In 2002 I stood almost alone among international observers ofthe Japanese economy in predicting that Japan's future was stillbright--and that three percent economic growth was quite attainableover the next few years. Some, especially the prophets of a rapidJapanese meltdown, Argentina-style, mocked this prediction. Otherswere simply skeptical. But suffice it to say, the Japanese economyhas now shown eight straight quarters of economic growth. Annualreal growth in the third quarter of 2003 was at 3.3 percent--and anastonishing 7.5 percent in the last quarter--beyond my guardedlyoptimistic estimate. While Japan faces real problems--which havebeen discussed in these pages in past issues--they are far frompermanent. And economic data have clearly shown that the pessimistsare wrong. Japan is moving in the right direction, and growth islikely to be sustained for the next few years, barring aninternational convulsion.

Key to Japan's re-emergence is the fact that throughout Japanesehistory, determined leadership has arisen in response to crises,reshaping the nation's destiny. The impetus for change has broughtabout a turning point, allowing Japan to exit the counterproductivecycle of deflation, fiscal imbalance and public sector growth forstructural economic reforms that will return Japan to anentrepreneurial society ready to reassert a leadership role in Asiaand the world.

The institutional logjams affecting Japan both in the corporateand government sectors are well known. For now, though, it is clearthat Japanese companies have begun to take the bitter medicine longprescribed by global investors. Firms have been buying back theirown stock and some are consolidating through mergers orrestructuring. Capital investments made, particularly in themanufacturing sector, are beginning to pay off.

Weltschmerz is rapidly disappearing from the Japanese worldview,and a dim fog seems to be lifting from the economy. For the secondconsecutive year, Japan will outperform U.S. and European markets.This is a modest achievement based on the postwar past, but a vastimprovement over conditions in the 1990s. In most analyst surveys,Japan is the least popular region for investment relative to abenchmark global stock index. Skepticism is widespread, and as oneWall Street wag noted, "Japan is of no general importance except asa laboratory experiment for deflation."

This position is myopic. Unlike the herd of market analysts whoonly see the Japanese glass half empty, a new, more hopefulposition is starting to emerge based on compelling evidence. Forone thing, so-called cross-shareholder unwinding, that is, banksoffering underwriting and clients taking stakes in banks, haspeaked, thereby reducing the interlocking economic arrangements andthe selling pressures in the market. Companies with large cashpositions have been buying back their stock. Toyota MotorCorporation bought back 453 billion yen of its shares. Telecomprovider KDDI Corporation bought 235 billion yen of its shares,while Matsushita Electric absorbed 99 billion yen of its stock.

Jim Rohwer, author of Remade In America: How Asia Will ChangeBecause America Boomed (2001), makes the case that Asia'sgargantuan pool of household savings--approximately $15 trillion,with the overwhelming portion of it in Japan--is beginning tostream into stocks. Rohwer notes that new issues drew $109 billionafter the 1997 crash, marking the first time Asian companies raisedmore in the market than from banks. Rohwer contends that when Japanawakens from its economic slumber it will derive enormous benefitsfrom the 90 percent of the Asian pension fund assets it alreadycontrols.

Japan has also seen a dramatic increase in merger andacquisition activity in 2003. Most industries have participated inthis trend, which has helped productive firms gain market share.Seiko Epson Corporation, which produces the Colorio ink-jet printerand holds 50 percent of the Japanese consumer printer market,soared 35 percent in its debut on the Tokyo stock exchange, beatingthe 26 percent increase in the Nikkei after it hit its bottom inApril 2003. Nippon Steel, which consistently fell short of targetsin the 1990s, shows signs that restructuring efforts have begun tobear fruit. Company profitability rebounded significantly in thelast quarter of 2002, with operating profit up 35 percent.Moreover, consolidation has given the company a larger market sharethan was previously the case.

The senior management of JGC Corporation--a Japanese oilservices company--finally came to the surprising conclusion that ifit discarded obscure and impenetrable accounting practices, itmight secure foreign investment. This happened with Deutsche Bank'sasset management arm. And JGC is not alone. A host of Japanesecompanies have adopted transparent accounting practices, in manyinstances overtaking their American counterparts in variousdisclosure statements, according to Standard & Poors.

Partly because of this openness, more foreign companies aretaking controlling stakes in Japanese corporations--somethingunheard of until recently. Britain's Vodafone, for example,acquired 67 percent of Japan Telecom, and Renault has 44 percent ofNissan.

One of the biggest converts to openness is Mitsubishi--once thesymbol of the secretive keiretsu system in which affiliated groupsoperate in an accounting fog. Now, however, Mitsubishi outpacesEastman Kodak, Hewlett Packard and Microsoft in its accountingdisclosures.

It is also instructive that the Bank of Japan--largely resistantto change in the past--is getting the message. In a recent address,Osamu Takemoto, the bank's chairman, argued for increased liquidityalong with structural reform in order to offer the economy a fiscalstimulus. Significantly, he maintained that the Bank of Japan mustexplain the aims of "quantitative easing", since the public doesnot have a clear idea of the government's goals. Takemoto wasobviously arguing for consensus for change--a consensus, I shouldhastily note, that is starting to emerge.

Nippon Keidanren, the Japan business federation, has a blueprintfor Japan in the 21st century that emphasizes openness,competition, deregulation and regional integration. Clearly thebusiness community is beginning to appreciate the fact that thecommand economy of the past, which involved top-down decisions,cannot define Japan at this time.

Of course, these are mere baby steps on the road to recovery,but the giant steps will be taken with the marketing of new,value-added products--the high-end technology most in demandworldwide. Japan again leads the way in flat-screen televisiontechnology and digital cameras. Masahiko Sato, Manager of EquityMarketing at Nomura, notes that Japan has rediscovered itsmanufacturing zeal: "With demand for flat-screen tvs and digitalcameras now soaring, the Japan that had lost confidence in itsability to make things has now unearthed it again."

Koichi Tanaka, who won a Nobel Prize in 2002 for chemistry, washonored for developing a new way to measure proteins, an innovationthat has revolutionized the drug industry and brought enormousprofits to Shimadzu, a publicly traded precision-instruments firmwith annual revenues of $1.6 billion.

The Yokohoma Institute for Earth Sciences has developed theEarth Simulator NEC-GS40, the world's fastest computer, powerfulenough to create realistic models of the planet's atmosphere,oceans and crust. It can perform 35 trillion calculations persecond, five times faster than its nearest competitor.

Japanese companies are already leaders in solar power and arerapidly gaining a foothold in fuel cell technology. Nippon SteelCorporation is developing a 10 kilowatt solid oxide fuel cell thatis 10 percent more efficient that the conventional polymerelectrolyte fuel cells (PEFC) for the same cost. Moreover, solidoxide fuel cells have a life span 10 times longer than PEFCs andare much more resistant to deterioration.

Tokyo Gas and Mitsubishi Heavy Industries, Ltd. have developedan efficient method of extracting hydrogen from natural gas to useas an energy source for fuel cells. This development improves thepossibility of using existing natural gas fueling stations forproducing and supplying hydrogen to fuel cell cars. Japan plans tohave 5 million fuel cell cars on its roads by 2020.

The Toyota Motor Company leads world automobile companies in thedevelopment of the intelligent vehicle, one that can parallel parkautomatically and is loaded with sensors that will reducefatalities and accidents substantially. While U.S. car companiesare investigating similar technologies, Toyota will haveestablished a niche by being the first to market the "smartcar."

At the Riken Brain Science Institute outside of Tokyo,scientists found levels of a plaque-causing enzyme that seems to bethe primary culprit behind Alzheimer's disease. Although a cure isnot imminent, this discovery is considered critical and may lead topreventive drugs and treatment.

If one aggregates the internal reforms such as transparency,mergers, competition, monetary easing and technological advantages,a case can be made that Japan is poised for an economic takeoff,with growth beyond the 2003 level. Naysayers, of whom there aremany, are likely to note that if Japan frittered away a decade withbotched policy decisions and Keynesian formulations that didn'twork, why should the future be different? The answer resides in thenotion that no government demands widespread sacrifice until thealternatives have been exhausted.

Japan has reached that point. Infrastructure projects did notpull Japan out of recession, nor did low interest rates.Politicians can no longer console themselves with illusions. Thetime for structural change has arrived.

Nonetheless, the future of Japan may not be related to presenttrends. There are those who contend that the motion of currentevents will catapult Japan into an era of great success. As formerWhite House economist Larry Lindsey noted: "A cyclical upswing isbecoming embedded in the Japanese economy." There are thepessimists who argue that Japan cannot escape a debt overhang thatis at 140 percent of GDP. Yet amazingly, Japanese banks haveeliminated more than 15 percent of their non-performing loans inthe last year. With the appropriate policy decisions, Japan willemerge from a decade of despair and enhance the positive trend thatis beginning to emerge.

Although the Japanese economy is looking much better today thanjust a year ago, the nation is not out of the woods yet. Furtherstructural change is still needed to tap the incredible potentialof the Japanese people and restore the nation's economic vitality.It is also the case that much of the recent growth can beattributed to exports, with particular attention given to China.Should China lapse into recession, it could have a dampening effecton Japanese growth.

Nonetheless, Japan is now poised to build on the economic growthof the past two years and create a solid economic foundation in thedecade ahead. With the appropriate measures, the Japanese can lookback on the "lost years" (the 1990s) as a lesson learned and not tobe repeated.

The so-called setting of the Japanese sun, predicted by JamesFallows, among others, is largely a mirage derived in part from thelens that observed unprecedented success between 1950 and 1990.Four decades of success produced the illusion that any investmentwould lead to a significant rate of return. Many ill-advisedinvestments prompted by government linkages to the banking industryprecipitated the debt crisis. But the government has learned itslesson. Hence, debt is being reduced and the Nikkei is showingsigns of vitality. Although the growth rate will not measure up tothat of Japan's greatest boom years, 3 percent GDP growthcompounded should produce a new generation of wealthy Japanese.

It is no surprise that Wall Street is finally taking notice.Japan is back on the investment radar screen. The sun is notsetting in Japan. Rather, it is starting to rise. Any other bet inthe next couple of years is likely to be misguided.