For more than two decades before Shinzo Abe became Japan’s prime minister second time round, Japanese governments had set out no comprehensive strategy for economic reform that took account of the country’s new position in the world. Japan’s economic performance suffered. Its international diplomacy seemed adrift.

These are the so called ‘lost decades’. It was not just that economic growth stagnated and that Japan slipped down the rankings among advanced economies. There was a malaise in the country that saw people turn inward and lose confidence in Japan’s place in the world.

Whatever anxieties there may be about Mr Abe’s stance on a range of matters from domestic freedoms to the history issues with Japan’s neighbours, his new administration brought a bold plan that sought to break out of the mould of national defeatism and to restore confidence in the Japanese economy and its people.

Abe’s three arrows economic reform program and his reclamation of Japan’s international standing are both works in progress. There are still some long-lasting problems that confront him.

The reforms that are needed to deliver higher economic growth in Japan are largely domestic: they have to do with fixing problems in the public and service sectors that are in large part a consequence of a rapidly ageing society. Social benefits, the health sector, the pension system, taxation, and migration policy are all areas that need change.

But there is also an important international dimension to the structural reforms that Japan needs, related to how Japanese firms can best realise opportunities in the global economy. Currently, the ratio of Japan’s trade (exports plus imports) to GDP is only one-third of Germany’s, and services trade as a proportion of GDP is low, with relatively slow growth. The share of foreign investment in Japan is lower than that in any other advanced economy.

At a time when China went from accounting for 3.5 per cent of Japan’s total merchandise trade to being by far its largest trading partner with a share of more than 20 per cent, there was very little proactive policy change in Japan toward China during the period 1990–2010. The remarkable shift in Japan’s trade relations occurred despite continuing political tensions with China. The bilateral trading relationship is now the third largest in the world and is continuing to grow.

Japan’s domestic circumstances also infected the psychology of economic diplomacy and foreign policy. Foreign and security policy have not adapted to Japan’s new circumstances. Whether this will be sustainable in the long term given Japan’s deeper economic interdependence with China’s growth is the critical question.

Read the whole article at East Asia Forum.

Image by Futureatlas.com on Flickr under the CC BY 2.0.