ON APRIL 1, Japan raised the consumption tax from 5 to 8 per cent in the hope of boosting government revenue by 5 trillion yen (S$61.05 billion). It was an important step towards fiscal consolidation for the country with a massive general government gross debt of over 1,000 trillion yen, or 243.2 per cent of gross domestic product.
Fortunately, the Japanese economy is not likely to plunge into recession as it did in 1997, when the consumption tax went up from 3 to 5 per cent. This year, the world economic outlook is good and Japan's banking system is healthy. After a short drop, growth will turn positive in the third quarter, the Japan Centre for Economic Research predicts.
Under Prime Minister Shinzo Abe, the government has pledged to halve the primary fiscal deficit (which excludes interest payments on debt) by next year, and achieve a primary surplus by 2020. But it will not be easy.
According to the International Monetary Fund's Fiscal Monitor 2014, the cyclically adjusted primary deficit will decline from 7.9 per cent of GDP in 2013 to 5.3 per cent in 2015 and to 3.4 per cent in 2019. But the primary deficit will not be eliminated with the higher consumption tax alone. It is imperative that the Japanese government start reducing social welfare spending by cutting down on medical costs and pension payments.
Meanwhile, stock prices have risen, the Japanese yen has depreciated, job offers have increased, and the economy has started to grow again. There is nothing surprising about this, however. The economic recovery is largely a product of a highly expansionary monetary and fiscal policy - the first two pillars of Abenomics.
The Bank of Japan adopted an inflation target of 2 per cent by early 2015 and undertook bold quantitative and qualitative easing last year in order to achieve it. In addition, a fiscal stimulus package of 5.5 trillion yen was introduced to mitigate the negative impact of the consumption tax hike. A record-high expenditure of 95.88 trillion yen was authorised in the FY2014 budget plan.
But the expansionary monetary and fiscal policy is merely a tool to buy time to implement the third and most important component: growth strategy. Policymakers and specialists agree on what is needed.
Japan should bolster investment, fully mobilise the workforce, promote innovation, and integrate more closely into the world economy.
To bolster investment, Japan is considering cutting corporate taxes from 35.64 per cent now to 25 per cent. Japan's competitors have much lower corporate tax rates. China's is 25 per cent, South Korea's is 22 per cent, Singapore's is 17 per cent, and Hong Kong's 16.5 per cent. Japan's corporate tax cut is expected to boost investment and push up wages.
To mobilise the workforce more fully, attention is turning to the under-utilised female segment. Last year, the working-age population (between 15 and 64 years) became smaller than 80 million for the first time in 32 years. More than 25 per cent of Japanese are now over the age of 65.
Japanese women typically leave the labour market after having children, and stay out for about 10 years. Currently, 3.4 million women, or 5 per cent of the working-age population, are unemployed despite their willingness to work.
The government is trying to increase the number of childcare centres to accommodate an additional 200,000 children. The idea is to create the right environment for young mothers to re-enter the labour market.
But even if the female labour force is fully exploited, the number of workers will still continue to decline. Japan will eventually have to turn to the aged but healthy population at home as well as to foreign workers.
Innovation is the third pillar of the growth strategy. Last month, the Japanese government designated two metropolitan areas, one prefecture and three cities as special zones where innovative regulatory reforms will be implemented and tested.
A small city in the west named Yabu has become a special zone for innovative agribusiness. With its population of 26,000, of which one-third is aged over 64, Yabu will embark on the production and promotion of high-quality agricultural goods.
It will do this by bringing together business entrepreneurs, deserted farmlands and aged but physically fit local farmers. Reformist city mayor Sakae Hirose has asked the central government to relax regulations to make it possible for aged farmers to work longer hours, and for corporate entities to buy and sell farmlands.
The last pillar of the growth strategy involves the promotion of regional free trade agreements (FTAs). Being a party to all regional economic partnership initiatives such as the Trans-Pacific Partnership, the Regional Comprehensive Economic Partnership and the China-Japan-Korea FTA, Japan is in a good position to achieve its goal of raising the percentage of FTA-based trade from the current 19 per cent to 70 per cent by 2018.
During Australian Prime Minister Tony Abbott's visit to Japan earlier this month, the two countries agreed in principle on a bilateral economic partnership. This pact will raise Japan's FTA-based trade by 4.44 per cent.
In fact, the growth strategy embodied in Abenomics looks more like "10,000 needles" (as characterised by JP Morgan economist and author Jesper Koll) rather than one big arrow. It consists of many small regulatory changes and incentives.
Ultimately, its success will depend on how the slowly recovering Japanese economy will respond to the acupuncture treatment that Mr Abe and his aides are performing right now.
The writer is professor at the National Graduate Institute for Policy Studies (Grips) in Tokyo, where he is director of the Security and International Studies Programme.