Japan: the nuclear, economic fallout

The tragedy of last month’s earthquake and tsunami in Japan has been immense for the Japanese people, but its effects, nuclear and economic, will also be felt in other parts of the world.

Just as the human suffering after the 11 March earthquake and subsequent tsunami in Japan’s north-eastern region of … was initially underestimated, so was the effect the crisis would have on the wider world.

First estimates of the damage caused by the catastrophe in monetary terms have tripled and the Japanese government now puts the rebuilding costs at $309 billion. This would make it the most costly natural disaster in history, according to the Economist. 

The cost is, of course, not only a reflection of the size of the disaster but also mirrors the relative wealth of the country where it occurred. The 2004 tsunami in the Indian Ocean, which killed 250,000 people and devastated wide areas in the region, did not even figure in the Economist’s statistics, because it mainly affected poor people.

While the practice of using dollar amounts to measure the effect of a crisis may therefore be of very little comparative value and seem cynical in the face of the loss of lives and human suffering, it does give some indication of Japan’s ability to cope with the disaster in economic terms.

Despite a contraction of 1.3 per cent in the final quarter of last year Japan’s economy grew 3.9 per cent in 2010. Given the size of the destruction the International Monetary Fund expects a drop in Japan’s economy in the short term, but said it would not have a long-term impact.

“Despite the extensive damage we are of the view that the economic costs are manageable,” Ken Kang, the IMF’s Asia Pacific chief, noted.

$309 billion represents approximately 6 per cent of the Japanese GDP. Compared with the CI$2.8 billion of damages caused by Hurricane Ivan, the equivalent of 183 per cent of Cayman’s GDP at the time, the assumption of a swift economic recovery may not seem far-fetched.

Japan’s ability to cope

While Japan’s share of the global economic output has dropped considerably over the past two decades, it still stands at 9 per cent, which makes it significant enough for any decline in the Japanese economy to be felt globally.

But economists tell us that people, impressed by the images and news of devastation, tend to overestimate the impact of natural disasters that are often localised events, only affecting a small part of a country’s economy.

As economic thinking goes, history of comparable disasters shows that a short-term drop in production is generally recovered relatively quickly, in particular in a country that is as rich as Japan. In the medium term this would also benefit the rest of the world as Japan’s demand for imports ultimately increases.

Disasters provide the impetus for new infrastructure spending and the adoption of new technologies, which lead to improvements in total factor productivity, researchers Mark Skidmore and Hideki Toya from the Universities of Wisconsin and Nagoya found in a 2002 paper.

According to this somewhat perverse logic, countries may at times in fact be better off replacing something that is destroyed than maintaining something that is not, albeit of course only in economic terms.

An important factor for the country’s ability to cope is that Japan has experience with this type of disaster as the rebuilding after the Kobe earthquake in 1995 showed. In Kobe the destruction was measured at $200bn and despite a sluggish economy, Japan appeared to take the rebuilding efforts in its stride with a stoic resolve that could also be witnessed in this year’s disaster.

The economic effect of the second largest earthquake to hit a developed urban area was small and industrial production output recovered to pre-disaster levels within 15 months. Japan’s economy at the time registered a single quarter of economic decline.

The area hit by the disaster this year contains fewer people and is by comparison more agricultural. Japanese investment bank Nomura calculated that the three prefectures that were affected most only contribute 3.6 per cent to Japan’s economy. 

Although a fiscal stimulus package can be expected to be larger than that for the rebuilding of Kobe this time around, it should be feasible if spread over several years. The government announced it had $16 billion available immediately to kick-start reconstruction.

Given the country’s huge amount of public debt – Japan has the worst public debt position of all developed countries – another $300 billion becomes hardly relevant, some observers argued. However, credit default swaps, instruments to insure against default, for Japanese sovereign debt became immediately more expensive and indicates that in the long-term the cost of maintaining Japan’s huge debt burden will become more expensive.

However, Japan has the second largest foreign reserves, after China, at $1 trillion and most of Japan’s state debt is held domestically. Japan’s domestic savings rate is also very high and should provide the resources needed to begin reconstruction.

The Bank of Japan reacted swiftly to the crisis by pumping money into the system and buying government and corporate debt to prevent the evolution of an economic crisis into a monetary one.

Meanwhile Japan’s currency appreciated and the soaring yen reached a record high against the dollar. This is no doubt a danger for the country’s export-dependent economy. In a concerted effort the Bank of Japan and the G7 countries had to intervene in the currency markets to stabilise the yen.

In the medium and long term, Japan’s central bank will play a crucial role in maintaining a cheap enough yen to support exports and fight deflation and increase domestic spending at home.

In the short term some initial obstacles will have to be overcome for a recovery to take place.

Supply chain

Most importantly is the disruption of supply chains, resulting from the shut-down of manufacturing plants especially in the electronics and automotive industry. Well-known Japanese multinational companies are halted in their tracks, either because their own suppliers are affected or due to the rolling electricity black-outs in the country and limited transport systems.

Japan’s car industry, which accounts for 10 per cent of the country’s economic output, has stalled as suppliers are unable to deliver key parts and components. 

Japan is also one of the world’s largest producers of intermediate goods, which means that supply chains were not only disrupted at the national level but also worldwide.

How long it will take to bring the factories back online will largely depend on the full return of electricity supplies and transportation routes.

The nuclear question

According to the IMF it is crucial to restore power supplies, as the country was forced to introduce rolling power cuts for the first time since World War II, further weakening the production of goods. Even power cuts of only a few hours per day have forced factories, for example in the chemical industry, to shut down completely.

The longer electricity rationing has to be continued, the more depressed the economic production will be. The situation is complicated by the fact that electricity in Western and Eastern Japan is supplied at different frequencies of 60 hertz and 50 hertz. 

“The uncertainties from the nuclear situation and the power interruptions could weigh on the recovery by disrupting production across the country, and by weighing on corporate and household sentiment,” IMF’s Kang said.

But before the problems with electricity capacity can be addressed, it is imperative to deal with the radiation leaks at the Fukushima Daiichi power station. Whether the situation is resolved is far from certain, in part because the information policy of the operating company and the Japanese government has proven unreliable.

Japan has ordered immediate safety reviews at all of its nuclear plants, days after the European Union called for a similar move. Other countries including Germany and China are reconsidering the role nuclear energy plays in their energy strategies, with Germany having taken older nuclear power plants off the grid with immediate effect.

A general widespread backlash against nuclear energy can be expected, which in turn concerns the producers of nuclear reactors such as Toshiba, Hitachi and Mitsubishi.

What is clear already is that the stricken Japanese plants cannot be repaired and will be decommissioned. 

In the long-term this shortfall from Japanese plants and the reduction of the reliance on nuclear energy in other countries will have to be covered by alternative energy sources, potentially increasing the prices for oil and gas.

Commodity prices

As a result, concerns were raised over the impact of the disaster on global commodity prices. The effect, however, is not clear cut.

Immediately after the crisis oil prices dropped because investors believe that demand for oil will slow in line with decreasing output in damaged Japanese factories. 

But economists from HSBC argue that the effect may well be reversed down the line. As the nuclear crisis in Japan’s reactors means that at least some of the 25 per cent of energy provided by nuclear reactors will have to be replaced by a source of alternative, imported energy, demand for oil and gas should rise together with its price, HSBC suggested. 

Demand for iron ore or steel may see an immediate effect of plant shut-downs in the automobile industry for instance, whereas demand for other raw materials in turn should increase in response to the reconstruction.

The net impact on demand for raw materials may thus be negligible in the long term, but certain commodities like oil may rise in price because of the disasters.

Stock markets

In Tokio the Nikkei Index fell nearly 11 per cent in one day alone, but this type of knee-jerk panic selling is commonplace in response to a crisis and rarely due to changes in the underlying value of the companies themselves. In the medium to long term share prices should rebalance.

In fact, despite or better because of its terrible performance for the past two decades, the Japanese stock market had to be considered comparatively good value even before the earthquake struck. After the recent correction the average price/book value of Japanese stocks, with most of the companies trading at the net value of their assets, has made the market even more attractive.

The humanitarian effort

All the talk of an economic recovery should not overshadow that more than a quarter million Japanese are homeless having lost their homes for good and a further 200,000 people had to be evacuated. In some districts even those who have a home don’t have food and a shortage of fuel and electricity have been compounded by the cold weather.

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New vehicles damaged by the March 11 tsunami waters sit lined in a Toyota parking lot at Sendai port, Miyagi Prefecture, northeastern Japan, Monday, March 28, 2011. The earthquake and tsunami and subsequent damage to the Fukushima Dai–ichi nuclear power plant have disrupted the flow of the Japanese auto industry that might affect Japan–imported cars around the world.
AP

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