Land of the Rising Sun.

Michiho Kishi is showing me around Roppongi Hills, a 54-storey, US$2.2-billion complex in Tokyo complete with observation lounge boasting views of Mount Fuji, a contemporary art museum, an exclusive club where entrepreneurs can exchange ideas, and three Starbucks outlets. Goldman Sachs and Lehman Brothers have their offices here, as did Takafumi Horie until recently. He's the controversial mogul behind Internet giant Livedoor whose January arrest shut down the Tokyo Stock Exchange as panicky investors dumped shares, burning up nearly US$400 billion of the market's value. No worries, says Kishi, public relations manager for Roppongi Hills. In recent years, that may have deepened panic about the economy, but things are looking up and the price of prime office space is set to rise even more.

On March 9, central bank governor Toshihiko Fukui effectively declared Japan's recession over. "The Japanese economy is improving steadily," he told reporters, "with prices having turned positive and expected to stay positive. This trend is strengthening." To back up his words, Fukui announced the bank's intention to end its "loose-money" policy, which kept interest rates near zero for the past five years. With deflation retreating, doubts about Japan are fading fast.

Since bottoming out in April 2003, the Nikkei index has doubled. Corporations like Toyota and Matsushita Electric (maker of the Panasonic brand) are setting record profits, driving a demand for labour that is creating a surplus of jobs for the first time in more than a decade. Real estate prices are rising in Tokyo and other major centres. Business confidence is up, investors are spending and optimism, a word long forgotten when discussing Japanese economic prospects, is now de rigueur. "This is a historic moment," says Donald Coxe, global portfolio strategist for BMO Financial Group. "This is not a false dawn, it's a real recovery. There will be setbacks, but…the reasons why [Japan] got into trouble and stayed in trouble have been worked through."

I'm shopping in Tokyo's Snoopy Town, a large store dedicated to all things Snoopy, from wallets and chopsticks to limited edition Snoopy SUVs. There's no better place to shop on earth than Japan, where there are more varieties of nail clippers than doughnuts at Tim Hortons, and women remain the most important luxury-goods sales demographic on earth. During the recession, shopping may have slowed somewhat, but department stores are once again mobbed, and the stylish Louis Vuitton bags are flying off shelves.

Japan's so-called lost decade began in 1990, when the Nikkei began a sharp drop, losing 80% of its value over the next 14 years. The cause of that free fall was largely bad debt, held by Japan's big banks, which enjoyed an overly cozy lending relationship with Japan Inc., the massive corporations that wield tremendous influence over the economy and politics. Trillions of yen were loaned, obscuring real valuations, while real estate speculation fuelled market hype. When several large financial institutions went under, Japan's credit rating slipped, deflation followed, jobs evaporated and nervous investors held back.

In a culture where absolute loyalty to one's company and political party was rewarded with guarantees of lifetime employment, black-suited salarymen were reluctant to openly question superiors. But as layoffs began to wipe out those guarantees, loyalties faded. "When people realized their company could leave them, in a sense they realized they could leave the company," says Tod Baudin, president of IDA, an Osaka-based translation firm, and a Canadian who has been working in Japan for 17 years. Present since the crash, Baudin foresaw that companies had to change old ways quickly if they were to survive. "Panasonic took tough steps early on," he says of layoffs, "but emerged ahead, wrote off their debts, increased R&D and turned it around."

Then came Prime Minister Junichiro Koizumi. The handsome young reformer took control of the governing Liberal Democratic Party in 2001, his stylish waves of hair like fearsome tsunamis that swept away the old guard. Koizumi gave more independence to regulators and central bankers, pressured financial institutions to clear up bad debts and encouraged younger, reform-minded allies to rise within the party. Koizumi's most ambitious goal is the privatization of Japan Post, the national postal service, the country's biggest employer and the world's largest holder of personal savings at US$2.1 trillion. "By challenging the LDP way of doing things and running against the old guard, Koizumi has built in a mechanism for maintaining reform by winning at the ballot box," says Coxe. He calls Koizumi's September parliamentary landslide an "epochal event," cementing reform and an open economy as the chosen way forward. Turning back is not an option.

Atop the viewing platform of Kyoto's train station, digital cameras are bleeping furiously. "Chinese tourists," remarks Kanako Murayama, director of overseas marketing for the luxurious Hotel Granvia Kyoto. "Actually," Taiwanese," she clarifies. I ask her if she could tell by the accent. "No, by the clothes," she says, adding that Taiwanese have more fashion sense. While Chinese visits are on the rise, Murayama says that conflicting government policies (promoting tourism while restricting visas) need to be fixed. "It's foolish," she says.

To many Japanese, China's spectacular growth is a direct threat to their economic well-being. Mix this with strong racism and nationalist animosities, and China becomes a convenient whipping boy. "There have been waves of anxiety in Japan about Chinese economic dominance, the same way the U.S. did over Japan 20 years ago," says Prof. Mac Destler, of the University of Maryland's School of Public Policy. "But China has become an engine of growth, and there's a lot of Japanese investment in China as well."

In fact, China's boom is credited by many as the "wind of God" that filled Japan's empty sails. As China's manufacturing sector picked up, it created demand for Japan's specialized machine tools. Japanese businesses are now seizing upon opportunities linked to China's rise. "China accounts for 13% of Japan's exports and 21% of its imports; the United States accounts for 22% and 12%, respectively," says Yoji Takeda, the Hong Kong-based director of RBC Investment Management (Asia) Ltd. "Many Japanese companies had established manufacturing facilities in China for cheap labour initially, but increasingly for China's domestic market…Toyota, Honda and Nissan are all ramping up production of their latest models in China, which is likely to become the second-largest automobile market in 2006."

With so much hype surrounding China's economic success, many foreign investors moved money there. But hot on its heels, Japan was growing quickly too, presenting a more secure, if less publicized, environment for investing than its Communist neighbour. "I think people have overlooked Japan because of China" says Philip O'Neill, manager of business development for McGill University's MBA program in Tokyo, and president of the Canadian Chamber of Commerce in Japan. "Everyone's interested in China, but I don't know if they've made any money there. [Japan is] a well-developed market, with very well-educated people. While market regulations aren't so clean, you will get paid. There's a transparent legal system." To those who have heard horror stories about Chinese intellectual property theft, expropriation, quality-control disasters and industrial espionage, Japan is a no-brainer.

Walking along Osaka's trash-free streets, I marvel at how perfect it all seems. "Are you kidding me?" says Kristin, an old friend from McGill University now living here. "Japan? Efficient?" Working as a teacher in Kyushu prefecture, she has seen beyond the sleek Plasma screens and multi-tasking cellphones. Kristin talks about previously unimaginable levels of waste in workplaces: people sitting idly at desks, afraid to ask for more work or to leave early; few automated systems; pointless paperwork so vast that one municipal education office she worked at actually carted it away to an abandoned amusement park.

"The Japanese economy is incredibly bifurcated," says Destler." [There's] an efficient working structure and incredible companies, but the distribution of services is backward, and banking is not advanced. The strength of manufacturing pulled up the economy for a time. As it dropped, service was needed to pull ahead, but it wasn't flexible enough."

To a visitor, this is astounding, as Japan outwardly appears to be the most well-oiled country in terms of service. But talk to any western banker in Tokyo and he will spill forth on the daft backwardness of the Japanese financial system. Things normally taken for granted in Canada are lacking. Workers learn early to keep their heads down and mouths shut. There are miles of red tape, mountain ranges of paperwork, intricate and confusing codes and traditions governing relationships and power-all wasting money. Add to this a regulatory framework that is obscure and incomplete, and it can spell financial disaster. The problem with the Livedoor crash in January was that the stock exchange's systems were antiquated and ill-equipped, and its management too slow and inflexible to foresee it.

As foreign investment in public companies forced western-style governance upon the Japanese, things have improved recently. Still, according to the Office of the United States Trade Representative's 2006 report, Foreign Trade Barriers in Japan: "Despite being the world's second-largest economy, Japan continues to have the lowest inward foreign direct investment (FDI) as a proportion of total output in any major OECD nation…Cross-border M&As are more difficult in Japan than in other, countries, partly because of conservative attitudes towards outside investors, and partly because of differing management techniques and the relative lack of financial transparency and disclosure. The scarcity of qualified lawyers, auditors, arid accountants is another impediment."

Five metres of snow are piled up outside Osamu Yamazaki's ski chalet, a record-breaking year for this northern resort in Niseko, Hokkaido. When Yamazaki, a former Olympic mogul skier, isn't carving deep powder, he sells investment management software to a growing number of Japanese online investors. The past few years have seen smaller venture-capital-focused markets emerge, coinciding with the retirement of the first wave of baby boomers. "There's still a lot of interest after Livedoor," says Yamazaki, referring to the large number of day traders out there. Even though he lost money in Livedoor's crash, his faith in the market is unshaken. "Investment in stocks and the market is the best way [to make money]," he says. "Up until now it was 'work like a dog, you know, hand-to-mouth." As more boomers retire, Yamazaki says, they'll be looking to the market to provide for them.

Just as it gets back on its feet, Japan has begun dying. Literally. This year, for the first time, Japan's population will likely decrease. If this continues uninterrupted (Japan does not have a pro-immigration policy to offset native decline), there could literally be no Japanese in four centuries. Immediate effects will be felt sooner. As baby boomers retire, fewer workers will fill their spots, diminishing taxpayer revenue to fuel the social services necessary to care for a rapidly greying population. "In a funny kind of way, Japan is the wave of the future," says Coxe. "If you have demographic decay, you cannot generate a sustained domestic consumer boom." While the real estate market is on the rise in big cities, towns in the countryside are emptying out, becoming shutter communities. Soon enough, real estate supply will meet the demographic slide and flatten out.

The generation now in the workforce needs to lift a tremendous weight, but here, the legacy of the recession may come back and bite Japan. Many now in their 30s emerged from university over the past decade with nothing on offer but minimum wage and part-time jobs. With no transferable skills or experience, this group, called "freeters," will have a tough time picking up the slack left by retiring boomers. Without a committed, long-term plan 'to deal with its demographic problem, Japan's revival as an economic leader could face another setting sun.

PHOTO (COLOR): Japanese women stroll past Chanel mega-shop in Tokyo's Ginza fashion district

PHOTO (COLOR): Panasonic giant screen outside Tokyo's Shibuya Station

PHOTO (COLOR): Snoopy Town store in Tokyo mall

PHOTO (COLOR): Central bank governor Toshihiko Fukui

PHOTO (COLOR): Prime Minister Junichiro Koizumi

PHOTO (COLOR): Electronic share price board in Tokyo

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By David Sax