For all the pain and angst suffered by the Japanese over the last several months, this ongoing disaster and its ripple effects do offer them at least one source of smugness.
The world — obsessed with the new — had for years glibly dismissed Japan as a part of the past, preferring instead to enthuse over China and other emerging economies.
But now, like the old man in the workplace, ignored until he stops doing his job, this horrible disaster has made clear Japan's still critical role in the global supply chain and the global economy.
Still, if smugness can offer some satisfaction, it cannot generate electricity or staff factories. And Japan now needs to do both. The questions are: How soon, if ever, will Japan recover its former productive role and how will the shock of this disaster change its economy's long term direction?
Too much uncertainty remains to make any precise forecast on timing. Even now, three months after the first quake struck, questions remain about when, or if these reactors can resume generating electricity, as some have already have. Neither is the extent of damage to the reactors yet clear, nor is the severity of radioactive contamination. Since these reactors have several layers of containment shielding, even the cracked one hides the full extent of damage. Without some notion on these fronts, no one can gauge how fast rebuilding can begin.
Even after rebuilding begins, it will take years to ascertain exactly how bad things got. At Three Mile Island, for instance, it was five years after the disaster ended that the Nuclear Regulatory Commission could open the containment vessel completely to discover that during the trouble, half the nuclear fuel had melted and done so quite quickly. Of course, the delay at Three Mile Island was welcome, as it would be in Japan if a situation similarly severe has occurred at Fukushima. Those same containment vessels that hide the information also protect. They were the reason why Three Mile Island avoided contamination and death and why, so far, it seems, Japan has avoided the severe contamination and death associated with the Chernobyl nuclear accident in 1986 where there was no containment vessel.
Still, despite the huge remaining mystery, it is possible to draw some broad conclusions about economic and financial prospects for Japan and the rest of the world. It is certainly clear that the immediate shuttering of much commercial and industrial activity in Japan will drive down economic activity there in the second quarter and possibly in the third as well. It is also clear that the repercussions of this economic interruption will almost certainly crimp economies elsewhere that use Japan as a supply source — though for them, the economic shortfall will not likely turn growth to decline. It also seems likely, contrary to commonly held beliefs these days, that one way or another the supply chain problems will quickly dissipate. But after such immediate effects, Japan will rebuild and faster than the consensus of opinion presently expects, and this crisis has the potential to alter the fundamental directions of the Japanese economy. Each phase of renewal has its investment implications. However, a change in economic direction would open a number of investment opportunities in retailing, for instance, not typically associated with Japan.
Japan's economy has already felt the practical weight of this tragedy. The Tohoku region produces just under 9% of Japan's overall national output. Beyond that, Japan has lost some 25% of its electric generating capacity, extending the adverse economic effects far beyond the region immediately affected. Many factories cannot run as actively as they would like. Transportation links have broken down or have suffered disruptions, slowing the shipment of goods and the movement of people to and from work. The shock of events has also understandably set back consumer and business confidence, causing cutbacks in spending, hiring and business expansion plans generally. As these effects continue to play out, all major economic gauges will likely pause or decline. Accordingly, the consensus forecast for real Japanese growth has gone from a meager 1.5% rate of expansion in 2011, to a modest 0.4 % dip. Some prominent Japanese forecasters worry about a 1.5% drop in real economic activity.
Japan's impact on the rest of the world seems to have arrived more in detail than generally. In aggregate, Japan simply no longer carries the weight it once did to rock the global economy. It presently amounts to less than 9% of world GDP, far below the almost 18% it constituted at the time of the Kobe earthquake in 1994. Japan's slow growth rate in past years makes it even less significant to the global growth picture. The International Monetary Fund (IMF) estimates that Japan, during the past five years, had contributed a mere 1.0% to overall real global growth. The removal of such an influence would hardly be noticed. But if aggregate effects mean less, the particulars of certain supply chains will give Japan's immediate troubles an outsized global impact.
This effect will lie mostly in electronics and automobiles. The nation produces 60% of the world's silicon wafers; 90% of the BT resin essential in printed circuit boards; 60% of the air flow sensors so important in modern autos; one-fifth of the world's semiconductors; almost 17% of its consumer electronics; and over 6% of its larger-size LCD panels and a larger percentage of LCD components. Of course, the disaster affects only a part of this production, but still, it is significant enough to interrupt global production rates in these areas.
An even bigger burden will fall on autos, where Japan has dominated for decades. There are already reports of how parts shortages have forced slowdowns or shutdowns in Toyota and Honda plants in Japan, the United States and elsewhere around the world. Even General Motors and Chrysler, who at first glance would seem to benefit from the misfortunes of their Japanese rivals, report a need to slow production for fear of outrunning the Japan-based inputs they have on hand, or even American-based inputs that in turn depend on Japanese production.
Industry sources predict that for at least a while, auto production may fall by one-third, but for the year as a whole, consensus seems to have settled on an overall shortfall of about 7% — not an insignificant figure, especially when most of the ill effects are concentrated in just the next quarter or two.
Prospects for Supply
Still, as acute as some particular supply chain problems seem, a broader consideration of the situation suggests that the effects may not last as long as some fear. Already, energy-short factories in Japan, at least those outside the area of immediate danger, have restarted operations with temporary power sources, such as portable diesel generators. While jerry-rigged operations are not a lasting answer, they can fill enough of the gap to keep factories running and supplies flowing. The hiatus, of course, will undoubtedly last long enough to do damage but nothing from which the Japanese and global economies cannot quickly recover.
The supply interruption and substitutions may, however, have a strangely perverse impact on energy and commodity demands. Though the interruption in Japanese commerce and industry has immediately reduced world energy and commodity demands, the effect may reverse very soon. Japan is so efficient, in energy especially, that any substitute production, particularly if based in the emerging economies, will almost certainly use more energy and other commodities, than if production could have remained in Japan. Further, a shift in sourcing out of Japan will move production to places more reliant on fossil fuels to generate electricity than the highly nuclear Japan. If, as history shows, the substitute supply links stick, the heightened oil and commodity demands may well linger with obvious upward pressures on prices. Shipping also will likely become less efficient, as it adjusts to substitute supply sources. Unlike fuel demand, however, if the substitute sources hold their business, shipping would eventually adjust and shed the immediate inefficiencies and pricing impacts.
However this immediate disruption works out, there can be little doubt that Japan will rebuild and likely much faster than many now anticipate. After the Kobe quake, for instance, which so many at the time claimed would set back Japan's economy for years, even decades, the local economy and the port rebuilt sooner than any projected. It reached 98% capacity only 15 months after the first tremors of that quake.
Though the still unresolved nuclear questions will delay rebuilding this time, certainly compared to Kobe, the economic issues hinge less on full recovery than on its start. As soon as Japan can stabilize the nuclear situation, it will almost surely move forward with a massive effort — first to clean up and then to construct new generating facilities, either on the affected site or nearby or both. As this push develops, Japan's economy will substitute a stimulus for today's immediate shortfalls, so much so, in fact, that Japan during this time will offer the world economy more of an engine of growth, than in a long time.
Consensus figures point to an economic growth pace of 3.5% to 4 % in Japan during this phase of events — very strong by Japanese standards. Though it is uncertain when the effort can begin, some of this effect seems likely by the fourth quarter at the latest.
Once the rebuilding effort gains momentum, construction activity in Japan will soar, with all the associated ripple or multiplier effects. Aside from increasing Japan's demands for fuel, commodities and materials, the effort will also raise demands for construction equipment. Japanese rebuilding efforts may well rely exclusively on Japanese equipment, especially if run by the government. But there is only so much capacity, leaving room for American and European producers to make inroads in third markets left by the Japanese producers as they become fully absorbed in their country's increasing domestic demands.
Similar opportunities will emerge in mining, as well as in oil and gas extraction equipment, especially if Japan and other countries turn away from nuclear power.
Finance & Politics
Of course, the question of finance haunts any Japanese rebuilding effort. Insurance companies will at most pick up $20 billion to $30 billion of the estimated $200 billion-plus rebuilding cost. However, most of it will fall on Japan's government, which, as the world already knows, is deeply in debt. Japan's gross public debt exceeds 200% of the economy's GDP, far higher than any other developed nation, including even the shaky nations on Europe's periphery. Against such a burden, some have questioned whether Tokyo has the wherewithal to finance a rebuilding effort that effectively would amount to some 2% to 3% of its GDP. Some of the rating agencies have already threatened downgrading in the face of the additional debt.
But as precarious as the financial situation may seem, there are at least four reasons why such doubts about rebuilding are misplaced: First, it is essential for the country's prosperity, leaving government with little choice but to rebuild if it wants to stay in power. Second, this spending will likely spread out over two to three years, making for more incremental — though not insignificant — additional annual credit demands. Third, Japan's gross debt burden ignores the government's substantial liquid wealth in financial investments abroad and substantial foreign exchange reserves, mostly held in U.S. treasury bills and notes. Fourth, about $50 billion of this fiscal year's budget, set before the disaster, consisted of make-work construction projects. By shifting these monies toward more economically productive rebuilding, Tokyo will cover much of rebuilding's annual cost without much additional financial strain and to much better economic effect.
The government should also have no trouble selling the additional debt. Some 95% of Japan's debt is held by its citizens, who will be even less likely to balk now in the face of an emergency. Besides, it is clear that the only way Japan can meet its public debt obligations — large or small — is with a vibrant economy, and that requires rebuilding. Rather than fret over such spending and even the debt incurred to do it, existing bond holders would seem likely to welcome it as the best way to ensure that the country can meet its future interest and principal payments. If the rating agencies — wedded as ever to their rigid and mechanical algorithms — cannot see this, then their judgments are even more suspect than they already seem and perhaps betray a fundamental misunderstanding of the nature of public finance and debt generally.
But if the financing is likely easier than it appears, this setback still raises more fundamental, economic issues. For two decades, while Japan's economy has suffered deflation and near stagnation, the authorities in Tokyo have failed to implement needed fundamental economic reforms. Their failure is that much more profound because it is clear to all how Japan must change. Its aging population demands that it shift from an export-driven to a consumer-driven economy. When one-fifth to one-quarter of a nation's population exceeds 65 years of age, it is impossible to remain the workshop of the world. With a limited workforce, it also must innovate more and depend less on big industrial conglomerates. Government, industry and academia insiders are aware of Japan's need to move in these directions. But, politics has prevented much reform.
Now, this great crisis — the worst since World War II, according to many in Japan — may well provide an opportunity for these long sought after, fundamental changes. Given the disappointing performance of Japanese politics, the odds, even after such a shock, remain long. But there is a chance that the relatively newly-elected Democratic Party of Japan may see such moves as a way to make its mark and secure future power.
If Japan's leadership can use the crisis as a way to overcome the resistance that has stymied reform for over 20 years, then a range of new business and investment opportunities could open in services, retailing and small capitalization firms, more than in the massive exporters with which that economy has long been associated. If a reformed Japan uses its superior training to leverage the labor and natural resources of the rest of Asia, then opportunities could also open in design, consulting and of course, finance — an area otherwise dormant for a long time. But it all hinges on the leadership's willingness to make the change.
Milton Ezrati is the senior economic strategist at Lord Abbett
and affiliate of the Center on Economic Growth in the Department
of Economics at The State University of New York at Buffalo.
Register or login for access to this item and much more
All On Wall Street content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access