The scale of the earthquake and tsunami that struck Japan in March was far greater than even the authorities’ worst scenarios foresaw. Nearly six months later, the total damage remains difficult to estimate. Social unrest and confusion, as well as radiation leaks from the Fukushima Dai-Ichi nuclear power plant, continue.
Now the country has absorbed another huge blow: another downgrade of its bond ratings. Both Moody’s and Standard & Poor’s now rate Japanese bonds at only their fourth-highest level.
So what policies should be implemented in response to these economic blows?
Last year, Japan’s economy grew at a relatively healthy 3 percent annual rate, higher than in the US or the EU, owing mainly to the fiscal expansion undertaken after the collapse of Lehman Brothers in 2008. Growth this year had been predicted to slow even before the earthquake. Indeed, the economy shrank by 3.5 percent year-on-year in the first quarter.
Now, with so much fixed capital and infrastructure destroyed by the earthquake and tsunami, the economy’s productive capacity has fallen by an estimated 2 percent of GDP. However, that may not be a bad thing: Prior to the earthquake, Japan had a demand-supply gap of approximately 5 percent of GDP. While reducing this gap to 3 percent of GDP has led to higher prices, this is exactly what Japan needs after years of persistent deflation.
Meanwhile, higher public spending on capital investment and other special procurements will boost domestic demand. The Hanshin earthquake in 1995 destroyed capital stock worth 2 percent of GDP. This time, the loss is estimated at 3.4 percent of GDP, implying a larger increase in domestic demand if the right public policies are pursued.
On the downside, confidence among consumers and investors alike has taken a hit, mainly owing to fears about radiation leakages and power shortages. According to the Japan Center for Economic Research, power-supply disruptions could negatively affect the Japanese economy for the next three years. If the Tokyo metropolitan area’s power supply were to decrease by 10 percent this year, for example, Japan’s GDP would fall by 2 percent.
Soon after the disaster, the government announced that reconstruction demand and higher prices would bring about relatively rapid economic recovery. I think this view is too optimistic, because I suspect that the government wants to finance its new expenditure with a tax hike. Moreover, the extremely sharp contraction in first-quarter GDP may indicate that the disaster’s negative impact on the economy was more significant than expected.
Indeed, the economy is expected to have shrunk by another 2.6 percent year-on-year in the second quarter, with growth set to resume only between July to this month. And, contrary to the government’s outlook, the start of economic recovery could be delayed until the end of this year, with medium-term annual growth reaching 1.5 to 2 percent.
A key question has been the disaster’s impact on global supply chains. According to Japan’s Ministry of Economy, Trade and Industry, which surveyed firms roughly a month after the earthquake, more than 60 percent of production sites in affected areas had already recovered as of April 15. Almost 30 percent expected to recover by the summer, and the remaining 10 percent foresaw normal operations after the autumn.