Japan loses its economic thrust: The Nikkei index dropped 647 points on Monday, a sign of the recession stifling strong post-war growth. Terry McCarthy reports

ECONOMISTS, bemused at Japan's inexorable economic growth, used to refer to 'communism that works'. The centralised economy run by bureaucrats who dispensed administrative guidance to company executives and labour leaders alike appeared to differ little from the centrally planned economy of the old Soviet Union - except that in Japan everything worked.

Unemployment was negligible. Management-labour relations were stage-managed to avoid conflicts that might damage production. The financial markets were rigged to supply big corporations with cheap capital. Domestic markets were protected by a maze of regulations and invisible discriminatory practices. Export markets were relentlessly identified and exploited. Japan's single-minded pursuit of growth became for scaremongers the economic equivalent of the Soviet nuclear threat.

Things have changed. Communism is a relic of the past. The Soviet Union is no more. And things are not working so well in Japan, either.

The gloom on Tokyo's stock market, where the Nikkei index registered its largest drop this year of 647 points on Monday, to close at the year's low, has again focused attention on the sickness of the Japanese economy. The market rebounded on Tuesday, but is still 20 per cent down over the past four weeks. Analysts have produced an array of reasons for the latest market slump, from mediocre mid-term results from corporations to an imminent switch of the market index and manipulations by arbitrageurs.

But underlying the market fall is a deeper malaise. The country has been through two years of economic slow-down already with no sign of a recovery. Ninety six per cent of businessmen polled by a Japanese paper over the weekend said the recession would last at least until this time next year. Economists predict the economy will contract by some 0.5 per cent this year.

In previous recessions an external cause - oil price shocks or currency realignments - could be clearly shown to be the root of the problem. A willingness to learn from and adapt to changes from outside has been one of the secrets of Japan's success.

This time the recession has been home-grown. The problem is not so much how to adapt the economic structure to new circumstances; the problem is the economic structure per se.

The elite cadres from the Ministries of Finance and International Trade and Industry who masterminded Japan's post-war economic miracle have outlived their usefulness: centralised decision-making is stifling corporations' ability to innovate and keep pace with new business areas. Ichiro Ozawa, one of the leaders of Prime Minister Morihiro Hosokawa's new government, has pointed out that Japan is lamentably behind in fibre-optic technology - because of wrangles over licensing between the Ministry of International Trade and Industry and the Ministry of Posts and Telecommunications.

According to the Management and Co-ordination Agency, ministries have the power to issue regulatory permits and approvals in 10,942 categories across the economy. When Mr Hosokawa asked for a list of possible deregulatory measures, bureaucrats put forward a list of 90 suggestions. Bureaucratic sclerosis was not unique to the old USSR.

Another structural problem is the labour market. The old social contract where employees were assured a job for life in exchange for company loyalty is no longer sustainable. Companies could sweat out a few bad years without releasing workers, confident that when rapid growth resumed they would recoup the swollen payroll costs. With the economy maturing, there is little chance of rapid growth resuming.

No one dares to talk of lay- offs: at worst companies undertake 'employment adjustments', including early retirement and transferring employees to subsidiaries. But one way or another jobs are going. Unemployment reached 2.7 per cent in October from 2 per cent a year ago; economists predict it will exceed the all- time high of 3.1 per cent of 1987 within the next six months.

And the export-led growth that will this year give Japan a dollars 150bn ( pounds 101bn) trade surplus is rapidly becoming unacceptable to its trading partners, in Europe, the US and Asia. For future growth, Japan will have to redirect its attention inwards, to its consumers who have paid too much for too little for too long. Prices for everything from beer ( pounds 10 per pint) to a semi-detached house ( pounds 400,000 in a modest Tokyo suburb) are absurd. And consumer spending accounts for only 56 per cent of GNP in Japan, compared to 64 per cent in Europe and 68 per cent in the US.

Deregulation, more flexibility in the labour market and a shift away from export-led growth to domestic demand represent huge challenges to the social consensus of post- war Japan. The government has said it is committed to economic reform, but has achieved little so far, and is getting little help from bureaucrats who are jealous of their power. Even the relatively straightforward decision to cut income taxes and spur consumer spending has been delayed because of opposition from the Ministry of Finance.

Japan is not facing a Soviet- style economic collapse. With an economy five times the size of the UK and corporations that wield immense power around the globe, Japan will continue to be a keen economic competitor. But the mystique of 'communism that works' is rapidly disappearing as Japan seeks a way out of its worst recession in 50 years.

Leading article, page 32