Japanese Prime Minister Shinzo Abe’s program for hiscountry’s economic recovery has led to a surge in domestic confidence. But towhat extent can “Abenomics” claim credit?

Interestingly, acloser look at Japan’s performance over the past decade suggests little reasonfor persistent bearish sentiment. Indeed, in terms of growth of output peremployed worker, Japan has done quite well since the turn of the century. Witha shrinking labor force, the standard estimate for Japan in 2012 – thatis, before Abenomics – had output per employed worker growing by 3.08% year onyear. That is considerably more robust than in the United States, where outputper worker grew by just 0.37% last year, and much stronger than in Germany,where it shrank by 0.25%.

Nonetheless, as manyJapanese rightly sense, Abenomics can only help the country’s recovery. Abe isdoing what many economists (including me) have been calling for in the US andEurope: a comprehensive program entailing monetary, fiscal, and structuralpolicies. Abe likensthis approach to holding three arrows – taken alone, each can be bent; taken together, none can.

The new governor ofthe Bank of Japan, HaruhikoKuroda, comes with a wealth of experience gained in the finance ministry,and then as President of the Asian Development Bank. During the East Asiacrisis of the late 1990’s, he saw firsthand the failure of the conventionalwisdom pushed by the US Treasury and the International Monetary Fund. Not wedded to centralbankers’ obsolete doctrines, he has made a commitment to reverse Japan’schronic deflation, setting an inflation target of 2%.

Deflation increasesthe real (inflation-adjusted) debt burden, as well as the real interest rate.Though there is little evidence of the importance of small changes in realinterest rates, the effect of even mild deflation on real debt, year afteryear, can be significant.

Kuroda’s stance hasalready weakened the yen’s exchange rate, making Japanese goods morecompetitive. This simply reflects the reality of monetary-policyinterdependence: if the US Federal Reserve’s policy of so-called quantitativeeasing weakens the dollar, others have to respond to prevent undue appreciationof their currencies. Someday, we might achieve closer global monetary-policycoordination; for now, however, it made sense for Japan to respond, albeit belatedly, todevelopments elsewhere.

Monetary policy wouldhave been more effective in the US had more attention been devoted to creditblockages – for example, many homeowners’ refinancing problems, even atlower interest rates, or small and medium-size enterprises’ lack of access tofinancing. Japan’s monetary policy, one hopes, will focus on such criticalissues.

But Abe has two morearrows in his policy quiver.Critics who argue that fiscal stimulus in Japan failed in the past – leadingonly to squanderedinvestment in useless infrastructure – make two mistakes. First, there is thecounterfactual case: How would Japan’s economy have performed in the absence offiscal stimulus? Given the magnitude of the contraction in credit supplyfollowing the financial crisis of the late 1990’s, it is no surprise thatgovernment spending failed to restore growth. Matters would have been muchworse without the spending; as it was, unemployment never surpassed 5.8%, and,in throes of theglobal financial crisis, it peaked at 5.5%. Second, anyone visiting Japanrecognizes the benefits of its infrastructure investments (America could learna valuable lesson here).

The real challengewill be in designing the thirdarrow, what Abe refers to as “growth.” This includes policies aimed atrestructuring the economy, improving productivity, and increasing labor-forceparticipation, especially by women.

Some talk about“deregulation” – a word that has rightly fallen into disrepute following the global financialcrisis. In fact, it would be a mistake for Japan to roll back its environmental regulations, orits health and safety regulations.

What is needed is theright regulation.In some areas, more active government involvement will be needed to ensure moreeffective competition. But many areas in which reform is needed, such as hiringpractices, require change in private-sector conventions, not governmentregulations. Abe can only set the tone, not dictate outcomes. For example, hehas asked firms to increase their workers’ wages, and many firms are planningto provide a larger bonus than usual at the end of the fiscal year in March.

Government efforts toincrease productivity in the service sector probably will be particularlyimportant. For example, Japan is in a good position to exploit synergiesbetween an improved health-care sector and its world-class manufacturingcapabilities, in the development of medical instrumentation.

Family policies,together with changes in corporate labor practices, can reinforce changing mores, leading to greater(and more effective) female labor-force participation. While Japanese studentsrank high in international comparisons, a widespread lack of command ofEnglish, the linguafranca of international commerce and science, puts Japan at adisadvantage in the global marketplace. Further investments in research andeducation are likely to pay high dividends.

There is every reasonto believe that Japan’s strategy for rejuvenating its economy willsucceed:  the country benefits from strong institutions, has awell-educated labor force with superb technical skills and design sensibilities,and is located in the world’s most (only?) dynamic region. It suffers from lessinequality than many advanced industrial countries (though more than Canada andthe northern European countries), and it has had a longer-standing commitmentto environment preservation.

If the comprehensiveagenda that Abe has laid out is executed well, today’s growing confidence willbe vindicated. Indeed, Japan could become one of the few rays of light in anotherwise gloomy advanced-country landscape.