Economic recession, now in its seventh year, has left many Japanese apprehensive about their future. Eisuke Sakakibara, Japan's outspoken vice minister of finance, dismisses his countrymen's apprehension as "irrational pessimism" and predicts all this will change with the adoption of a massive stimulus package.

The newly unveiled plan comprises measures valued at $128 billion. Though the bulk of the package takes the form of public spending, Japanese households will eventually come into some $30 billion in tax cuts and credits. The government is projecting a 2% increase in nominal gross domestic product in the first year of the plan's implementation.

After years of policy mismatches, the government must overcome a credibility gap. Dissatisfaction with economic policies has caused Prime Minister Ryutaro Hashimoto's public approval rating to fall to 24%, its lowest since he took office in January 1996.

For some observers the question is not whether Japan's economic pump needs to be primed but whether it needs overhauling. The economist Henry Kaufman cautioned:

"Contrary to the current conventional view, fiscal expansion may help a little, but it is not the fuel that can meaningfully re-ignite the Japanese economic engine. Indeed, it was not highly stimulative fiscal polices that helped to overcome the American weak economy in the early part of this decade but ... decisive action on financial rehabilitation."

As shock absorbers for the country's ailing economy, Japan's financial institutions make too little profit, have lots of bad debt, and are compartmentalized into categories fixed 50 years ago.

Before announcing the stimulus package, the government had moved to craft an American-style bailout modeled after the Reconstruction Finance Corp. of the 1930s, when Uncle Sam bought shares in U.S. banks to help end the Depression.

As part of the $238 billion bailout plan, the government is buying securities issued by 21 banks to improve their capital ratios and to help ease a credit shortage. The bailout plan does not directly address the estimated $600 billion in nonperforming loans carried by banks.

It remains to be seen whether Japan's "big bang" financial deregulation initiative will be fully enacted, changing the fundamental characteristics of Tokyo's financial markets. Some of the items on this agenda, to be implemented by 2001, include legalizing financial holdings companies, lowering the barriers separating banking and securities, and deregulating the insurance sector.

What is clear is that the combination of big-bang reforms and poor returns to savers, who currently receive near-zero interest rates on their deposits, will result in a significant reallocation of the country's tremendous savings.

Without adaptation, it is highly improbable that banks will be able to continue to hold 60% of all savings.

Japan's actions to regain financial credibility and to build a 21st century financial system are crucial to the well-being of the nation and the global economy. The Asian tigers have long looked to Japan for leadership, and in their current economic crisis Japan can show the way with its own reforms.

Though most economies are vulnerable to the kind of run that affected East Asia in the past year, it is clear that such vulnerability is increased when domestic financial systems are strained.

The example of Taiwan is telling. With the lowest nonperforming loan ratios in Asia and the highest per-capita foreign reserves in the world, Taiwan has come through the region's financial crisis relatively unscathed.

Japan has taken a strong interest in the financial stability of its neighbors and trading partners in East Asia, having extended to them credit lines and other forms of import and investment financing in excess of $37 billion in recent months. But its actions of late suggest that its sights are less on financial regionalism than on rising to the challenge of the internationalization of finance.

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