Why the West should be worried

FOR 20 years in the Seventies and Eighties it seemed the Japanese economy could do no wrong. Japanese cars replaced British on our roads, their electrical goods put UK suppliers out of business, innovation with products like the Sony Walkman proved they were not just copiers of Western ideas, and Japanese banks became so large it seemed Tokyo would soon replace the City and challenge Wall Street as the world's leading financial centre.

Then in 1989 the Tokyo stock market bubble burst, and as the financial sector unravelled it highlighted the hollowness of much of the Japanese wealth creation machine. It still has, in companies like Honda and Sony, Toyota and Mitsubishi, some of the world's greatest firms, but they could not compensate for the inertia in Japanese business, or the inability of its government and society to adjust to the pace of innovation worldwide.

It takes a while for this to sink in because shops are still full of Hitachi televisions, roads are still lined with Nissan cars, and most people don't realise these are now built in Britain. That Japan's domestic economy has been on the slide for 12 years, and few in the West have paid attention, might be taken as proof that in a selfish world it does not matter very much to us. It will though if too much pain at home means they can no longer afford to locate these plants abroad - Japan is one of the biggest providers of manufacturing jobs in the UK.

The problem goes deeper. Because Japan is second only to the US in economic might it generates huge capital. The Japanese do not want to invest at home for obvious reasons so they pour money overseas and bring chaos in their wake. Japanese saving fuelled the Asian boom and its subsequent bust in 1997, devastating the Pacific rim economies. Japan moved on to Wall Street, stoked the technology boom, and its bust led to a worldwide economic slowdown.

That is why Japan matters. The world economy is a three-legged stool of the US, Europe and Japan. If one leg is weak, the economic world can never be stable. What is really worrying is that things in Japan seem to be getting worse not better. A City joke asks: 'What is the difference between Japan and Argentina?' Answer: 'Five years.' If it does go that way we will all be caught in the backwash.