Japanese Earthquake: The Cost to the Economy

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Unfortunately, earthquakes and Tsunamis have a much larger human toll than economic. And that is likely to be true in Japan as well.

Still, the 8.9 magnitude earthquake and resultant Tsunami that hit Japan near the city of Sendai on Friday comes at a time when that country’s economy was already vulnerable. The Japanese economy was hard hit by the US recession and as of the fourth quarter of last year was still shrinking. The US’s economy, by contrast, was growing again, up 2.8% in the fourth quarter. Some had expected the Japanese economy to finally follow the US and begin expanding again in the first quarter. There is a strong chance now that that recovery will be delayed. What’s more, Japan already runs large budget deficits. And there is a question as to whether it will be able to come up with the money to pay for the clean up.

Nonetheless, the area of where the quake hit, the nature of Japan’s economy coupled with the economics of natural disasters is likely to mean that despite the physical damage, the financial impact of Friday’s earthquake will be minimal in Japan, and indeed in the rest of the world. Here’s why:

First of all, the good news is that the quake hit in a Northern part of Japan that is not very populated. The area around Sendai, which was the city closest to the quake, is mostly depressed farmland. There are some factories there, including a number that make car parts for Toyota. Still, analysts estimate that the area that was effected accounts for less than 2% of the Japanese economy overall.

Of course, like in the case of Toyota and car manufacturing, one plant shutting down could have ripple effects on other plants that use those parts. One interesting sidebar to the economic impact of the quake was that the success that Japan has had with just in time manufacturing could come back to haunt the country, especially if it finds itself with few inventories, and problems with transporting goods.

Still, even if Japan’s manufacturing capabilities are weakened that might not matter than much over all. Like the US, the bulk of Japan’s economy these days is driven by services, and increasingly healthcare. Manufacturing accounts for only 20% of the Japanese economy, according to Michael Smitka, an economics professor at Washington and Lee University who has studied Japan and the auto industry. “The area has some manufacturing, but while manufacturing is important, it’s not the be all end all of the country’s economy,” says Smitka.

Another factor in Japan’s favor is that, unlike the US, it exports more than it imports. That means much of the demand for Japanese goods comes from outside the country. And there is no reason to believe demand from other countries would drop because of the earthquake.

Lastly, earthquakes in general tend not to be that economically devastating in the long haul. Confidence is a major driver of economic activity. When consumers and companies get nervous they spend less and that can cause recessions. But earthquakes tend not to cause big hits to consumer confidence. That’s because earthquakes are specific events and the scope of the damage is usually known pretty quickly, if not the eventual cost. SARS, for instance, caused much more economic damage than say the Indonesian Tsunami, because the fear of the disease caused months of stalled travel and uncertainty. People just didn’t know what they were dealing with.

In fact, estimates now are that if anything the Indonesian economy grew slightly faster than it would have in the wake of the Tsunami. Chile’s economy is stronger a year after the quake than it was 12 months ago. That’s because in the wake of a natural disaster billions of dollars of economic aid gets spent on clean up and reconstruction. Some are worried that Japan, which had already embarked on an effort to reduce its deficit, doesn’t have the economic power or political will to spend billions on a clean up. Here’s what economic forecasting firm IHS Global Insight had to say:

Although the main concentration of industrial Japan appears unaffected, the extent of the infrastructural damage will be severe. The earthquake and tsunami could also negatively impact on the country’s economy while exacerbating the country’s ballooning public debt issues, as spending by the Tokyo government will spike to carry out emergency response measures.

But Japanese interest rates, which are one measure of whether people are willing to lend money to the country, are actually lower than interest rates in the US. And the rate on 10-year Japanese bond actually fell on Friday. Officials have already said that a $2.4 billion emergency response fund was available. But that’s probably just the beginning of what the country will spend.

For the rest of the world, the economic impact looks muted as well. Oil actually fell on the news of the quake. That’s because Japan makes very little oil, but is a big importer. If the economy weakens, that would mean less demand for oil from Japan, which would be good for the US. Rising oil prices have been a growing worry for the US economy. After a mostly down week on Wall Street, stocks rose on Friday, up nearly 60 points.