Japan can bounce back

After the tragedy

Now that the totally unexpected nuclear disaster in Japan seems to be slowly coming under control, we can have a cold look at the economic after-effects of the devastation that Japan has suffered as a result of the 8.9 scale earthquake, followed by tsunami and then nuclear accidents at power plants. More than 20,000 people have been feared dead.

The World Bank estimates the damage to the economy (not counting the cost of lives lost and human sufferings) to be anywhere between $122 bn and $235 bn as against $100 bn cost of the January 1995 Kobe earthquake (6.8 scale) in Japan which killed more than 6,000 people. Kobe is a densely populated major port city which was economically more important than the more sparsely populated north-eastern costal areas where the recent tragedy struck.

Japan’s industrial production fell 2.6 per cent in January 1995, rose 2.2 per cent in February, then by another 1.1 per cent in March 1995. GDP growth was 1.9 per cent in 1995 followed by 2.6 per cent in 1996 which was above the country’s trend growth rate of 1.5 per cent at that time. So, going by past experience, though there would be an immediate negative impact, the recovery process would start soon. The full recovery where all the ravaged areas would be completely rebuilt may take longer — about 5 years — according to World Bank estimate.

As for immediate effects, Japanese exports and imports were affected as a result of disruption to transportation, distribution and other logistics. India sends only about 2 per cent of total export of goods to Japan — so the effect on Indian exports was not large.

India also does not depend on imports of any crucial raw materials from Japan. Japan produces about 40 per cent of the world’s supply of lightweight microchips used in flat-screen monitors, digital music systems, smart phones, tablet computers, etc. Chip prices globally went up immediately by 25-30 per cent due to disruption of the supply chain.

Rather surprisingly, the price of yen moved up within a few days of the disaster. Analysts explain this to be the result of insurers buying yen to pay insurance claims, Japanese bringing back funds from abroad to rebuild their lost physical assets and speculative investors buying stocks of Japanese companies that would gain from the future reconstruction activities.

To halt the appreciation of yen which would have hurt Japanese exports and pushed back the recovery process (from prolonged recession) in Japan and consequently global recovery, both Bank of Japan and G-7 central banks immediately intervened to sell huge quantities of yen to meet the rising demand. As a result, yen fell against dollar to the lowest level since 2008.

Demand for oil &  natural gas

Price of oil and natural gas is surging and is expected to go further up as Japan, facing shortage of power from nuclear plants, will have to use more fossil fuel. This comes on top of the increasing political uncertainty in the major oil producing countries. As many countries (including India and China) will delay the construction and commissioning of new nuclear power plants as a result of additional safety precautions following the Japanese nuclear accident, the reliance on oil, gas and coal will increase in the medium term.

If the high price of fossil fuel persists, this will give a boost to alternative energy industries like solar, wind and bio-fuel. Rising energy costs would increase prices further and may also slow down growth in oil-importing countries (like India), though Japan would grow faster than before due to massive reconstruction investment.

Japan is a major source of ODA (official development aid). ODA funds of more than $2 bn per annum has been flowing from Japan into India in recent years. This flow (mostly in Indian infrastructure sector) may be delayed as funds get diverted to domestic rebuilding activities and charity at home. FDI from Japan into India (like in transportation, consumer electronics) may not be affected as these are based on longer term considerations. If Japanese growth rate picks up, a larger fraction of global portfolio funds may, however, move to Japan in search of quick returns from construction-related  sectors.

The public debt-GDP ratio in Japan is highest among the developed countries. This public debt burden would definitely increase as Japan will have to run a bigger deficit to finance the reconstruction activities. Yet, Japan should be able to borrow from the market, without a significant rise in interest rate, given the high private savings rate in Japan and the faith of the world in the resilience of the Japanese industrial machine.

The theory of economic growth says that if physical capital is destroyed by war or natural disaster while human capital (in the form of knowledge and skills) remains in tact, the productivity of remaining physical capital goes up. This, in turn, raises the growth rate of GDP till capital stock comes back to its old level through investment in physical capital.

The miracle growth of post-war Japan is often cited as evidence of this theory. The same may be the case for Japan in its post earthquake-tsunami reconstruction phase, as we watch, in admiration, the discipline of the Japanese people in its hour of massive national tragedy.

(The writer is a former professor of economics at IIM, Calcutta)

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