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Will three arrows find their target?

By Andrew Leigh - posted Thursday, 6 June 2013

In the mid-1930s, John Maynard Keynes coined the phrase “animal spirits” to sum up the impact of a country’s mood on its economic environment. When nations get stuck in a funk, it’s hard to escape. Conversely, when growth gets going, exuberance builds on exuberance (sometimes to the point of creating a bubble). Either way, the sentiments of consumers and businesses can build on one another.

For Japan, the post-war decades are a story of astonishing transformation, as the country transformed itself from a developing to a developed country. By the 1980s, airport bookshelves were filled with tomes about the virtues of the Japanese economic model, with titles like Trading Places: How we are Giving Our Future to Japan and How to Reclaim It and Blindside: Why Japan Is Still on Track to Overtake the U.S. by the Year 2000.

But the past twenty years have been a story of malaise. Hard as it is to believe, the Japanese economy – in nominal terms – is almost exactly the same size as it was twenty years ago. The deflation trap has proved devilishly hard to escape, and net government debt is now more than 140 percent of GDP, the highest in the OECD (Australia’s debt share is one of the lowest).


Yet all this may be about to change, thanks to a policy dubbed "Abenomics" after the country’s new Prime Minister, Shinzo Abe. In a series of recent meetings with senior economic policymakers, I was struck by the positive impact that these policies appear to be having on the national mood.

Prime Minister Abe has identified three strategies to promote growth, which he refers to as his “three arrows”. The reference is to a Japanese legend in which a father shows his three sons that a single arrow can be snapped easily, but three together cannot be broken.

The first arrow is monetary policy. In an effort to break out of deflation, the new central bank governor Haruhiko Kuroda has committed to a 2 per cent inflation target, to be achieved via a massive bond-buying program. The second arrow is fiscal policy, focused particularly on reconstruction efforts after the Tōhoku earthquake and tsunami.

While monetary and fiscal policy can jump-start an economy, productivity growth is what keeps the engine humming along. So Japan’s third arrow – structural reform – is the one that matters most for enduring economic growth. While previous Japanese governments have typically shied away from major trade liberalisation, Prime Minister Abe has stated that a hallmark of his administration will be pursuit of the Trans-Pacific Partnership, a free trading zone in the Asia Pacific. In Australia’s case, a study by the Productivity Commission’s Dean Parham estimated that half of our productivity growth in the 1990s was due to our trade liberalisation. Japan could reap a similar reward.

Other reforms that people spoke about with me included encouraging more start-up firms, expanding the availability of child care in order to boost female labour force participation, and improving the efficiency of the service sector.

For Australia, the payoff from a growing Japanese economy is considerable. As the government’s Australia in the Asian Century White Paper noted, Japan is our second-largest trading partner and our third-largest source of foreign direct investment. We provide them with minerals, agriculture and energy; they provide us with manufactured products and foreign investment. The Australian and Japanese economies are remarkably complementary. At senior levels, there is a keen awareness that Prime Minister Gillard was the first foreign leader to visit Japan after the 2011 earthquake. Following the Labor Government’s Asian Century White Paper, all Australian high school children will soon have the opportunity to learn Japanese.


Japan’s nascent recovery could still go awry, as the recent downtick in the Nikkei has reminded us. The consumption tax has been legislated to rise from 5 percent to 10 percent by 2015. Demographics remain a serious concern, with the population due to shrink from the current 128 million to 95 million by 2050.

And yet for now, it is pleasantly surprising to see the general enthusiasm with which Abenomics has been embraced. Keynes’ animal spirits are alive and well in Tokyo, and for now, the three arrows seem to be flying towards their mark.

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This article was originally published in the Australian Financial Review on 4 June 2013.

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About the Author

Andrew Leigh is the member for Fraser (ACT). Prior to his election in 2010, he was a professor in the Research School of Economics at the Australian National University, and has previously worked as associate to Justice Michael Kirby of the High Court of Australia, a lawyer for Clifford Chance (London), and a researcher for the Progressive Policy Institute (Washington DC). He holds a PhD from Harvard University and has published three books and over 50 journal articles. His books include Disconnected (2010), Battlers and Billionaires (2013) and The Economics of Just About Everything (2014).

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