Economic Impact of Japanese Earthquake Will Be Felt For Some Time
Cheryl Smith, Ph.D., CFA
As we watched the awesome power and devastation of the Japanese earthquake and tsunami, our attention bounced between concern for the more than 18,000 people either dead or missing, horrified fascination with the evolving control issues at the Fukushima Daiichi nuclear power plant, and concern about the eventual impact on the Japanese and world economies. The appalling immediate and local impact of the tsunami was obvious from the photos and news coverage. Recovery is further complicated by the deteriorating and unknown final status of the nuclear power plant.
The economic effect of natural disasters varies with the type of disaster, the location of the disaster, and the degree of development of the country. By virtue of the speed of the water and height of the waves, the tsunami was significantly more destructive than an equivalent volume of flooding from rivers overflowing their banks or the destruction of a dam. In addition, the tsunami carried seawater rather than freshwater, and as the tsunami’s waters retreated, they left chemicals, salt, industrial wastes, sludge, and raw sewage in their wake. For example, The Wall Street Journal reported that up to forty percent of the farmland in the coastal city of Sendai has been destroyed by the increased salinity and contamination of the soil.
Earthquakes can also be more devastating than river floods or floods caused by the destruction of a dam, because they have a widely disruptive effect on roads, bridges, railroads, and power and telecommunication networks. This effect is complicated by the continuing series of aftershocks, many of which also qualify as major earthquakes. The massive scale of the earthquake greatly increases the probability of further significant quakes throughout Japan. Since the earthquake was centered off the less heavily-populated northeast coast of Japan, the death toll was less than it would have been if it had been near Tokyo, Osaka, or Kobe. Wealthier countries, and more highly developed and industrialized countries such as Japan, can marshal more resources to provide relief and to rebuild, and thus can be presumed to rebuild more quickly than would a more impoverished country.
Fifteen months after the 1995 Kobe earthquake, productive capacity in that city had returned to 98 percent of its pre-quake level, while Haiti was still struggling to reestablish the most basic level of services 15 months after its 2010 earthquake. The concentration of population, manufacturing, and shipping in Kobe resulted in a higher loss of property, buildings, and infrastructure. However, rebuilding in the more rural and less densely populated area hit by the 2011 tsunami will be more difficult and perhaps more expensive on a per capita basis because its victims are more numerous and geographically dispersed, and any particular improvement or rebuilding will benefit fewer people.
Nationally, Japan has the capacity to provide aid to the area, if it has the political will to do so. Monetary policy options are limited, since central bank interest rates are already near zero. Japan’s public debt levels were already high, as a result of Japan’s prolonged economic slump after its real estate crisis in 1992. Prompt and effective reconstruction requires significant spending. Since Japan has struggled to generate sufficient effective demand over the past two decades, this additional spending is unlikely to instigate higher overall inflation in Japan in the short term. Since the population of the immediately affected area is older than the general Japanese population, rebuilding homes and restoring community services will not result in as significant a rebound in production and productivity as was the case in Kobe, so public expenditure on disaster recovery is unlikely to generate any substantial increase in productive capacity and is also unlikely to bring in additional tax revenue. Therefore the addition to debt levels may be long-term. The Organization for Economic Cooperation and Development’s most recent analysis of the Japanese economy estimates that the effect of the earthquake and tsunami on Japanese economic growth will be temporary, dropping from a 3.9 percent growth rate in 2010 to 0.8 percent in 2011, returning to 2.3 percent in 20121, and significantly less than the 20 percent drop in real output as a result of the financial crisis precipitated by the bankruptcy of Lehman Brothers in September 2009. At the end of the first quarter 2011, Japan’s economy had shrunk by an annual rate of 3.7 percent, far worse than the 1.9 percent predicted by economists surveyed by Bloomberg and plunging the country into recession.2
Outside of the immediate impact area, the disaster disrupted the power grid, and much of Japan experienced loss of electricity for at least some time; the loss of electricity further complicated disaster management at the Fukushima Daiichi nuclear power plant. Outside of the impact area, the power grid has largely been restored, so losses in auto and electronics production outside of the immediate area are likely to be temporary. The fishing industry appears to have been more significantly damaged, as the tsunami damaged most of the smaller fishing boats and many of the larger ones; replacing such a significant loss will take time. In addition, as a result of the leakage of radiation from the Fukushima Daiichi nuclear power plant, smaller fish off the east coast of Japan, even those not immediately in the area, are showing levels of radioactive contamination unfit to eat; we can expect that the exposure from these radioactive fish will bioaccumulate over time in larger fish. The fishing industry, like the local agriculture industry, is thus likely to experience significant and extended disruption. The continued lack of control over the fuel rods and containment pools at the nuclear power plant only hinder efforts to restore economic activity. The ultimate size and extent of the safe perimeter area is as yet unknown. While the still unfolding nuclear disaster in Japan has raised anxiety levels, and may delay expansion plans in Asia, in the U.S. the Nuclear Regulatory Commission appears to be focusing on the reliability and duration of backup power supplies in its review of existing nuclear power plants. Overseas, since Fukushima the German government has announced it will phase out its nuclear program, and Italian voters rejected a ballot proposal in June to restart their country’s shuttered nuclear facilities.
Global Impact Limited
Overall, the direct effect on the global economy has been limited so far, with most effects transmitted through disruptions in the supply chain, but even these limited effects may have already been enough to destabilize the already tenuous world economy, and the financial impacts may magnify the disruption. Japan’s imports and exports are approximately four percent of overall world trade, but a much higher percentage of automobiles, chemicals, electrical equipment, semiconductors, and transportation equipment. All of these industries have highly integrated global supply chains. Ironically, the iconic dependability of Japanese production has supported extremely tight, just-in-time inventory management, which has amplified the effect of supply disruptions. Companies reporting lower earnings as a result of the earthquake included Apple, Texas Instruments, and Tiffany’s, while Honda, Toyota, Nissan, and GM have all reported disruptions or factory closings due to a lack of parts produced in Japan with the loss in production estimated at 100,000 cars. Supplies of electronic chips have been disrupted as well. Japan is the second largest importer of oil in the world, importing 5.2 million barrels of oil per day. A number of Japanese refineries have been shut down, which may help moderate the increases in oil prices instigated by political unrest in North Africa and the Middle East. Combined with the political crisis in North Africa and the Middle East, the disruptions in specific industries and uncertainty over the lack of control at the Daiichi nuclear power plant might have been enough to stall the fragile world economy, and indeed, the U.S. economy appears to be softening.
1. “Japan’s Economic Outlook Following the 11 March 2011 Earthquake,” April 21, 2011 at http://www.oecd.org.
2. “Earthquake and Aftermath Push Japan Into a Recession,” New York Times, May 18, 2011.