Despite the ambitious reform plans of Prime Minister Junichiro Koizumi, Japan's economy fell into recession again this year. A failure to solve the country's economic woes could lead to a crisis down the road.

Across Japan, people feel the painful bite of the country's worst economic slump since the second World War. One secretary says she tries to look for bargains and shops at sales more than ever before.

A young man says he now spends just $4 a day for lunch when he used to spend a lot more.

Economic data confirm what most Japanese already know: The economy is in recession, the fourth in a decade, with few prospects for a recovery. A record number of companies went bankrupt this year. The unemployment rate rose to 5.4 percent in October, an all time high. Consumer prices have edged lower every month for more than two years.

The Organization for Economic Cooperation and Development estimates that the economy will shrink one percent in 2002 and grow less than one percent in 2003.

Many economists, such as Richard Jerram of ING Barings Securities in Tokyo, say the downturn has only begun. "I think there are two main issues," he says. "The first is that there is a very severe recession and that is causing job losses and bankruptcies. The second issue is that the financial system is extremely weak."

Japan's banking system is burdened by bad loans, estimated at more than $18 billion. The loans were made to companies that are no longer profitable and can not repay their debts. Economists say the bad loans lead to a range of other problems, such as an ineffective monetary policy with interest rates near zero. The low rates discourage banks from lending even to successful companies, since returns are minimal.

Japanese Prime Minister Junichiro Koizumi vows to force banks to declare the real extent of their losses. The plan is a key aspect of his agenda to rebuild the economy. But doing so could prolong the slowdown and if the government tries to bail out the banks, it could cost taxpayers huge sums of money.

Other key planks of the government's reform program are reining in public spending and cutting the government's own heavy debt burden, the largest among the world's industrialized nations.

Ron Bevacqua is an economist at Commerz Securities in Tokyo. "The country, rather than fix its problems, has tried to borrow its way out. It has failed, and instead run up an enormous budget deficit and debt situation, much worse than the United States had during the Reagan era of the 1980s. There is no sign yet that it is going to be able to correct it," he says.

International credit rating agencies fear the government will not significantly reduce its debts. Moody's, Standard and Poor's, and Fitch IBCA downgraded Japanese government bonds this year. That could lead to higher overseas borrowing costs for Japanese companies that need to raise capital.

External blows also helped knock the Japanese economy to its knees. The September 11 terrorist attacks in the United States took a toll, hitting the already suffering travel and insurance industries.

In addition, Japan's technology and automobile industries saw sales slide as a result of the global economic turndown. Falling demand in the United States and Europe dented some of Japan's most competitive industries, leading to hundreds of thousands of job cuts.

While the picture is bleak, Mr. Bevacqua says that Japan will not enter a depression any time soon. "What really is going to happen is that Japan will trundle along and muddle through the best it can until it hits a really serious crisis, which probably means it will be facing a deflationary spiral, the potential for a depression and the inability to keep borrowing to keep itself afloat. At that point, when it truly hits the wall, is when it will be forced to change. When that occurs is anyone's guess, but probably not in the next couple of years," he says.

Mr. Bevacqua says that Japan's abundant savings and trade surplus will keep it afloat for at least a decade.

Some economists say that in 2002, escaping a deepening recession and rebuilding the economy will remain Japan's leading challenge.

Part of VOA's Year End Series for 2001