A fiery debate has broken out over an issue many thought had long been settled: Japan’s economy is sliding toward irrelevance.

The freshest evidence, reported earlier this week, is the first annual trade deficit in 31 years. It means, at the very least, that the huge pool of domestic savings that Japan uses to finance its staggering national debt might instead start going to support a trade deficit, an ominous sign.

Not necessarily a problem, says Eamonn Fingleton, a long-time observer who recently wrote an op-ed in the New York Times headlined “The Myth of Japan’s Failure.” His argument that Japan is a model worth emulating generated a huge buzz. So much, in fact, that it prompted a rebuttal from Nobel laureate and Times columnist Paul Krugman, who’s considerably less enamored with Asia’s No. 2 economy. Fingleton then rebutted the rebuttal.

Who’s right? I’m more in Krugman’s camp than Fingleton’s. Japan’s toxic mix of too much debt, too little growth, too many old people and too few babies will end badly if Tokyo doesn’t get its act together.

It’s important, though, to highlight where Fingleton is right. Japan is pretty close to a model society. It is an incredibly safe, clean, efficient, predictable and consistently quirky place for an expatriate to reside. Japan is reasonably egalitarian, its people have one of the highest standards of living and enjoy the longest life spans, and its cities feature the best infrastructure anywhere. On a more superficial level, Japanese cuisine arguably blows away all others.

It’s worth noting that, in some ways, the U.S. only wishes it could become Japan someday. All the chatter about “Japanization” takes on apocalyptic tones: lost decades, debilitating debt levels, zero interest rates forever, financial chaos and existential despair. Although those worries are valid, Japan never unraveled the way skeptics expected.

Crime didn’t skyrocket, homelessness didn’t explode, Arab Spring-like social instability never materialized. Workers and companies merely adjusted, living off their savings. Japan brought a whole new meaning to the concept of muddling through.

Could the U.S. pull off what Japan has? I doubt it. The key to Japan’s ability to withstand 20 years of stagnation is roughly $15 trillion of household savings. Many Americans couldn’t live two months without a paycheck. Japan, by contrast, is anything but a basket case.

Yet here is where Fingleton’s argument falls apart. In 1995, he published “Blindside: Why Japan Is Still on Track to Overtake the U.S. by the Year 2000.” Today, the real blindside among Japan bulls is thinking that what worked for Japan yesterday will work tomorrow.

Since its asset bubble burst more than 20 years ago, policy makers have worked frantically to keep the postwar boom alive. For years, pundits fretted about Japan’s zombie companies. The real zombie is Japan’s economic playbook.

The only reason Japan has any growth can be traced to its growing public debt, the world’s largest relative to the size of the economy, and the free money provided by the central bank. The economic equivalent of steroids is what holds Japan Inc. together, Krugman argues, not its organic vitality. To flourish, Japan needs to ease regulations, tap its female workforce and liberalize immigration. Lawmakers are doing none of the above.

There’s still a powerful aversion to change, and herein lies the nation’s Achilles’ heel. The Olympus Corp. scandal showed how corporate cronyism safeguarded an insular old-boys club. The radiation leaking from Tokyo Electric Power Co. reactors in Fukushima was a reminder of how dangerously top-down Japan is in a bottom-up economic world.

The Japanese news media are part of the problem. Change requires a vibrant and independent press policing leaders. Japan’s press is subject to a not-so-subtle form of control. If a reporter gets too enterprising and writes stories government ministries or companies don’t like ― say, by questioning Tepco’s radiation readings ― the sources dry up, making it hard to be effective. So, most play along.

Japan probably could keep its head down and its sense of uniqueness intact for a few more years were it not for China. Japan is now an incredibly expensive property in a poor neighborhood. Yes, it will be decades before China matches Japan in per-capita income, if it even can. Yet the competitive energy being unleashed by 1.3 billion incredibly industrious people means the status quo in Tokyo is no longer possible. Deflation is here to stay as developing Asia chips away at high-cost Japan’s market share and its prided egalitarianism.

Investors trying to predict the next debt crisis after Europe’s tend to look to Washington or Beijing. What about Tokyo? Those betting against Japanese bonds haven’t made much on the trade. Yet consider one inauspicious milestone reached this year.

On Jan. 9, youngsters celebrated Coming of Age Day, donning kimonos, visiting temples and partying the night away. This year, only 1.2 million Japanese turn 20, half as many as in 1970. A shrinking population complicates efforts to repay a $12 trillion debt, more than double the size of the economy.

It doesn’t take a Nobel Prize to know that paying off debt gets harder when you’re running out of people. 

By William Pesek

William Pesek is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)