can no longer rely on basic manufacturing alone to create its economic strength, since many of its Asian neighbours can offer lower production costs. Although Japan is scrambling to move into higher-technology areas, it lags behind the US in many service sector businesses, or "new" industrial technologies - such as the Internet.

"What we need is a new way of thinking. We need a Meiji revolution," argues Kenshin Oshima, president of the Shohkoh fund - a consumer finance group - and one of Japan's most successful entrepreneurs. More specifically, Japan needs a more flexible system for allocating capital and labour market resources.

Some optimists, such as Mr Oshima himself, think Japan is starting to embrace such reform. This month, for example, the government's Economic Planning Council announced that Japan needed to create a "knowledge-based" society - complete with steps that would have been inconceivable a decade ago, such as more immigration and educational choice.

The Ministry of International Trade and Industry (Miti) is encouraging more corporate restructuring and industrial innovation. "What has changed recently is that we realise we need supply-side reforms," Kaoru Yosano, Miti minister says. "This is a big policy shift."

In the corporate sector, deregulation and foreign competition are gathering pace. Japan, for example, has recently witnessed its first hostile takeover battle. It is even considering selling the nationalised Long Term Credit Bank to a US equity firm.

The younger generation is increasingly rejecting some of the recent Japanese stereotypes. "They don't want the 'job-for-life' system - they want to be like Bill Gates now," says Mr Oshima. Even the ossified political scene contains hints of reform: although the parliament is still dominated by the ruling Liberal Democratic party, a new, younger generation of politicians is starting to exert
more power.

But thus far such change still seems far too little too late. The political leaders lack any real sense of urgency, and most policy reforms are still occurring as a short-term reaction to a specific crisis, rather than a proactive, co-ordinated plan. The government has still made little attempt to tackle some of the most fundamental, longer-term structural changes that are badly needed to promote economic reform - such as a wholesale overhaul of the tax, accounting, social safety net, and pension systems.

Some Japanese blame this on the country's traditional preference for developing policy slowly through "consensus". Others blame the political system, which is beholden to traditional vested interests, such as farmers. However, other issues are also hindering rapid change. There is still a national sense of stoicism, perhaps because Japan's admirably egalitarian ethos means that pain is often spread around a community - or even corporate world.

ore tangibly, Japan remains a rich country, with an estimated ¥1,200,000bn worth of private savings. This means that the government can stave off any debt crisis for several more years by drawing on the huge national resources. It also means that most households can suffer economic pain for a long period before they are forced into protest.

ost perniciously, this wealth has allowed the country to repeatedly conceal the scale of woes this decade. The corporate sector, for example, has repeatedly used "window dressing" tricks to flatter their accounts, usually with tacit government approval. The banks have failed to reveal their bad loans. And although corporate transparency is now improving, the government is still shuffling money between different public sector accounts to flatter its budget figures.

Optimists might argue that this practice simply represents a Japanese trait. After all, the country is famed for its love of "tatemae" and "honne", (or the difference between the public face and private reality). If the Japanese leaders themselves are now aware of the economic "reality", the argument goes, then consensus for reform may still emerge - and drive another "Meiji-style" renaissance.

But another, gloomier, historical lesson also exists. Back In the 1920s Japan experienced another economic downturn, but that time the government staved off reform for more than a decade. The result was a slow-burn economic crisis that later helped fuel a virulent nationalism in the 1930s.

Such political extremism is now long gone. But the picture might change if Japan staved off reform for another decade, and watched economic decline erode the national wealth. For Japan's malaise is occurring just as some of its neighbours, such as China, are rising
in power.

Indeed, a newly-nationalist tone is already emerging in some corners of Japanese politics: some LDP politicians, for example, are now calling for a re-examination of Japan's constitution.

Such trends are too marginal to trigger alarm yet. But the 1920s moral about economic mismanagement and procrastination cannot be entirely ignored. The rest of the world has every reason to hope that 1999 will be the moment that Japan's second great "Meiji-style" restoration starts. If not, the implications are disturbing.


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