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Something new is happening in Japan. For the first time since the end of the Koizumi era in 2006, the country has a prime minister who is expected to serve a full term, has a clear notion of what needs to be done to revitalise Japan's economy and society, and who has - since Sunday's comfortable victory for his party in the Upper House elections - the political means to implement his plan to make Japan "a great country".
Could it be that the long period of debilitating drift in the world's third-largest economy - the two decades marred by stubborn deflation - is now coming to an end? For the first time in many years, the atmosphere was quite different at the ninth annual Japan Roundtable in Tokyo. A sense of cautious optimism and anticipation was palpable among the business leaders who participated in the meeting.
There were reasons for that. After he came back to power last December, Prime Minister Shinzo Abe launched his three-pronged programme, which was quickly dubbed Abenomics. As with many things in Japan, this initiative is linked to an allegory: the one about Lord Mori Motonari, who wanted his three sons to work together. He took three arrows to show his sons that if the arrows were taken separately they could be broken easily, but if they were taken together they could not be broken. In the same way, Mr Abe wanted to illustrate that the three prongs of Abenomics had to be taken together: an aggressive easing of monetary policy, a flexible fiscal policy and a set of structural reforms as a growth strategy.
What is truly innovative about Abenomics is the delinking of the reflation agenda from the agenda to restore growth through structural reforms - a bold move by Mr Abe. The Bank of Japan had always set structural reforms by the government as a precondition for taking significant reflationary measures. The prime minister got rid of the Bank of Japan governor and replaced him with Haruhiko Kuroda - who was formerly president of the Asian Development Bank - to initiate an aggressive monetary policy as the first step of Abenomics.
The first two parts of Abenomics have worked well so far. The Bank of Japan's aggressive quantitative easing has generated a lot of liquidity, and a significant supplementary budget has also created some stimulus in the economy. The objective is to achieve two per cent inflation over the next two years, thereby putting an end to the deflation that had stifled consumption and growth. This has led to the beginning of a virtuous circle: the weakened yen is supporting an increase in exports, which is helping boost business confidence and investment. This has driven up the stock market and helped increase domestic consumption. Both consumer sentiment and business confidence - as illustrated by the latest positive reading of the Tankan - have improved significantly.
Mr Abe's strategy, however, is not without risks. The supplementary budget has increased Japan's sky-high public debt, and the rise in Japan's sovereign borrowing costs may become a concern - all the more so because the budget deficit stands at 10 per cent of GDP and the country's public debt at 237 per cent of GDP. The goal of getting back to inflation in the next two years might be too ambitious since deflation is so entrenched - this might take at least five years, according to some experts. And Mr Kuroda might have to do even more to achieve this goal: until now the Bank of Japan's quantitative easing has represented a 50 per cent expansion of the its balance sheet. By comparison, the US Federal Reserve has expanded its balance sheet by 250 per cent. If Mr Kuroda follows his plans, the Bank of Japan balance sheet expansion would be 160 per cent - which might not be enough.
So an efficient reflation of the economy might require even more radical thinking and action. But everybody now recognises that a drastic growth strategy of a different dimension is required. Half-baked measures won't do. This time, contrary to past episodes of aborted reforms, the stability of leadership should ensure the stability and continuity of policy. There is a growing realisation that Abenomics is the only chance for Japan. The determination showed by Mr Abe - for instance in getting Japan to join the negotiation on the Trans-Pacific Partnership agreement despite opposition from agricultural lobbies - and the change in the attitude of the bureaucracy have generated a greater sense of optimism.
But the government will have to provide a clear road map, along with milestones, to answer the questions at home and abroad about Japan's ability to implement Abenomics. Everybody is now waiting for Mr Abe to announce a set of structural reforms - or his growth strategy - in September. In this respect what was announced in June on much-needed labour reform was by far too little. The prime minister has sent the right message by declaring that he will focus on structural reforms in the labour, energy, healthcare and fiscal domains and will wait for his other key objective of reforming the Constitution, especially abrogating the pacifist Article 9.
Mr Abe's success in revitalising Japan's economy and society does matter a lot outside Japan. This is, after all, the world's third-largest economy, with tremendous technological and scientific capabilities, as well as leadership positions in energy efficiency, environment protection, robotics, electronics and so on. There is no underestimating the extent of Japan's soft power, as a peaceful, democratic, very resilient country; its art and popular culture; and its international assistance programme. This soft power is very underutilised at the moment. Last but not least, at a time when China's emergence is redrawing the regional and global power maps, a strong Japan confident in its future without any aggressive nationalism can, and should, be a very important factor for regional and international stability. But this requires Tokyo to find a sounder basis for its relationship with China, aimed at lowering tensions over the Senkaku/Diaoyu Islands. Japan also needs to improve its perennially uneasy relationship with South Korea.
Until now, the widespread perception of Japan has been that it is a nation in decline. The success of Abenomics will be crucial to establish the notion that "Japan is back". However, a country cannot expect to matter significantly on the world stage if it does not have a national vision. Ever since Japan achieved its post-war goal of becoming a top economic power, it has been lacking any national vision. The dismal political context of the last 10 years did not help. Mr Abe's return to power and his ambition to make Japan "a great country" offer this possibility. But he should stick to his reformist goals if Abenomics is to successfully revitalise the economy. Finally, he must watch out for nationalistic initiatives and/or rhetorical excesses that might create a more difficult regional and international environment for Japan.
The writer is president of Smadja & Smadja
https://twitter.com/ClaudeSmadja
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