Twenty years ago, the conventional wisdom was clear: Japan was the world’s most successful high-income country. >Few guessed what the next two decades held in store. Today, the notion that Japan is on a long slide is conventional wisdom. >So what went wrong? What should the new Japanese government do? What should we learn from its experience? >We must put this in context. The quality of the train system and the food make a visitor from the UK realise he comes from an utterly backward country. >If this is decline, then most people would welcome it. >Yet decline it surely is. Over the past two decades the economy has grown at an average annual rate of 1.1 per cent. >According to Angus Maddison, the economic historian, Japan’s gross domestic product per head (at purchasing power parity) rose from 20 per cent of US levels in 1950 to a peak of 85 per cent in 1991. >By 2006, it was 72 per cent. In real terms, the value of the Nikkei stock market index is a quarter of what it was two decades ago. >Perhaps most frighteningly, general government net and gross debt have jumped from 13 and 68 per cent of gross domestic product in 1991, to forecasts of 115 per cent and 227 per cent in 2010. >What has gone wrong? Richard Koo of Nomura Research points to “balance sheet deflation”. >According to Mr Koo, an economy in which the overindebted devote their efforts to paying down debt has the following three characteristics: >the supply of credit and bank money stops growing, not because banks do not wish to lend, but because companies and households do not want to borrow; conventional monetary policy is largely ineffective; >and the desire of the private sector to improve balance sheets makes the government emerge as borrower of last resort. As a result, all efforts at “normalising” monetary and fiscal policy fails, >until the private sector’s balance-sheet adjustment is over.