By Clay Chandler
Washington Post Foreign Service
Monday, January 5, 1998; Page A01

TOKYO – Every Japanese schoolchild learns the bittersweet tale of Urashima Taro, the boy who rides the back of a giant turtle to a magic palace at the bottom of the sea. The visit seems brief, but Taro returns to discover that he has been away for many years. In his absence, time has transformed his village beyond recognition.

A modern-day Urashima Taro, had he left Japan as it was slipping into recession in 1990 and then returned this year, would have the opposite experience: Despite a few changes, he would find conditions in the world's second-largest economy depressingly familiar.

Japan's economy is barely growing, its stock and real estate markets are in the cellar and its banks are buried in bad loans. Consumer confidence is faltering, corporate bankruptcies are at record levels and the jobless rate is creeping to a post-World War II high.

And, just as in 1990, prospects for recovery remain in doubt.

Financial crises elsewhere in Asia have prompted investors and government officials around the world to wonder whether the giant Japanese economy, too, might be in danger of collapse. That possibility can't be ruled out, but the more likely scenario is that the former vigor of Japan's economy will pass with a whimper, not a bang.

The real risk for Japan, some analysts argue, is not that its current economic difficulties are so severe, but that they aren't severe enough. Short of a genuine calamity, the pessimists say, Japanese policymakers will see no reason to reassess the centrally guided economic model on which they have relied since World War II.

That model -- characterized by cozy alliances between government and industry, murky accounting rules, carefully ordered labor markets, special protections for domestic producers and heavy reliance on banks rather than the equity markets for corporate funding -- worked spectacularly when Japan was struggling to rebuild its war-torn economy and catch up to U.S. firms.

But now Japan's prolonged stagnation casts a cloud over the world economy that is perhaps more ominous than the blowups in other Asian nations. Japan's economy is seven times the size of China's and its gross domestic product (GDP) accounts for nearly 75 percent of the total output of all the countries in East Asia.

U.S. financial institutions in particular have developed a dense web of relationships and contractual obligations in Japan, while their connections in the rest of Asia remain relatively tenuous. And for U.S. exporters, even a tiny piece of the Japanese market is worth more than a big chunk of markets elsewhere in the region.

Many analysts expect Japan's GDP growth to come in at zero for last year, after adjustment for inflation. The government is projecting real growth of 1.9 percent for fiscal 1998, but private sentiment is considerably more bearish, with several economists estimating growth of less than 1 percent.

Such poor performance compounds Japanese economic policymakers' worst problem: As Japanese society ages, there will be fewer workers generating wealth, and more senior citizens claiming public benefits and drawing down their savings. By 2025, 26 percent of the Japanese population will be older than 65. Economists at the Organization of Economic Cooperation and Development estimate that by 2030 rising pension expenditures could produce a crippling budget deficit-to-GDP ratio of nearly 20 percent.

Robert A. Feldman, chief economist for Salomon Smith Barney in Tokyo, warns that Japan must achieve huge gains in productivity just to maintain current living standards, let alone to raise them.

"Japan will face major difficulties in maintaining living standards over the next 30 years," Feldman said in a recent report. "At recent levels of productivity growth, per capita income cannot even be kept flat in the face of an aging population."

After seven grinding years of recession and the prospect of a gradual decline in living standards, many economists, business leaders and ordinary citizens now say they're convinced that Japan has outgrown the postwar set-up and must replace it with more market-oriented institutions.

However, the bureaucrats who sit at the apex of the current system don't share that diagnosis -- in their view, the old machinery only needs a bit of tweaking. Meanwhile, the nation's political leaders have shown neither the ability nor the inclination to push for real reforms.

A telling example of how this mindset plays out is Japan's response to the growth of the Internet.

Thousands of jobs and new companies have been created in the United States to provide services for the Internet. To many U.S. observers, American achievement in these areas is a testament to the diffident, hyper-competitive culture of entrepreneurs in Silicon Valley and elsewhere -- and the speed with which profit-hungry venture capitalists have rushed to fund their best ideas.

But officials at Japan's powerful Ministry of International Trade and Industry have derived a different lesson. What has impressed them is that the Internet was developed with an initial shove from the U.S. government. And so they are herding rival Japanese firms into a publicly funded consortium that is developing online computer-aided design technologies to integrate the operations of Japanese manufacturing facilities around the world.

"We see a lot of opportunities" for Japanese companies on the Internet, a trade official said. The ministry does plan to turn the whole project over to the firms, he added, "once we get things going."

Just across the street from MITI, at the headquarters of the Ministry of Finance, the story is much the same. Officials there are scrambling to prop up the nation's banking system with a series of ad hoc reforms they hope will keep weak lenders alive until the economy recovers. Last month they postponed tightening capital adequacy requirements for domestic lenders to head off a credit crunch. This month they will coach politicians from the ruling Liberal Democratic Party in drafting plans for administering an $80 billion "financial stabilization fund."

The United States has experience in this area, too, with the 1980s savings and loan crisis. After several years of propping up weak thrifts just to see their losses get larger, the United States spent $156 billion in public money to close insolvent lenders, pay off depositors and auction off the remaining assets. Today U.S. lenders are in a strong position. But that kind of shock therapy is seen as far too messy and disruptive at Japan's finance ministry.

"We do not anticipate further bankruptcies," Japan's vice minister for international finance, Eisuke Sakakibara, told a group of foreign journalists last month.

In America, seven years of economic stagnation might terrify incumbent legislators -- or at the very least spark a national debate about reform. In the 1992 election, Bill Clinton claimed the White House with his platform, "It's the economy, stupid."

But economic malaise has not galvanized the opposition in Japan. Instead, leaders of the main opposition parties have spent recent months bickering over internal differences that have little bearing on the economy.

With Prime Minister Ryutaro Hashimoto's approval ratings plunging daily, Ichiro Ozawa -- the blunt-talking power broker who many Western observers had considered Japan's best hope for reinventing its political culture -- staved off a challenge for control of the party that he founded in an internal election. Then days later, he formally disbanded the group and declared his intention to start a new party with a new name.

"Even by Japanese standards, policy-making has been too reactive and characterized by a remarkable degree of vacillation and inconsistency," said Russell Jones, chief economist for Lehman Brothers in Tokyo, in a recent note to clients. "This is not an environment conducive to a sudden and rapid escape from the deepening cyclical malaise."

At a quarterly dinner meeting in an upscale Tokyo hotel last month, members of "The Bad Girls' Club," an informal group of about 50 accomplished Japanese career women with jobs in advertising, fashion, academia and civil service, blamed the torpor of Japan's economy on the fact that the nation's most important government agencies and biggest corporations are monopolized by men.

Because women traditionally have been excluded from top positions in Japan's mainstream institutions, many of those who have succeeded here have a far more entrepreneurial outlook than their male counterparts -- some say they would be delighted to take an ax to the postwar model.

By contrast, many Japanese men are conditioned to think of their salary as a function of their age, instead of a reflection of their contribution to the economy. Older men thrown out of work by the recent wave of corporate bankruptcies, for example, said in interviews that they despair of finding new employment on the grounds that their seniority will mean they "cost too much."

Over breakfast at Tokyo's ANA Hotel the other morning, an executive for one foreign firm, negotiating for potential hires with a representative from a faltering Japanese company, found it necessary to stress twice that he didn't want to interview anyone too proud to take orders from someone younger.

There are a few signs that Japan is loosening up. Two years ago, for example, Henry Wallace, a Scottish executive from Ford Motor Corp., was named president of Hiroshima-based Mazda Motor Corp. And all the fuss about corporate bankruptcies is beginning to generate clients for Akio Mikuni, the long-suffering proprietor of Japan's only independent corporate bond rating concern. Recently his company moved to larger quarters.

Meanwhile, Masayoshi Son, an upstart software entrepreneur who has been heralded as the "Bill Gates of Japan," plans to join the big leagues of the Japanese equity market later this month by listing his company, Softbank Corp., on the first section of the Tokyo Stock Exchange. Despite nagging questions about financing, most analysts think the profit outlook is healthy at Softbank, whose businesses include the Comdex computer trade show in Las Vegas, computer publisher Ziff-Davis Inc. and a 37 percent stake in the Yahoo! Internet navigator.

Together with Australian-born media baron Rupert Murdoch, Son, who was raised in Japan's Kyushu region but is of Korean descent and was educated at the University of California at Berkeley, is planning a 150-channel digital satellite broadcasting service in Japan.

That grand plan is possible because of recent changes in Japan's cosseted telecommunications sector. Since the government bowed to U.S. pressure in 1994 to open its market for cellular phones, for example, competition has forced down prices and consumer demand has soared. Subscriptions have skyrocketed to 34 million in 1997. Economists have estimated that deregulating mobile phones has added over $10 billion in new demand to the Japanese economy.

Such examples remain an anomaly in Japan.

Evidence of the old way is on display along the Tokyo waterfront, where a tangle of mammoth exhibition halls, hotels, and office towers rises from man-made islands in the middle of Tokyo Bay. The sprawling development, hatched at the peak of the "Bubble Era" in 1989, was built by a consortium of private firms and the Tokyo metropolitan government at a total cost of more than $80 billion. Backers initially projected monthly office rents of $400 per 3 square meters. Actual rents have been less than half that -- and Tokyo taxpayers have been asked to help foot the bill.

The difficulties of overcoming such deeply ingrained habits have led a few die-hard reformers here to joke darkly that they envy South Korea, where the danger of imminent default is forcing drastic economic liberalization to qualify for an emergency credit from the International Monetary Fund.

Japan, of course, is too rich to need a bailout from the IMF. Even with its problems, it remains the biggest creditor nation in the world. Yet it can ill afford this prolonged stagnation.

Still, even many Japanese who say reform is needed shudder at the idea of embracing U.S.-style capitalism -- with its harsh focus on individual responsibility and clear distinctions between winners and losers.

"Like many IBM veterans who would still like to keep pushing out mainframe computers in a PC world, Japan continues to adhere to obsolete policies simply because they used to work," wrote Richard Katz, the New York correspondent for Japanese business magazine Diamond Weekly, in a recent essay published in The Washington Quarterly. Japan's leaders, Katz argued, are "blinded by the glare of past triumphs."