Having seen its ranking in the world economic league table slip from second to third behind the US and China, Japan was reminded in dramatic fashion of its critical importance still to the Asian and global economy when much of the country’s industrial production was crippled in early March by a massive earthquake and tsunami plus a nuclear disaster.
The double natural disasters – a record magnitude 9.0 earthquake and a tidal wave that in places towered nearly 50 feet high – damaged or destroyed much of Japan’s most sophisticated IT-related and other high-tech industry situated along the country’s north-east coast of the Tohoku region.
In what the Organization of Economic Cooperation and Development (OECD) has called “the worst disaster in Japan’s post-war history”, the tsunami knocked out a six-reactor nuclear power complex at Fukushima, creating a nuclear emergency that persists to this day. Together with damage done to other power plants, this triggered power shortages and blackouts that threaten to stymie industrial output for a considerable time.
As Asian Development Bank president Haruhiko Kuroda told Emerging Markets in a Tokyo interview shortly after the triple calamities occurred, Japan is at the very heart of “Factory Asia” – a complex system of regional production networks and supply chains.
When production in many Japanese firms ground to a halt in the days following the disasters, as a result of earthquake or tsunami-inflicted damage and destruction – as well as through power shortages in the eastern part of the country – the regional and even global implications of Japan’s plight began to be revealed.
Japanese automobile giants such as Toyota, Honda, Nissan, Mazda, along with many of their myriad parts suppliers, as well as electrical and electronics majors such as Panasonic, Toshiba and Sony – again along with their suppliers – were unable to resume production even where plants had not been damaged. Electric power was not available.
Toyota announced on April 25 that it does not expect to return to pre-disaster production levels until the end of this year. The motor giant’s production lines are currently working at only half volume in Japan and 40% overseas because of supply chain disruptions caused by the March 11 earthquake and tsunami; production is expected to pick up only gradually during the remainder of 2011.
GLOBAL DISRUPTION
The effects rippled across the world, affecting Japanese firms’ subsidiaries in the US, Latin America and Europe. But this was only half the story: those Japanese prefectures worst hit by the earthquake and tsunami (Iwate, Miyagi, Fukushima and Ibaraki) are home to production of sophisticated items such as semi-conductors, silicon wafers, resins and other products, some of which are scarcely manufactured elsewhere.
The reason for this concentration (apart from Japanese know-how), says chief economist Kyohei Morita at Barclays Capital in Tokyo, is because of the abundance of clean sea water and even cleaner air on Japan’s Pacific coast. It makes the region almost uniquely suitable for certain types of high-tech industrial production.
Many of the items produced there are essential to the motor industry worldwide, and it was not long before non-Japanese automakers such as General Motors in the US and some in Europe began halting their production lines or reducing output in the light of the Japanese output bottlenecks.
So too did electronics and vehicle manufacturing firms across Asia – in China, Taiwan, South Korea, Singapore, Thailand and elsewhere. Trade ministers from Japan, China and South Korea expressed concern at a meeting in Tokyo in late April at what they said were likely to be extended interruptions to production in all three countries caused by problems with supply chains in the wake of Japan’s disasters.
By the end of April, no end to this problem was in sight. All hinges on when Japan can restore electricity supplies to industry, let alone clear mountains of rubble and begin rebuilding damaged and destroyed factories and infrastructure.
The Japan-centred production networks developed in east Asia “are important and must be maintained”, Kuroda told Emerging Markets. “But at the same time companies must recognize the production risks in one part of the network could affect the entire network. They must establish alternative sources of supply,” he said.
Getting a handle on just how far Japan’s industrial disruption will eventually affect the regional and global economy is not easy. It could take a year or more to “build a data base that enables an accurate assessment to be made”, the ADB’s newly appointed chief economist Changyong Rhee tells Emerging Markets.
The ADB has begun work on such an undertaking, as has the Paris-based OECD, and the IMF is expected to launch a similar exercise. Japan’s cabinet office and the Ministry of Economy, Trade and Industry (METI) will also be assessing damage to production networks.
But for now, most analysts remain in the dark as to how far the disruption to production networks will spread, and how long it will go on for.
A Japan already darkened at night by electric power saving ordinances could be plunged into greater darkness as the summer approaches with maximum demand for air-conditioning.
An initial plan by the Tokyo Electric Power Company (Tepco), operator of the crippled Fukushima complex, as well as by other tsunami-hit utilities such as the Tohoku Electric Power Company, to impose “rolling blackouts” to spread the pain of power cuts around Japan’s eastern half was abandoned.
But this happened only after Japan’s leading business federation known as Keidanren agreed with the government on behalf of Japanese industry to voluntary restraints on output to conserve power. Operating hours and days will be “controlled” (restricted) across industry sectors and companies, company vacations will be staggered and enforced, and some production will be shifted.
POWER SHORTAGES
Few if any reliable estimates exist yet as to precisely how long these power shortages will last.
Hiroshi Watanabe, president of the Japan Bank for International Cooperation (JBIC) tells Emerging Markets that in his estimation it could take up to two years before electric power supplies are fully back to normal in the east of Japan.
Nobua Tanaka, head of the UN International Energy Agency, estimates that Japan has a sufficient number of idle or de-commissioned fossil-fuel electricity generating plants to replace the output of Fukushima and other tsunami-damaged power plants. However, bringing them back on-stream would be time consuming and costly.
Ironically, there are relatively abundant supplies of electric power in the west of Japan, which was not affected by the natural disasters. However, power there is generated at a different frequency to that on the east side and can only be transferred through provision of banks of costly new transformers – again taking time to construct.
Here, as in the case of production network damage assessments, prime minister Naoto Kan’s government has had little chance to produce reliable forecasts of how long the electrical emergency will last, because it has had its hands full dealing with almost daily emergencies elsewhere.
Along the ravaged north-east coast of Japan, some 14,000 bodies have so far been recovered, and a similar number of people are still listed as missing. Some 26,000 people have been rescued and put into temporary shelters, and there are mountains of debris to be removed before the mammoth task of rebuilding roads, bridges, railways, factories and homes can begin.
This says nothing of the continuing battle to prevent a total meltdown of damaged fuel rods in the stricken reactors of the Fukushima Number One or “Daiichi” complex, which has alarmed the entire world. It has kept some government ministers labouring almost around the clock to prevent a calamity and to evacuate and temporarily house nearly 100,000 people living within a 20km radius of the power station.
Given these extreme conditions, estimates of the final impact on Japan’s economy remain as uncertain and wide-ranging as those relating to the impact on electric power output and industrial production – in Japan and elsewhere.
The estimates range from quite strongly positive to equally strongly negative. For example, the ADB’s chief economist forecast – shortly after the March 11 disasters – that Japan’s real GDP would expand by around 1.5% in 2011, or close to pre-quake forecasts. However, he has since revised this to nearer 1.1%.
The IMF too is on the upper side of most predictions with its forecast of 1.4% growth in Japan during 2011, only slightly down from a pre-crisis forecast of 1.6%. The OECD, however, has cut its growth forecast for Japan in 2011 to 0.8%, which is around the same as that forecast by the Institute of International Finance (IIF) in Washington.
At the lower end of the scale, JBIC’s Watanabe says Japan would be lucky to escape negative GDP growth this year, while Goldman Sachs suggested in the immediate aftermath of the March 11 disasters that the Japanese economy could suffer a contraction of around 2.5% in 2011.
An assumption by many economists outside Japan has been that, while Japanese output would sink sharply in the second quarter of this year, it would rebound sharply in the second half of the year on the back of reconstruction spending, leading to a respectably positive outcome for the year as a whole.
Such assumptions were based on Japan’s experience after the Great Hanshin earthquake of 1995. In the case of the Great Hanshin (or Kobe) earthquake, however, there was no tsunami to inflict massive secondary damage, nor was there a nuclear crisis to disrupt electric power supplies and to hobble Japan’s industry and exports.
The same wide variations that characterize the forecasts for Japan’s economic growth in the aftermath of the quake, tsunami and nuclear crisis also apply to calculations of how much the triple Japanese disasters will cost to fix.
All that can be said with any degree of certainty is that these costs will be very large. The World Bank has suggested that the cost of remedying the damage will be anything from $122 billion to $235 billion, or 2.5–4% of Japan’s annual GDP, while OECD secretary-general Angel Gurría suggested on a visit to Tokyo in April that the cost could be as high as 5% of GDP.
WORLD’S MOST EXPENSIVE DISASTER
The Japanese government (cabinet office) has estimated damage from the earthquake and tsunami at ¥16–25 trillion or $190–295 billion. The upper of these two estimates would make it the world’s costliest natural disaster, ahead even of Hurricane Katrina in the US.
The Japanese government estimate covers damage to roads, homes, factories and other infrastructure, but excludes lost economic activity from power outages and costs arising from damage to the Fukushima nuclear power plant, as well as the impact of swings in financial markets and business sentiment.
Japan’s central government has said it expects to pick up the lion’s share of the tab, so that local governments in the hardest hit areas will not have to shoulder an excessive burden. But this raises the question of how a government, whose outstanding debt to GDP ratio is already at a record 200%, can take on more debt.
In the view of the OECD’s Gurría, Japan’s fiscal position is already at a “critical” point, and the government must find ways to finance economic recovery that do not rely on creating more debt if a potentially dangerous rise in long-term bond yields is to be avoided. There is relatively little room to cut government spending in Japan, so taxes must be raised, the OECD says.
The most likely candidate for tax hikes is Japan’s national sales or consumption tax, which is levied at a rate of only 5% but which the OECD believes must rise as high as 20% to get Japan’s fiscal house properly in order. Japan has a window of opportunity to begin raising consumption tax now while the public mood favours levies to cover reconstruction costs, the OECD believes.
The Bank of Japan has pumped some ¥40 trillion of special liquidity into Japan’s financial system in the wake of the crisis – equal to around 10% of GDP, or roughly one-fifth of the central bank’s balance sheet. But the Bank of Japan remains opposed to going further and underwriting the issue of special reconstruction bonds or regular government debt issues to take the pressure off bond yields and long-term interest rates.
So far as property damage is concerned (118,000 buildings were damaged and 15,000 destroyed by the quake and tsunami), the amount of insurance pay-outs in Japan is expected to be around ¥1 trillion or $12.2 billion – “it’s the highest such pay-out in Japan’s history,” Rei Masunaga, a former vice-president of the Japan Centre for International Finance, tells Emerging Markets.
However, late-April estimates by some of the world’s leading insurers and reinsurers suggest that they will have to foot a considerably larger bill. Risk modelling agency RMS reckons the total insured loss at between $21 billion and $34 billion, while Eqecat is looking at $12–25 billion and AIR Worldwide at $20–30 billion, respectively.
Whatever the final outcome and costs of Japan’s mega disasters, they seem certain to have a lasting impact on the global energy market.
The ADB, in its most recent Asian Development Outlook, noted that: “To the extent that Japan’s unfolding nuclear crisis raises long-term worldwide concerns about the safety of nuclear energy, it may precipitate a structural shift in the global energy mix.”
The IIF was blunter in its assessment: “The Fukushima disaster is a curse for the [global] nuclear industry,” it said. “The political backlash is already evident in environmentally sensitive countries such as Germany.” Japan has meanwhile frozen, for the moment, plans for an ambitious expansion of its nuclear power programme although others such as the United States and China seem undeterred.
PILING ON THE PAIN
In an irony for Prime Minister Kan, the boost to Japan’s agricultural exports he was hoping to achieve through efficiency-boosting reforms to the protected agricultural sector may not now materialize. This could mean that Japan’s bid to join the Trans-Pacific Partnership, an Asia-Pacific free trade agreement, may lapse if Japan cannot liberalize imports of agricultural produce. In that case, plans to reduce or abolish high tariffs on food imports in return for offering farmers subsidies may also lapse.