Q&A: Japan's economic problems

Construction companies are collapsing with multi-billion dollar debts. The economy is shrinking, the fourth recession in a decade is well advanced and after throwing money at the problem for years, Japan is up to its ears in debt. 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 in recession, this is much more difficult.

And the day of reckoning for the banking sector cannot be prolonged much longer, 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.

The combination of these factors, with rising unemployment and falling prices, has led many analysts to predict a deepening recession in Japan.

The prediction appears to be coming true. The latest figures show that in the 12 months to September the economy shrank 2.2%, and few would bet on any early improvement.

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 early December, 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.

The Bank of Japan charges 0.25% as a base rate.

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 could jeopardise the increasingly fragile political hold on power of the ruling Liberal Democrats.

Admittedly, the current Prime Minister has an advantage denied his predecessors: he is popular.

The incumbent, Junichiro Koizumi, appears different from the rest of his party. He speaks clearly, he has told the electorate that recovery will be a deeply painful process, and that resonates with a country sick to the back teeth of incompetence and time-serving at the top.

But there are many who think that for all the words nothing will actually be done. Even if Mr Koizumi himself is a real reformer - and that is far from certain - he could (and usually is) hampered by others in his own party.