Large, but (probably) temporary, impact on the Japanese economy; small impact on the rest of the world
It is still too early to tell what the full impact of the March 11 earthquake, tsunami, and growing nuclear crisis on Japan’s infrastructure, industrial base, and economic growth will be—let alone the broader global impacts. Nevertheless, past natural disasters and disruptive events (the Kobe earthquake of 1995, 9/11, and Hurricane Katrina in 2005) give us some idea of the likely economic effects (and timeline) of this horrific event. The economic impacts of these events are typically large for a quarter or two after the event, and are mostly concentrated in the region of the disaster. After about two quarters, however, growth is boosted by the reconstruction effort. At the national level, the impact on economic growth is usually noticeable but small (a few tenths of a percent). In the case of Japan’s most recent calamity, given the damage to the electricity power generation capacity, the impact on economic growth could be greater.
The following is IHS Global Insight’s preliminary analysis of the impact on Japan and the rest of the world.
- The scene of devastation along Japan's northeastern coastline is staggering, and it is believed that despite the country's preparedness efforts, tens of thousands lost their lives.
- Although the physical destruction largely occurred away from Japan's industrial core, considerable near-term macroeconomic disruption should be anticipated. Aside from the impact on the workforce, supply chains are affected, power may be rationed, and government finances will be stretched.
- The near-term impact on Japanese growth is likely to be negative and potentially quite large. However, by the end of this year, the reconstruction effort is likely to get under way and provide a substantial boost to growth.
- The big uncertainty about this disaster (and what sets it apart from other such disasters) is that roughly 10% of electricity generation capacity (both nuclear and coal) may be offline for a few months, until oil- and gas-fired plants can ramp up. In the near term, this could have major negative ramifications for Japanese industrial sectors; some steel and automotive factories have already been closed.
- In an attempt to forestall financial panic, the Bank of Japan has already pumped about $250 billion worth of liquidity into the Japanese economy.
- Meanwhile, the fiscal cost of this disaster to Japan has been conservatively estimated at $200 billion. Despite concerns about Japan’s already-high debt levels, financial markets are likely to take a benign view of the Japanese government's reconstruction spending.
- Based on very crude and preliminary estimates, IHS Global Insight estimates that Japanese real GDP growth could be cut by 0.2–0.5 percentage point this year and boosted by 0.5–1.0 percentage point next year. If the nuclear crisis turns into a full-blown catastrophe, then the negative effect on growth this year will be much larger.
- The good news/bad news is that Japan has not been an engine of global or Asian growth for some time. This means the impact of much lower Japanese growth on the world economy probably will be limited and small.
- The major transmission mechanisms of the earthquake and tsunami on the rest of the world will be via trade flows; however, since Japan’s exports and imports are a relatively small share of GDP, the economic shock waves will be weak.
- Given the disruptions in Japanese industrial activity, the impact on global supply chains could also be significant. This is especially important in industries such as autos, telecommunications, and consumer electronics.
- Nevertheless, the global impact on this event may not be all negative. Lower Japanese growth could also lower world energy demand and prices, albeit temporarily.
- Disruptions in Japanese automotive and steel production may result in a boost in the demand for these products from other sources, including the rest of Asia, the United States, and Europe.
- Rough estimates suggest that the negative impact on global growth this year will be negligible—at most in the 0.1–0.2% range, with a correspondingly small boost to growth next year.
- Worries about the impact of Japanese private-sector investors (insurance companies, etc.) liquidating U.S. treasury holdings seem a little overblown. In such a scenario, the yen would likely appreciate. This is the last thing the Japanese government and the Bank of Japan (BoJ) would like to see. Therefore, a sell-off of U.S. treasuries by the private sector in Japan would likely be offset by purchases by the BoJ.
- Foreign trade linkages are a key channel through which Japan's earthquake will affect the United States. Japan's share of U.S. exports is small, so a weakening in demand from Japan would have little impact on the U.S. economy overall, and reconstruction demand should ultimately boost exports. On the import side, though, an interruption of Japanese supplies could disrupt production, especially for Japan's U.S.-based auto plants.
- Far less easy to quantify is the potential damage to confidence, especially for a fragile consumer. Sentiment fell sharply in early March because of the recent surge in oil prices amid turmoil in the Middle East. The Japanese earthquake, with extreme uncertainty over the extent of the nuclear disaster there, may add to a sense that global events are spinning out of control. This can make consumers—and, perhaps, businesses—more fearful, which can lead to postponement of decisions to purchase or hire. Such reactions to natural disasters are usually short lived, but we cannot yet know when events in Japan will stabilize.
- In 2010, the United States exported $60.5 billion in merchandise to Japan, 4.7% of total U.S. exports. That means merchandise exports to Japan represented 0.4% of GDP, which is very small. There is likely to be some initial disruption, but as reconstruction efforts gather pace, one would expect exports to Japan to rise, rather than fall.
- In services trade, the United States exported $41.4 billion to Japan in 2009, 8.2% of services exports and 0.3% of GDP. Of this, $16 billion represented travel, passenger fares, and transportation, which would be vulnerable to disruption.
- On the import side, the United States imported $124 billion in merchandise from Japan in 2010, 6.4% of total U.S. imports. That is equivalent to 0.8% of GDP.
- By far the biggest share of imports is in motor vehicles and parts ($46 billion in 2010), split into passenger cars ($32 billion) and parts ($14 billion). The second-most important sector for imports was in high-tech equipment, where imports of computers, computer accessories, semiconductors, and telecoms equipment were $12 billion in total in 2010.
- In cases where supply chains rely on Japanese parts, there will be disruption to U.S. production. The U.S. operations of Japanese automakers are the most obvious example. Ideally, they would like to gear up U.S. operations to replace imported vehicles that will not be arriving, but if crucial parts made in Japan are unavailable, they will have to cut production instead. Any other U.S. activities reliant on imported components from Japan, such as semiconductors, are also vulnerable to disruption.
- Some domestic producers will gain due to substitution effects. If Japanese-brand vehicles are in short supply, that will shift demand to other brands. If domestic parts can be substituted for Japanese parts, then demand for domestic auto parts suppliers will rise. But even non-Japanese U.S.-based producers may source some supplies—such as electronics—from Japan.
- The overall impact on European growth should be limited. Japan is not a huge export market for most European countries, although any impact to global growth would obviously have an effect. In 2009, Asia as a whole accounted for 7.3% of German exports, 6.6% of French, 5.6% of Italian, and 8.1% of United Kingdom.
- If the impact on Japanese growth will be limited in the near term and there is some boost to growth further out from reconstruction work, then Western European growth will not be significantly effected.
- The main concern for Western Europe is that the economic climate is still pretty fragile, with overall recovery from the deep 2008/09 recession being gradual overall and bumpy so far. Therefore, it is more vulnerable to shocks than would be the case if it was in the middle of a robust upturn.
- Germany is the most export-oriented Eurozone economy, so it may be hit more than most. But German growth is showing clear signs of becoming more broadly based due to elevated employment and improving wage growth, so it is likely to hold up better than if this had happened a year ago. The direct trade impact is not that large, as Japan provides less than 3% of German imports and Japan buys just over 1% of total German exports. Export and import shares of other large European economies to Japan are roughly the same or smaller than Germany’s.
- Indirect effects via the dampening impact on intra-Asian trade could be larger. Roughly 54% of Japanese exports go to other Asian countries, and 45% of Japanese imports come from Asia. The time factor will be critical. Any extended period of much-reduced trade activity between Japan and the rest of Asia (notably China) will also inhibit German exports to non-Japan Asia.
- Most of Japan's manufacturing base has not been directly affected either by the earthquake or the tsunami, so disruptions to intra-Asian trade as a direct effect of productive capacity loss are likely to be limited. For countries relying on energy exports to Japan, such as Australia and Indonesia, events in Japan may in fact provide a small opportunity if some of Japan's energy needs, previously met by nuclear energy, are redirected toward thermal coal or gas. In such an event, Indonesia stands to benefit more, as Australia's mining sector already operates close to full capacity, apart from still recovering from the effects of the Queensland flooding (though most of the flood-related damage was done to coking coal mining, not thermal).
- The biggest unknown at this point remains the possibility of factory shutdowns due to insufficient electricity supply (as opposed to facility damages). Current expectations are that blackouts will phase out by the end of April, but should they continue beyond that point or become more severe, there will be detrimental effects on Asia's integrated manufacturing cycles. In this respect, while South Korea, Taiwan, and Thailand do not have an excessive export dependence on Japan (roughly 6%, 7%, and 12%, respectively), a much larger share of their imports come from Japan (approximately 15%, 21%, and 20%, respectively). These countries are, therefore, more vulnerable than others to sustained disruptions in Japanese output. At the same time, any hits to output due to such temporary factors should not be outright GDP losses for the year as a whole, since they probably can be compensated for during the second half of the year. Hong Kong may experience similar issues, though probably of a lesser degree.
- There will be little impact on India's economy, seeing not only that its economy relies little on exports, but also that only about 3% of India's exports go to Japan. Other South Asian economies are also unlikely to be much affected by the Japan disaster given their lesser trade exposure to Japan. Vietnam does export more to Japan (roughly 12% on average over the past three years), but these are mostly agricultural and low-value-added goods, such as textiles, that are not integrated from a production perspective and demand for which is expected to remain stable. Moreover, Vietnam's fish exports may benefit from the hit to Japan's own fishing industry in the tsunami-affected area.
- Reconstruction efforts in Japan will contribute to upward price pressures on commodities such as cement, steel, etc. China and India have been the epicenters of regional demand for construction materials over the past couple of years, but demand from Japan is now due to increase. There may also be a slight increase to food prices, yet the impact may be obscured by the overall expected moderation in food prices across the region, as supplies of vegetable and grains are improving.
- The direct demand impact on China should be relatively muted. Japan only accounted for 7.7% of China's goods exports in 2010 ($121 billion out of $1.58 trillion). With goods exports representing 27% of China's GDP, all of China’s exports to Japan account for 2% of the Chinese economy.
- Japan's supply-side impact on China is more substantial, however. A little less than 13% of China's goods imports come from Japan ($177 billion out of $1.39 trillion), and much of those are capital goods and parts for manufacturing assembly, especially in electronics. As imports represent 22.9% of China's economy, Chinese imports from Japan account for 3.4% of China's 2010 overall output.