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Wednesday, 14 August, 2002, 17:03 GMT 18:03 UK
What caused Japan's recession?
Japan has been suffering stagnant economic growth and a series of recessions for more than 10 years. How has a country once seen as the ruler of the 21st century come to such a pass? And what, if anything, can the government do about it?

Why is Japan's economy in decline?

Japan is still suffering from an economic crisis that hit the country in 1989-90, when the "bubble economy" of high land prices and high stock market prices collapsed.

Both banks and businesses had much of their assets in either land or in cross-shareholdings with companies to which they were allied.

Suddenly, these assets - and therefore the debts on which they were secured - were wiped out.

As a result, banks became burdened with bad debts and lending to companies for expansion dried up.

Gradually, companies which produced in Japan have shifted some of their factories abroad, increasing unemployment.

And as unemployment rose to record levels, people have stopped spending so freely, causing prices to drop.

This makes everyone more reluctant to spend in the hope that they might get even greater bargains in the future.

What might happen next?

Japan has been seriously affected by the world economic slowdown.

In the past, exports by its large and successful companies have helped sustain its economy, but with the US economy wobbling, this is much more difficult.

The day of reckoning for the banking sector is getting closer, with banks being forced finally to declare their non-performing assets.

In addition, Japan is suffering from a large debt overhang from its excessive government borrowing, which will have to be reduced to lower long-term interest rates.

What has the government tried to do?

The government has repeatedly tried to stimulate the economy by spending money on public works.

The result has been some very well-equipped - if often unnecessary - regional infrastructure projects, but relatively little of the money spent reached those who have been made unemployed.

Much of it has in fact gone into the coffers of Japan's huge construction companies, which have very close links to ruling party politicians.

The spending has kept them afloat; without it many might already have gone bust. As it is, the first domino fell in December 2001, as Aoki Construction went under with debts totalling 522bn yen ($4bn).

And the massive outlay means government borrowing has reached 130% of GDP, higher than any other industrialised country.

This means that in the long run Japan will have to reduce its spending levels, at a time when it is facing increased pressures from an ageing population and the increased cost of health care.

And that could prove politically painful.

Can lower interest rates help?

Japan already has near zero interest rates.

It has now said that it will also buy Japanese government bonds to help boost the money supply

But despite the low interest rates, with the worsening economic prospects it is not easy to persuade either consumers or companies to borrow more money.

And long-term interest rates are dragged down by the huge government debt burden, despite the low overnight rates.

What are the prospects for reform?

The Japanese government says it is committed to structural reforms like eliminating its budget deficit and forcing the banks to declare the real extent of their losses.

But its reform programme has been made difficult by the severity of the downturn.

Making more banks insolvent could prolong the economic slowdown and eventually cost the government a lot of money if it has to assist with the bail-out.

And cutting government spending is a tricky political process.

The incumbent Prime Minister, Junichiro Koizumi, is known to be a reformer, and he has stressed his determination to press on with economic reform even if it means short-term hardship.

But there is little evidence so far that Mr Koizumi's words are being put into practice.

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