In hindsight, it seems clear Japan should have removed the fences as its economy matured. But protected companies continued to build up key allies among bureaucrats and politicians. So while the Sonys and the Toyotas turned into innovative exporting powerhouses, thousands of other companies grew lazy behind a web of formal and informal trade barriers. Today, protectionism is hurting not just the country's trading partners, but Japan Inc. as well. "The 'Japanese economic system' was a marvelous system to help a backward Japan catch up to the West," writes Katz. "But it turned into a terrible system once Japan had in fact caught up."

That's one reason why pouring billions of dollars into the construction industry has done so little good for the economy as a whole. Construction costs in Japan are 30% higher than in the U.S., due to red tape and informal price-fixing cartels called dango that keep foreigners out. Overseas companies won just five of the central government's 767 orders last year, according to the Construction Ministry. The absence of competition allows companies to ramp up prices, wasting taxpayers' money. Despite the government's help, the industry is awash in red ink. Much of the pork flowing in from Tokyo has done little more than prop up sick companies.

The tight control of home markets that has protected mediocre companies also has checked the growth of a U.S.-style consumer society. In the past, Japan's companies have gotten around the problem by exporting what they couldn't sell at home. But now the country has too many factories--and so does the rest of the world. And in the post-cold war economy, Washington isn't willing to let Japan export its way back to recovery at the cost of U.S. jobs. Washington is already threatening to take action against Japan's rising trade surplus. In Tokyo last week, Richard Fisher, deputy U.S. trade representative, warned: "There are limits to tolerance."

Some officials are finally waking up to the seriousness of the problem. In an unusually frank report, the EPA conceded that public-works spending has achieved little besides driving up the debt. The agency also said that Japan should have tackled its bank-loan problems sooner. But the EPA's Sakaiya says turf battles among ministries make fixing the economy an uphill struggle. (The Agriculture Ministry last month called Sakaiya an idiot for questioning Japan's sky-high rice tariffs.) Says Sakaiya: "It takes an enormous amount of energy just to take one step." As the bureaucrats dither, Japan's citizens continue to wait, not for more rosy pronouncements but for real action.

With reporting by Sachiko Sakamaki/Tokyo

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