AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies
IIPSRIPSInstitute for International

The Japan Institute ofResearch Institute for

Policy Studies

International Affairs

Peace and Security

Editorial Advisory Board:

No. 195

Akio Watanabe (Chair)
Masashi Nishihara
Yoshiji Nogami
Taizo Yakushiji

4 April 2014

Editorial Committee:

THE OUTLOOK FOR ABENOMICS’
THIRD ARROW

Taizo Yakushiji
Hisayoshi Ina
Tsutomu Kikuchi
Shujiro Urata andToshiro Iijima
Editor & Online Publisher:Motoshige ItohYoshji Nogami
President, JIIA

Abenomics has aimed to break free of deflation
through a bold monetary policy (the first arrow) anda flexible fiscal policy (the second arrow), andattention in Japan and abroad is now turning
toward its third arrow. To set the Japanese
economy firmly on the path to recovery,
private-sector demand must be steadily expanded
in terms of consumption, investment and exports
and competitiveness improved to boost thepotential growth rate.

The views expressed in this piece are the author’s own and should
not be attributed to The Association of Japanese Institutes ofStrategic Studies.

AJISS-Commentary
The Association of Japanese Institutes of Strategic Studies

Some overseas investors are skeptical of this third arrow. Prime Minister
Abe has declared his determination to break through the solid bedrock that isJapan's regulatory regime, but reforming bedrock-like regulations is no simple
matter. Deregulation is well known to be politically difficult not only in Japan but
in all developed industrialized nations, and the ability of the Abe administration tosee this through will be put to the test.
Many people believe the third arrow to be “a growth strategy,” but it must
be pointed out that this is incorrect; the third arrow of Abenomics is “a growthstrategy to stimulate private-sector investment”. If it were simply a growthstrategy, supply-side policies would come to mind: pursuing regulatory reformand opening markets to more efficiently allocate resources and encourage
innovation.

Adding“tostimulateprivate-sectorinvestment”

includesdemand-side policies as well.
An important point in understanding the Japanese economy at present isthat balance sheet adjustments in the private sector are over. During the “losttwo decades” following the bursting of the economic bubble, households,
companies and financial institutions all suffered from overloaded balance sheets.
However, households, companies, and financial institutions substantially
improved their asset quality during this 20-year adjustment. Put simply, there isan abundance of funds available for investment, in sharp contrast to the situationin the US and Europe, which suffered in the adjustments that took place after theLehman Shock and the euro crisis.
How will these private-sector funds be mobilized to stimulate
investment? This is a key aspect of Abenomics’ third arrow. A breakout fromdeflation is crucial because of the difficulty of stimulating private-sector
investment as long as deflation continues.
Looking at the reforms that the Abe administration has tackled, there aresectors emerging in which large-scale investment can be anticipated. One
typical example is reform of the electrical power system. Large-scale
investments in new power plants and retail business can be expected if electric
power generation and transmission are further segregated and if retail sales areliberalized. Significant developments can already be seen within the purview of

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AJISS-CommentaryThe Association of Japanese Institutes of Strategic Studies

Tokyo Electric Power Company as it is compelled to undertake extensive
reforms.
Japan’s hosting of the Olympics and Paralympics will also provide major
opportunities for private-sector investment. Many companies have begun tothink seriously about what they will do leading up to the 2020 Olympics, and thegovernment is no doubt aware of the importance of encouraging the private
sector’s latent willingness to invest.
The import of demand-side measures has been noted, but it is by nomeans the case that supply-side reforms are inconsequential. In fact, the market
is closely monitoring whether Japan will begin these reforms in earnest. The key
point here will be where these reform efforts are directed.
Drilling head-on into the bedrock of Japan’s regulatory regime will taketime. There should be weak points in this bedrock, however, and it is important toseek out these points for reform. For instance, revamping the labor market isvital, but poses many politically difficult problems. Hopes are thus converging on
approaches that zero in on promoting active roles for women, as a narrower
focus enables more intensive reforms. Limited space precludes an in-depth
examination of these “pressure points” for reform, but corporate tax reform andTPP negotiations are among the more prominent.

Motoshige Itoh is a professor of international economics at the Graduate
School of Economics, University of Tokyo, and he is also a member of Council on Fiscal
and Economic Policy of the Japanese Government.

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