It seems the string of disasters in our part of the world this year is not letting up – the Australian floods, the New Zealand earthquake, and now a massive earthquake and tsunami in north east Japan.
At this stage the full extent of the damage in Japan is unknown, but it is clear it has resulted in a terrible human tragedy.
Right now the focus is on the rescue effort and our thoughts are with the Japanese people and all those affected.
The AMP’s chief economist and strategist, Dr Shane Oliver looks at the likely impact on economic activity, investment markets and Australia.
Economic impact
All natural disasters follow a similar pattern in terms of their economic impact and the Japanese earthquake is unlikely to be any different.
The initial impact is negative as production is disrupted as a result of damage to factories, the power supply, transport infrastructure, confidence, and to homes which means workers are focused simply on survival.
This then gives way to recovery as rebuilding kicks in and production returns to normal.
This was seen in terms of the Kobe earthquake in Japan in January 1995, which claimed 6,434 lives.
Japanese industrial production fell 2.6% that month only to be followed by gains of 2.2% and 1% respectively in the subsequent months.
In fact it’s worth noting while Japan’s GDP fell 0.7% in the December quarter 2004, it actually rose 0.8% in the March quarter 2005 when the quake hit and rose another 0.8% and 1% in the June and September quarters respectively.
It was also seen in the Boxing Day Tsunami in Asia of 2004, with initial negative economic consequences in the areas affected followed by a strong rebound.
In fact it was barely a blip in the Asian growth story at the time.
The initial negative effects from recent floods are now being felt in Australia, but there is good reason to expect a rebound in growth from the June quarter.
The areas most affected by the earthquake account for around 8% of Japan’s GDP.
It is a centre for auto production with Toyota, Nissan and Honda plants being shut down.
Electronics plants have also been affected and damage to fishing and agricultural production is likely to be immense.
That said, given the area directly affected by the earthquake is a smaller part of the Japanese economy than the area affected by the Kobe earthquake in January 1995 it’s possible the economic affect may be smaller this time.
According to Bank of America Merrill Lynch the three worst hit prefectures in the Kobe earthquake accounted for around 12% of Japan’s GDP.
However, it is still very early days in assessing the damage and there are some reasons to be a bit more concerned this time around.
First, it’s the tsunami which has caused most damage this time, wiping away whole towns and parts of cities, as opposed to just earthquake damage to buildings, roads, etc.
This also means the rescue operation may be more involved as will be the clean up before rebuilding can commence.
Some areas may now even be unliveable given the shift in land and sea levels.
Second, as a result of problems at nuclear power stations, the interruption to power supply may be greater and longer than was the case in 1995.
Third, the loss of life this time around is likely to be much greater.
This will have a potentially bigger impact on confidence than was the case in 1995.
Finally, there is a risk of a serious nuclear catastrophe this time around, which if it occurred would result in a far more disastrous impact.
The most likely outcome would seem to be a set back in activity over the next few months – perhaps 2% or so knocked off industrial production – before rebuilding kicks in boosting growth again during the second half of the year.
Post the Kobe quake the rebuilding effort was very quick and efficient and the same is likely this time.
The Bank of Japan has already committed to a “massive” liquidity injection into the Japanese banking system.
This has initially taken the form of increased short term cash injections, but should also include more quantitative easing (i.e. using printed money to buy government bonds and foreign exchange).
Fiscal stimulus is also likely to be announced soon.
There are three bigger issues for Japan though.
Firstly, Japan’s recovery since the GFC has been the most fragile -of the G3, i.e. the US, Europe and Japan.
This was highlighted by the fall in Japanese GDP in the December quarter and much weaker levels for consumer and business confidence. (See the next chart).
The earthquake will likely only add to Japan’s fragility.
More fundamentally is the impact on longer term confidence.
The Kobe earthquake arguably damaged Japan’s national confidence in the 1990s adding to the malaise of the last two decades.
The latest quake may only add to this sense of longer term malaise.
Finally, while price deflation means Japan has plenty of potential for further monetary easing, further fiscal stimulus will add to already very high public debt levels.
Japan’s budget deficit is already 8% of GDP and public debt is around 200% of GDP.
This is way above levels at the time of the Kobe quake and is even far worse than Greece.
Short term it’s easy to finance as the private sector in Japan is a net lender. Longer term it is more problematic as a rapidly aging popula
