Japan: A Rising Sun?

THE THIRD WAY AND PROSPERITY

As Japan enters the twenty-first century, it sits on the brink of the biggest transformation in its history. Some observers want to write off Japan as stuck in a cycle of debt and deflation, but today's structural reforms in the Japanese financial system are quietly setting the stage for an economic revolution. Although rebuilding the Japanese economy will be no easier now than it was during the Meiji Restoration or after World War II, the present changes are more fundamental than anything the country has ever seen. Japan's revolutionary path will utterly transform it from the state-run industrial powerhouse of the twentieth century toward an innovation-driven, globalized economy of the twenty-first.

This transformation, however, is not necessarily synonymous with economic recovery. In fact, an overhaul of this magnitude is likely to shrink the economy as Japan initially encounters higher unemployment, lower capital investment, and other deflationary problems. But these downturns are temporary. Japan's financial sector is being reformed -- forcibly changing the way companies do business. As it develops, this new financial system is sowing the seeds for an entirely new Japanese economy -- one driven by innovation and competition among small and medium-sized enterprises and high-tech companies. The old economic guard of Japan still receives most of the world's attention. But the real action is taking place in the smaller, newer, more creative enterprises that will bring twenty-first-century prosperity to Japan.

THE EMPEROR'S LAST STAND

The spark that ignited Japan's economic revolution was cast by the collapse of the nation's financial system in the late 1990s. Until that collapse, Japan preferred that the government have nearly total control of the economy. While other modern democracies relied on free-market competition to distribute capital, Japan spent the last century perfecting a financial system that allocated capital according to government criteria. In fact, the recent affinity for state-directed economic policies began much earlier. When Japan isolated itself from the rest of the world during the Tokugawa era (1603-1867), the shogunate tightly controlled all domestic activity, from transportation to commerce.