It’s more than 20 years since the Japanese real-estate and stock-market bubble peaked and burst in 1989. Yet for Japan to revive its animal spirits, things need to get worse before they turn around, says Thierry Porte, operating partner at private-equity firm JC Flowers & Co.

Porte was formerly president of Shinsei Bank (JC Flowers & Co continues to hold a stake in the bank), and is also chairman of the Japan-US Friendship Commission, among other activities.

Speaking recently at a luncheon organised by the Asia Society in Hong Kong, Porte cites a 1979 book by Ezra Vogel, Japan as Number One, which was the first book to present a modern Asian society as a competitor to the West.

For the next decade after its publication, Vogel seemed to have been correct, as Japan’s economy and influence leapt from strength to strength. The Nikkei 225 went on to hit nearly 39,000 in December 1989.

Today the Nikkei struggles around the 9,800 mark.

Porte notes that many visitors to Tokyo fail to see why Japan’s two decades of malaise are a big deal, given the obvious glitz and good life on display.

He cites four problems with the ‘big lights, big city’ vibe of Marunouchi and other urban centres: a failure for Japan to contribute to global growth; its reliance on mercantile or protectionist policies; a decline among young people’s willingness to take risk; and sakoku (seclusion, closing off), a term once used for Tokugawa-era autarky and now used to refer to how more young people prefer to stay at home rather than engage the world.

This last one is particularly worrying to Porte, who notes the numbers of Japanese students studying in the United States and other countries has fallen by 40% over the past few years. (He argues that Japan should make study abroad mandatory.)

Those are the symptoms. The causes are several.

First, pricking the asset bubble, which revealed excess capacity and indebtedness, and a need to deleverage. This process was paralleled with a long-term decline in asset prices. But the government did not want to see people get fired, which led to support for zombie companies and, for many years, a refusal to clean up the banks. Companies capped wages and spending, and built up a hoard of cash. This required the government to try to fill the gap with fiscal and monetary policy, but to little effect.

Second, the collapse of the financial system and a banking crisis. It took Japan too long to fix its banks, although Porte says in Tokyo’s defence that the situation was unprecedented and the government lacked the tools to fix the problem. Finally, by 2004, the banks’ dud loans were cleaned up.

Third, the Japanese business model. What Ezra Vogel praised as mutually enforcing advantages – life-time employment, factory and school discipline, LDP leadership, the seniority system – were truly useful for an economy playing catch-up. But the model became a burden. Japan is in the midst of a transition to a new model, but no one knows yet what it will look like.

As an investor, Porte says this situation does create opportunities, both long-term and immediate.

For the long-term opportunities, he says one should be pessimistic. He thinks things in Japan will worsen, but as there is no alternative to true reform, the outcome is going to be positive. Such reforms include reducing the fiscal deficit and the government debt, which keeps real interest rates higher than real growth rates: in other words, deflation.

He reckons Japan has about three to four years before the reality of its debt burden forces it to make real adjustments, such as shedding excess capacity, closing zombie companies and encouraging healthy companies to be more active overseas.

Sectors that are ripe for take-off, if such reforms are enacted, are in services (education, healthcare, tourism) and agriculture.

Although Porte was speaking about Japan, he was also talking about how America is dealing with its burst real-estate bubble. He notes the subtitle of Vogel’s book was “Lessons for America”, which holds true today, albeit under very different circumstances.

Porte says the US should look to Japan to understand the impact of deleveraging, the limits of fiscal and monetary policy to combat deflation, the consequences of postponing political and economic reforms, and the failure to combat vested interests.