Hard blow to Japan economy

China Daily, March 25, 2011

The death toll in the devastating earthquake and tsunami that hit Japan on March 11 rose to 9,487 on Wednesday, and 15,617 people were still missing. The twin natural disaster damaged the Fukushima Daiichi nuclear power plant, too, triggering a radiation scare. The triple disaster, as the media are calling it, especially the radiation threat, has affected the Japanese economy because many foreigners - tourists and workers both - have been leaving Japan in a rush. Fears are now being raised that the economy could even suffer long-term damage.

The Great Hanshin earthquake (or the Kobe earthquake) on Jan 17, 1995, killed about 6,400 people and caused an economic damage of about 10 trillion yen ($100 billion), or 2.5 percent of Japan's GDP then. But the March 11 quake is estimated to have killed more people and caused more damage than the Kobe earthquakes. In fact, the Japanese government says it could cost $309 billion. This is particularly surprising because the GDP of Kobe and Osaka (Hyogo and Osaka prefectures) is more than two times the size of Japan's northeast region(Iwate, Miyagi and Fukushima prefectures)that was devastated by the March 11 quake and tsunami.

The March 11 quake and tsunami destroyed power plants in the coastal areas, too, though they were designed to withstand even massive quakes. The resultant disruption in power supply in the Tokyo metropolitan area has thrown industrial production out of gear. The chairman of the Federation of Economic Organizations has said that the semiconductor sector is expected to suffer heavily because semiconductors cannot be produced under rationed electricity supply. Moreover, a delay in the production of manufacturing parts and related products in the Tokyo metropolitan area will hamper production in other areas.

The effects of the triple disaster on small- and medium-sized enterprises (SMEs) will be huge. Many large enterprises have established business continuity management systems to maintain business activities even in the face of natural disasters or to recover from them as soon as possible by repairing the damage and procuring manufacturing parts from non-regular sources. But SMEs don't have enough funds or resources to have such systems in place. Besides, if they fail to deliver in time they can lose their business.

All these raise the fear of recession in Japan, because although the devastated area in proportion to the entire economy is relatively small, the indirect damage, such as reduction of business activities in the Tokyo metropolitan area, is huge.

The impact of the triple disaster on the Japanese economy will change with the passage of time. In the short term, the economy may see a strong growth because of the rising demand for the civil engineering industry and the construction sector, including their related sectors, during the reconstruction and rehabilitation phase. But after that, that is, in the long term, the economy could face depression. There are three principal reasons for that.

First, much of private capital in Japan's northeastern coastal area has been lost. So the crippled companies have no choice but to depress their production, and will thus drag down the GDP.

Second, many companies are likely to shift their operations, including manufacturing, from Japan to other countries. Large domestic enterprises and foreign companies are more likely to do so, given their international networks. Such a phenomenon was witnessed after the 1995 Kobe quake. A fast recovery in the northeastern coastal areas is not expected also because on the supply side, voluntary or temporary firms are likely to replace the existing ones.

Third, the destruction caused by the triple disaster will require the government to arrange for massive funds and resources to fuel economic recovery. For example, the central and local governments spent 16.3 trillion yen for economic recovery after the Kobe quake. But since the damage to infrastructure, such as roads, ports, power plants and supply lines, and farmland is far greater and more widespread this time, the costs of recovery and rehabilitation will be many times more.

The government may have to issue large numbers of bonds to finance the costs. The relatively high percentage of savings in Japan will certainly help the government to get a big part of the funds from the domestic government bond market. But if they prove inadequate, the government may have to get the extra money from foreign financial markets at high interest rates.

After the Great Kanto earthquake in the Tokyo metropolitan area in 1923, killing more than 100,000 people, the Japanese government issued government bonds in foreign markets at higher interest rates than in the domestic market to get the funds for reconstruction and rehabilitation. But if the government were to do the same this time, it would increase its financial burden just like it had done in 1923.

In conclusion, fiscal action for reconstruction and recovery this time would boost the Japanese economy in the short term because of an increase in the demand for construction and related industries. But in the long term, it would be difficult for the economy to sustain the upward trend.

Indirect damage caused by the shortage of electricity, fleeing of foreign companies, and the damage to the supply chain and production capacity will worsen the economic outlook. Moreover, the fiscal burden accrued from massive fiscal expenditure may have further negative effects on the economy.

Hence, the triple disaster is expected to depress the Japanese economy in the long run.

The author is an assistant professor of economics at Meikai University, Japan.