How America Lost Its Industrial Edge

Economic commentator Eamonn Fingleton speaks bluntly about what he sees as the frittering away of the United States' manufacturing base and what he regards as the consequent stagnation of the American standard of living. For those who believe in the superiority of the current U.S. postindustrial strategy, a reading of the OECD Economic Yearbook makes for a distinctly chastening study. As Fingleton puts it: "The United States trails no fewer than eight other nations, all of which devote a larger share of their labor force to manufacturing."

Fingleton, who distinguishes between high-end and low-end jobs, insists that the former, advanced manufacturing, must be reconstituted if the United States wants to remain a superpower. And what are these eroded industries? Semiconductor materials, ceramic packaging for semiconductors, charge-coupled devices (CCD), industrial robotics, numerically controlled machine tools, laser diodes and carbon fibers, to name only a few.

Where did the manufacturing of these items go? In most cases, Japan now dominates the more advanced areas of these industries, says Fingleton, who lives in Tokyo. Moreover, he argues, by dint of superior know-how and large capital investments Japan now enjoys a global lock on key manufacturing processes.

Fingleton recalls an America where men and women went to work and made the nation great, the old-fashioned way, by producing products people wanted and needed. And he juxtaposes the loss of advanced manufacturing jobs in this country with what he regards as the overvalued dollar, America's compulsion to borrow huge sums of money to fund its deficits and an illusionary U.S. prosperity based on unsustainable debt. For now Japan and China, both running huge trade surpluses, pay the United States' bills, he says. Where does this leave the American worker? He puts the answer simply: Out of work!

It is not true that Japan is in dire economic straits, Fingleton maintains. In a recent article in the London journal Prospect entitled "Japan's Fake Funk," he writes: "The Western consensus is that Japan is a basket case: It is not. That is a misreading by the West."

Meanwhile, he says, ill-conceived U.S. policies have failed to protect home-based American industries, leading to the transference of the most advanced technologies known to mankind. Fingleton says flatly that Japan has built up its industrial base at the expense of the United States, and that China now is chomping at the bit to do the same.

Insight: You speak of the transference of hard industries. What do you mean by that?

Eamonn Fingleton: I mean those engaged in advanced manufacturing. Specifically, industries that are both highly capital intensive and highly know-how intensive. They typically are many orders of magnitude more capital-intensive and know-how intensive than the most advanced of "New Economy" services, such as computer software developed in the last three decades.

Although Japan is known in the West for its leadership in certain consumer products such as cars and television sets, its area of greatest leadership is in much more advanced industries that largely are invisible to the consumer. Specifically, Japan leads almost right across the board in the sort of advanced materials, high-tech components and production machinery that are driving the electronic revolution. Some products may be assembled in the United States, but their key manufacture - the manufacture of the advanced components and materials - is done in Japan.

Q: Do U.S. manufacturers hide from the American people how dependent they are on foreign suppliers?

A: The impression given is that outsourcing is done within the U.S. and that available components come from many sources. But it is clear that most advanced components and materials now are outsourced from Japan. Corporate America is very guarded about its dependence on foreign suppliers, and this applies in spades to outsourcing by American defense contractors.

A: It is absolutely gone. The U.S. started losing its edge about 30 to 40 years ago. By the early eighties, America was already in serious trouble.

The sad truth is that advanced manufacturing accounts for only a very small part of the total U.S. economy and much of it merely is customizing equipment for the needs of the American market. Final assembly of manufactured products often is carried out in the United States and, to the extent that it is the sort of manufacturing that requires close proximity to customers, it likely will stay in the United States.

Meanwhile, high-tech manufacturing here largely has disappeared, particularly mass-production manufacturing. American companies can make almost anything if price is no object, and thus they can produce in small batches, for instance, for defense purposes. But they no longer master the mass-production techniques that are necessary to be cost-efficient in serving world markets.

Q: How vulnerable are Americans to job dislocation and unemployment because of what's happened to advanced manufacturing in this country?

A: I believe most of the job loss already has taken place. The blue-collar worker we all knew some 30 to 40 years ago was the backbone of the American economy. He or she was the best-paid worker in the world. But more and more Americans of average ability now are employed in "Mac-jobs" within the service industries. Typically they are not as well paid as in manufacturing.

The manufacturing jobs are gone, and the U.S. standard of living has been impacted badly by this. When I first came to the United States in the 1970s, I was stunned at how wealthy Americans then seemed. Since then, Western Europe largely has closed the wealth gap with the United States, so that living standards even in a country like Ireland that seemed poor a few decades ago are not far behind American levels.

Q: You describe significant job loss to Japan at the high end of the industrial food chain. Are low-end jobs endangered, too?

A: At the higher end of the food chain, Japan already has taken its bite: The jobs are gone. There now is a serious threat emanating from China, which is vying for the lower end of American manufacturing. Beijing is moving very fast and threatening what remains of the job base in the United States.

A: Blue-collar workers have been hit hard and the erosion of their jobs will continue. But America is of course now overwhelmingly a service-based economy, and jobs in services largely are insulated from international competition. America as a whole is therefore feeling relatively little pain, even in currency markets.

East Asian economies are supporting the U.S. dollar as well as funding the U.S. trade deficit. As a result the dollar has not shown the effects of the hollowing out of American manufacturing, but we are about to see the free market play itself out in the currency markets.

A: It is obvious to many in the U.S. financial sector that Japan, China and, to a lesser extent, Taiwan are supporting the dollar in an organized effort to benefit their own industrial policies. These nations want to promote their manufactured exports, and the lower their exchange rates are vis-à-vis the dollar the more profitable it is for their manufacturers to export.

The dollar now is vastly overvalued vis-à-vis the East Asian currencies. The best way to look at this is to ask yourself a question: How low would the dollar have to fall to enable the United States now to balance its trade deficit? To answer that, you have to look at both the state of American export industries and the extent to which the United States now is dependent on imports for goods that it no longer can make - at least cannot make in mass-production volumes.

The numbers are shocking. In the late 1980s the U.S. dollar traded above Y140 [yen]. Today, the dollar trades at Y117. So we have seen some depreciation even since the Japanese bubble collapsed in 1990. But, for the United States to begin to win back export markets, we probably would have to see the dollar fall to Y60 or lower. A 50 percent devaluation against the Chinese currency also is necessary.

A: It began in the 1960s and became really serious from the mid-1970s onward. One key factor early on had been a U.S. government policy of transferring technology to Japan. There was an American tendency to underestimate the Japanese competitors. This was particularly apparent in the electronics industry, where American companies that won contracts to supply semiconductors to IBM, for instance, would be required by IBM to license a "second source" - a company that could continue to supply if the primary contractor were hit by an act of God.

American companies like Motorola and Intel invariably chose to license Japanese companies to do such second sourcing, on the theory that the Japanese were incapable of eating America's lunch.

Also, there existed a very powerful Japanese plan to extract technology from this country. By the early 1970s, Japan was the second-largest economy in the world, a market that could not be ignored. Firms such as IBM and others were eager to sell their products in Japan. But the Japanese insisted on a quid pro quo. If an American company wanted to sell in Japan, it would have to manufacture there. Then, when the company moved to the next stage of the technology, it often closed down its American factory and served the entire world market from its Japanese operation. Sometimes technology transferred to the Japanese subsidiary leaked to the company's major Japanese competitors.

It all adds up, and now America imports much of its manufactured goods, with the current account deficit at 4.7 percent of GDP [gross domestic product] and almost all of it related to manufacturing. By comparison, the worst trade deficit in the early 1970s when [Richard] Nixon took the U.S. off the gold standard was just 0.5 percent of GDP.

A: Many jobs indeed. But there was also the myth known as the "New Economy," which for 20 years had been growing in fashion.

I was working then at Forbes magazine in New York and I recall how struck I was by the large number of sophisticated people I met who exclaimed that "the future is in services! Manufacturing is a commodity business! We need to get out of it!"

Indeed, America did get out of it. Having allowed its manufacturing base to disappear, the U.S. now is in possession of almost an entirely service-based economy - beating all standards of economic history. The manufacturing sector exports, on average, 11 times more, based on per unit of output, than do service industries. Herein lies the problem: The United States no longer produces the goods to pay for its imports. You have to fund the gap.

For 30 years the United States has run these trade deficits. In the early days, they were relatively small and explained away as a temporary phenomenon. They long since have ceased to be considered temporary even by the most trenchant advocates of laissez-faire.

They have major negative consequences for the United States, particularly in undermining America's ability to project economic power abroad.

Don't get me wrong: I am not saying imports are necessarily a bad thing. But when the United States must go to foreign central banks with its hand extended to fund huge trade deficits for decades on end, something is desperately wrong.

A: Highly dependent. Two countries now are serious capital exporters: Japan and China. There is one huge capital importer: the United States.

The U.S. Treasury is more and more beholden to the Japanese Ministry of Finance, which is a power-driven organization. One doesn't want to be an alarmist, but there is the matter of sovereignty here. It is inappropriate that the world's superpower is dependent on government agencies in other nations to get it through the day.

Q: You argue that the information economy is not the key to future prosperity. Why isn't it?

A: You are referring to the subtitle of my book In Praise of Hard Industries: Why Manufacturing, Not the Information Economy, Is the Key to Future Prosperity. The point I was making is that the prospects for the information economy, meaning the all-digital service economy that the American press was then talking about, were vastly overblown. Many of the services being created were basically worthless, a point that has been resoundingly vindicated by subsequent events.

I should make clear, however, that my argument carried no Luddite content. I pointed out that the Internet and many other manifestations of the information economy that were so hyped at the time were indeed great advances for the world in general. But the idea that America could somehow establish a hammerlock on such services and thus graduate to some ineffably higher level of prosperity by providing them to the world was the purest nonsense.

In reality, many of those services are highly labor-intensive and, to the extent that international trade can be conducted in them, they should be located in places such as India, Russia, Latvia and so on, where labor is much cheaper than it is in the United States.

Meanwhile, the United States would be well-advised to follow the lead of the Japanese, the Germans and the Swiss by maintaining and enhancing its position in advanced-manufacturing industries.

Prospect Japan's fake funk November 2002 The Japanese economy is far from being a basket case. In fact, during the 1990s, Japanese living standards and trade surpluses continued to rise and the country extended its lead in key technologies. But the gloom story diverts attention from Japan's closed markets and its economic alliance with China

Eamonn Fingleton For a decade now, the western consensus has been that Japan is an economic basket case. But this is a dramatic misreading of a perennially secretive society. Indeed, it may come to be seen as one of the most significant misreadings in economic history.

The geopolitical implications of this misunderstanding go far beyond Japan or east Asia. The myth of Japan's "collapse" has encouraged the west to imagine that the east Asian economic model (largely an extension of the Japanese model) is inherently flawed. Beyond a certain point, the argument runs, a nation must embrace the Anglo-American free-market model or flounder. Amongst other things, this view has fostered a dangerous degree of complacency towards the rise of the overtly authoritarian Chinese economic system. Incomes in China are still only a fraction of Japan's but if ever China comes close to matching Japan's success it will be bigger than the EU, the US and Japan combined.

Any summary of the case against the consensus must start by acknowledging that Japan has, of course, suffered serious financial strains in the last decade. But these strains have been largely confined to the financial sector and have done little, if any, damage to other areas of the economy. On the contrary, the wider Japanese economy has quietly thrived-so much so that, in many of the ways that matter to Japanese policy-makers, Japan has actually now surpassed the US to become the world's leading economy. In particular, measured in terms of its ability to project economic power abroad, it is Japan, not the US, that is the world's leading superpower.

As generally recounted, Japan's story in the last 20 years is a morality tale of the perils of overarching ambition. It begins in the mid-1980s when Japan suddenly seemed to be sweeping all before it. But just as this new Sparta was on the verge of vanquishing the freedom-loving west, fate-in the form of the Tokyo stock market crash of 1990-intervened. The wheels came off the Japanese economic pantechnicon. Ever since, Japanese leaders have been engaged in increasingly comical efforts to get them back on.

This story has enormous appeal in the west-not least for the free-marketeers who edit the business pages on both sides of the Atlantic. But the key reason why this story has been so widely accepted is because various vested interests want it to be believed. The most important such vested interest is the Japanese economic establishment. For Japanese economic planners, the most obvious benefit of the basket case story has been its effect in cooling the west's once dangerous anger over Japanese trade policies.

The truth is that dozens of facts contradict the gloomy consensus. Here are just a few.

1. Living standards increased markedly in Japan during the so-called "lost decade" of the 1990s, so much so that the Japanese people are now amongst the world's richest consumers. (See box p39.)

2. Japan's trade has continued to expand. Its current account surpluses totalled $987 billion in the "disastrous" 1990s. This was nearly 2.4 times the total recorded in the 1980s (when Japan was already seen as the "unstoppable juggernaut" of world trade).

3. Although you would expect the Japanese yen to have declined sharply against, for instance, the US dollar in recent years, the reverse is the case: the yen's dollar value has increased 17 per cent since the beginning of the Tokyo financial crash.

4. At last count, the all-important Japanese savings rate, which has been the main driver of the country's success, was 8.7 per cent of GDP. By comparison, the rate for the US was 5.7 per cent and for Britain only 4.5 per cent. In the 1990s, Japan routinely accounted for nearly 30 per cent of all new savings in the OECD group of rich nations. It is sometimes suggested that Japan's high savings rate is a problem. If so, it is a problem that most of the world's nations would be delighted to have. (To the extent that there are excess savings in Japan, these can be easily and-in national power terms-usefully deployed in buying foreign assets.)

5. Japan has continued to invest heavily in its industries and infrastructure. Investment per job in manufacturing, for instance, has consistently run at about twice the rate of the US over the last decade.

6. Although the eagerness with which Japanese investors snapped up foreign assets in the 1980s was a major reason why Japanese expansionism came to be eyed so suspiciously in the west, Japan's net foreign assets have continued to mushroom. As measured by the IMF, they nearly quadrupled in the 11 years ended in 2000. How do we reconcile this with reports that the Japanese banks' problems have been forcing a wholesale retreat by Japanese finance from foreign markets? The reports are nonsense. A nation's ability to export capital is a function not of its banks' financial health but rather of its trade performance: each dollar of current account surplus creates a dollar of capital exports. So long as Japan runs the world's largest current account surpluses, it will remain the world's largest capital exporter.

7. As a glance at Tokyo's crane-filled skyline confirms, even in the hard-hit real estate sector the pace of investment has continued at an astonishing rate. An all-time record of more than 2.2m square metres of new office space will be completed in Tokyo next year. On the site of a disused railyard near the Ginza shopping area, no less than 12 major buildings and many smaller ones are being erected in one huge development which will create more space than was contained in the towers of the World Trade Centre.

8. Japan passed the US in the early 1990s to become the world's largest foreign aid donor and, as of 1999, it was paying out 67 per cent more in aid than the US. The UN is only the most prominent of many international bodies that depend heavily on Japanese money. (Japan accounted for nearly 20 per cent of the UN's budget in 2001.) Tokyo is reaping a rich reward in terms of rising influence in everything from the International Whaling Commission to Fifa.

9. Corporate Japan's worldwide spending on sponsorship-from motor racing to universities-has grown by leaps and bounds. In the latter half of the 1990s, Japan's sponsorship budget in the US alone increased by about 80 per cent. In Britain, an interesting instance of recent Japanese sponsorship is the Asahi Shimbun newspaper's donation for the British Museum's Great Court. It is hard to imagine, say, the Guardian, which is roughly the Asahi's British counterpart, doing anything similar in Tokyo. In fact, the Guardian can't afford a staff correspondent there. By contrast, on the strength of big increases in advertising in the last decade, not only can Japanese newspapers like the Asahi afford large bureaus in Britain but they can undertake extensive goodwill programmes.

Western analysts manage to overlook the above achievements, and tend to focus on various alleged crises for Japan that, in reality, are no such thing. First, consider the claim that Japan's manufacturing industries are being driven to the wall by China. The mistake analysts make here is to assume that the Japanese economy is still highly labour-intensive. But Japan is probably the world's most capital-intensive economy at present. Capital-intensive Japanese companies supply the sophisticated components, materials, and machines without which labour-intensive Chinese factories would have no exports. Japanese exports these days are not television sets and pocket calculators but rather machine tools, electricity-generating plants, railway rolling stock, broadcasting equipment, telephone switching equipment and internet routers.

Capital goods industries are invisible to the consumer and thus Japan's dominance in many of them is easy to overlook. But capital goods are the ultimate fount of the world's wealth and historically the nation that dominates their manufacture-Britain in the 19th century, America in the first 75 years of the 20th century-has been ipso facto the world's leading economy. Capital goods industries are the toughest to break into because they require not only heavy investments of capital but large reservoirs of highly-sophisticated proprietary know-how-usually know-how that takes decades of learning-by-doing to acquire. It is no surprise that in many of the capital goods industries in which they are strong, Japanese companies face no significant competition from anywhere, let alone from third world nations like China.

Second, what about the claim that the Japanese economy is in the grip of a deflationary spiral? Actually, what Japan has been experiencing is similar to the persistent deflation the US experienced in the late 19th century. This was when the US went from rural backwater to the world's most powerful economy.

In Japan today, as in the US then, monetary policy has been so effective in maintaining the currency's domestic purchasing power that the economy's rapid productivity improvements translate into a steadily falling price level. This is hardly a recipe for large profit margins. The result is a feel-bad feeling in corporate Japan. Similarly, as described by the historian Walter LaFeber, the productivity-induced deflation experienced in the US in the 25-year period to 1897 was "economic hell." But it was thanks to US industry's market-glutting productivity improvements in this period that the US succeeded Britain as the world's greatest economy.

Third, it is claimed that Japan has been eclipsed in high technology by a resurgent US. This mantra of the 1990s has admittedly been less often heard in the wake of the bursting of the American internet stock bubble in 2000. But it was never true. All the evidence is that Japan has greatly lengthened its lead in the last decade. Take, for instance, the crucial area of supercomputers. Japan and the US ran neck and neck in this industry for many years, but Japan has now clearly broken ahead. At last count, the title of the world's fastest computer was held by a weather-forecasting computer made by Tokyo-based NEC. By contrast, the fastest American supercomputer, an IBM-built machine used for designing nuclear weapons, is little more than one third as fast.

Japan's lead in supercomputers is hardly surprising given its domination of most of the enabling technologies driving the global electronic revolution. The world now depends on Japan for virtually all of the many highly-purified materials needed to make computer chips. To make today's ultra-powerful chips, you need ultra-pure silicon, for instance. US companies led the industry into the 1980s but they have long since fallen by the wayside. In the race to develop ever purer silicon, such unsung Japanese technology leaders as Shin-Etsu, Sumitomo Sitix and Mitsubishi Materials have now prevailed.

Japan leads the world also in the production of countless high-tech components such as laser diodes (the enabling components in the CD family of digital devices) as well as in the optical fibre networks that have transformed the communications industry. Meanwhile, Japan dominates in the supply of all nine major enabling components in mobile phones. A Deutsche Bank Securities study found that 29 out of 36 suppliers of these components were Japanese.

The story is similar in the advanced machinery used to make electronic components. Take so-called steppers-the minutely precise optical devices that print circuit lines on computer chips. Broadly speaking, a chip's power is a function of how much circuitry can be packed onto it. So the technological imperative is to develop ever more precise steppers that print ever finer lines. American companies once dominated the stepper industry but Japanese companies like Nikon and Canon have now taken their place. The only other significant producer is ASM, a Netherlands-based company which sources its optical technology from Zeiss of Germany.

Japan's high-technology dominance has been sealed by several key high-technology acquisitions in the US in recent years-acquisitions that would have created a political firestorm in Washington in the "Japan-bashing" 1980s. Take Furukawa Electric's purchase last year of an advanced optical fibre business from financially distressed Lucent Technologies. At a stroke, this gave Japan clear control of a crucial industry formerly dominated by the US. (The optical fibre business has been in a slump for the last two years-but this is a short-term factor that hardly bothers Japanese corporate leaders.) Another example is Hitachi's announcement earlier this year that it was buying IBM's path-breaking disk drive business. The deal includes IBM's Almaden Research Centre in California, which was described by the New York Times as one of America's "science and technology jewels."

Fourth, even the west's understanding of Japan's financial trauma has been wrong-headed. If the western press is to be believed, bad loan problems have threatened an uncontrollable wave of banking collapses. Yes, the Japanese banks have suffered huge bad debts from their ill-considered late-1980s lending binge. But there is no risk of a domino effect. And the banks' problems peaked as far back as 1997-reflecting the fact that virtually all the problems are ultimately traceable to Japanese real estate and shares, whose prices have fallen little from their mid-1990s lows. Since then, the banks have been progressively restoring their balance sheet strength thanks to the generous "spreads" they enjoy between their lending and deposit rates.

Moreover, the financial malaise has not starved Japanese industry of investment capital. Far from it; faithful Japanese savers have continued to save, thereby producing the wherewithal for the financial system as a whole to maintain and indeed expand its financing of Japanese industry.

One of the most remarkable aspects of the basket case story is how it keeps mutating. As in a Harrison Ford movie, no sooner does Japan dispatch one problem than a more daunting one emerges from the deep. At first, the problem was the stock market collapse. Then it was the banks' real estate loan problems. Then other problems swiftly followed: the banks' accounting for the loan losses, a consumer spending funk, and a corporate investment strike.

The latest "disaster" is Japan's allegedly out-of-control government spending. But Japan's budget problems are grossly exaggerated. OECD figures show that in the first eight years of the 1990s, Japan actually ran large budget surpluses. Since then the government's position has deteriorated somewhat but is still no worse than many other nations.

It is often pointed out that Japanese government debt supposedly represented 120 per cent of GNP in 2000. This does seem shockingly high-but, unbeknownst to most western observers, it is a gross figure that should properly be netted for the Japanese government's huge and continually increasing financial assets. These include not only the world's largest foreign exchange reserves, but extensive holdings of its own bonds. On a net basis, Japan's national debt represents just 51 per cent of annual GDP-higher than the US's 43 per cent but lower than that of most other developed countries.

As Adam Posen of the Institute for International Economics in Washington has pointed out, the Japanese debt scare is a storm in a teacup. "Savings, public and private in Japan, is a vast multiple of the government debt, so there is no solvency problem." And, as Posen notes, when the Japanese government borrows, it borrows almost entirely from its own citizens-only 6 per cent of Japanese government debt is owed to foreigners. By contrast, the US depends heavily on foreigners, notably the Japanese, to fund its national debt.

Press suggestions that Japanese public spending is inordinately wasteful are equally unfounded. Typical of such suggestions is a now notorious comment by The Economist on the opening of the Akashi Kaikyo bridge in the mid-1990s. The Economist dismissed the new engineering marvel-at 2.4 miles long, it is the world's longest suspension bridge-with the headline, "The bridge to nowhere in particular." Thus began a media myth that much of Japan's public spending is squandered on "bridges to nowhere."

In reality, in ultra-densely populated Japan, it would take a truly perverse genius to build a bridge to nowhere. Some bridges, it is true, lead to what are (by Japanese standards) relatively underpopulated areas. But such projects are hardly wasted in a nation where so few citizens enjoy easy access to the countryside. In any case, the Akashi Kaikyo Bridge links the Osaka region to Awaji Island. Awaji's 160,000 residents hardly think of themselves as living "nowhere." For them, indeed, the bridge is their only road connection to the mainland. Perhaps more important in the long run is that the bridge promises to induce a more equitable distribution of population in the congested Osaka region.

No one would suggest that every yen of the Japanese budget is well spent. The point is that the abuses do not seem disproportionate in relation to the many badly needed projects that have been undertaken in recent years. In my own area in inner Tokyo, for instance, two new underground railway lines have opened in the last two years. The area has also been the recipient of, yes, a new bridge. The Rainbow suspension bridge has greatly eased traffic in central Tokyo. Further south is the new Aqua Line, which by dint of a 5.9-mile tunnel (the world's longest sub-sea road tunnel) offers millions of cramped Tokyoites rapid access to recreation areas across Tokyo bay in Chiba for the first time. Another improvement in central Tokyo is in the sewage system, which has been transformed in the last decade. Each of these projects accounted for a large chunk of the national budget (construction work is expensive in no-immigration Japan, where even the least skilled male worker is paid a full breadwinner's wage). But anyone who knows Tokyo would find it hard to argue that such improvements are unnecessary.

As the story of Japan's alleged public spending profligacy indicates, much of the responsibility for the west's misunderstandings must be put down to the western press. Relatively few correspondents speak or read Japanese. Moreover, they are blinded by western ideas that do not apply in Japan. They assume, for instance, that the stock market plays as prominent a role in Japanese finance as it does in British or American finance. When the Tokyo stock market crashed, this was seen as comparable to the Wall Street crash. In reality the stock market is regarded by the Japanese establishment as a rather dirty sideshow that can be neglected for years on end with impunity.

Similarly, westerners assume that Japan, in common with nations like Britain and the US, is avidly competing in some sort of financial beauty contest for the favours of the world's investors. That this is nonsense should be apparent from the fact that for decades Tokyo fiercely resisted American requests for even a token opening of Japanese financial markets. In the end, whether or not foreign investors consider Japan an attractive place to invest is irrelevant because, in contrast with Britain and the US, Japan is a capital exporter, not a capital importer.

Whatever the western media's responsibility, the lion's share of the blame for the misunderstandings rests with the Japanese establishment. The impression of dysfunctional economic management in Tokyo is no more than grand kabuki-a thespian exercise in mock distress acted out by a Japanese elite that has always believed in cloaking its true agenda. Such theatrics are fundamental to Japan's administrative culture-a culture whose father-knows-best ethos imposes no obligation on leaders to speak frankly to their own people, let alone to outsiders.

For example, official press packs distributed to visiting journalists routinely describe the economy as being in a "slump." (The word connotes, among other things, very high levels of unemployment-several times anything Japan has suffered in the last decade.) In April 1998, Sony Corporation chairman Norio Ohga went on record saying, "The Japanese economy is on the verge of collapsing." A few months later, Toyota president Hiroshi Okuda added that Japan's problems could trigger a "worldwide financial crash." When corporate chiefs talk like this, we might assume their comments reflect their own corporations' experience. In fact, profits in 1998 for both corporations were much higher than in 1989, the last year of the Japanese boom. In Sony's case, the growth relative to 1989 was 131 per cent; in Toyota's 56 per cent. If the latter figure seems modest, it compares favourably with the performance of Ford and General Motors in the same period.

One thing is clear: given the country's success in boosting both its consumers' living standards and its exports, its economic growth numbers have clearly been understated in recent years. (Official statisticians can readily manipulate the figures by varying assumptions about, for instance, qualitative improvements in economic output.)

None of this subterfuge is new. Japanese leaders have a long tradition of artfully understating their country's strengths. In the late 1930s, for instance, the Japanese military let it be known that Japanese soldiers couldn't shoot straight and that Japanese planes were made of paper. In the event, Japan's opening gambit in the second world war, the Pearl Harbor offensive, proved a military masterpiece.

Business leaders play the same game. When I arrived in Tokyo in 1985, the car industry conceded it was good at making small cars but it was somehow incapable of making anything the size of a Mercedes-Benz or a Cadillac. In the late 1980s, however, Japanese car makers launched the Lexus, the Infiniti and other superbly built top-of-the-line limousines.

Why would the world's most proficient car makers affect such humility? In retrospect their motive is obvious: they were concerned to calm the fears of western competitors (who in the event proved all too willing to take Japanese false modesty at face value).

The basket case myth serves many propaganda purposes, of which trade diplomacy is merely the most obvious. The myth has also proved serviceable as an excuse for not compensating victims of Japan's second world war atrocities and in batting down unsolicited requests from poor countries for development aid. (Japan's aid programme favours east Asian nations; other nations are politely refused with an excuse about the state of the Japanese economy.)

Even foreigners in Japan have an interest in fostering the myth. Expatriate executives in Tokyo, for instance, find that sob stories about the Japanese "slump" are the perfect excuse for a sub-par business performance. And for foreign diplomats, who in the Japan-bashing climate of the 1980s had to spend most of their time trying to tear down Japan's trade barriers, life is much easier. Now that the Japanese people have come to be universally seen as too poor or too scared to consume, western diplomats in Tokyo can go back to the status quo ante of exchanging elaborate pleasantries with top Japanese officials.

For foreign correspondents too, the basket case story is heaven sent. It not only guarantees them a frequent position on page one but, in a country where covering other forms of news is often very hard, it requires little effort: most of the sources are English-speaking analysts who, in sharp contrast with the extreme formality of normal Japanese practice, are happy to be interviewed by telephone.

All this might seem like merely an interesting sidelight on how different this "globalising" world still is, except that the geopolitical consequences are so important. Apart from the obvious point that the "collapsing Japan" myth has bought Tokyo's trade bureaucrats a decade of undeserved peace, there is the larger point that it is clearly facilitating the transformation of China into a true superpower. Certainly, if westerners in general-and Americans in particular-had understood how well the Asian economic system has been doing in the last decade, they would have been far more wary about welcoming China into the world trading system.

But surely if Japan's fake funk has facilitated the rise of an unpleasant new superpower on the east Asian continent, Japan would be the first to be concerned. After all, as portrayed in the western press at least, few nations are as wary of China as Japan-and vice versa. In reality, however, leaders of the two countries are far from daggers drawn. Although the public rhetoric on both sides is not always sweetness and light, they share much common ground-most obviously a centuries-old aspiration to rid east Asia of western influence. Although it is often assumed that America's military bases in Japan are there to protect the Japanese from China, the truth is they signify Washington's fears, not Tokyo's.

As seen by Japanese leaders, the task of ridding east Asia of western influence is already half complete. By dint of decades of Japanese mercantilism, America's once world-dominating export industries have been almost completely gutted-and with them America's ability to project economic influence abroad. To put it at its most basic, whenever Washington wants to project economic power abroad these days, it must first phone Tokyo for the money.

Moreover, Japanese leaders are already planning for the day when China will take over as the world's most powerful economy. Although when measured at market exchange rates China's economy is today no more than one quarter the size of the Japanese economy, it is closing the gap rapidly. Given their uniquely clear-sighted insight into the wealth-creating potential of the east Asian economic system, the Japanese expect China to become the world's largest economy in little more than 20 years. And with economic success will surely come commensurate military power.

The underlying warmth of the relationship is evident in trade matters. Although Japan has never had any compunction about erecting barriers to US exports, it has welcomed many of China's exports with open arms (including exports of electronic goods which it generally does not accept from the US). Even more significantly, Japan has permitted its leading companies to transfer important technologies to China-something that it has usually opposed in the case of other nations, including the US.

But all this has to remain sub rosa for now if the Japanese-and of course the Chinese-are to retain privileged access to the US market. By promoting the myth of its economic collapse, Japan has pulled off the near impossible: it has retained good relations with the US, while tipping the global balance of power in China's favour. Eamonn Fingleton's attack on the internet stock fad, "In Praise of Hard Industries," was published in 1999

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