It is still too early to talk precisely about the economic effects of the 2011 Tohoku Earthquake, as there are some hard-to-predict “X-factors” that can affect the performance of the Japanese economy. However, economic theory and the historical experience in Japan and elsewhere are quite useful when we conjecture about the future performance of the Japanese economy. I will focus on the long-term effects in this article, as the direct or immediate effects of the earthquake (e.g., property damage, shortage of food, water, and fuel in the affected region) are clear and have been widely reported on in the media.
Standard economic theory offers a clear prediction about the long-run performance of the Japanese economy. As large as it is (5 to 7 percent of Japan’s GDP), the earthquake-related property damage is mostly temporary shocks to the economy, and temporary shocks are unlikely to affect the long run trajectory of economic growth.
Of course, there are a few scenarios in which temporary shocks can be important. The first scenario is the so-called coordination failure in which firms expect that consumers and business partners are too poor to purchase their products and act on this expectation by choosing not to re-build their businesses. The second scenario is that the affected businesses and households might have difficulty in obtaining financial capital for re-building. Both of these scenarios are theoretical possibilities that can slow down the speed of economic recovery; however, they are likely to be of secondary importance in the long run, when one considers how the Japanese economy responded to similar or even larger shocks in the past.
For example, the Allied Bombing of Japanese cities (1944 to 1945) did not alter the performance (or even the industrial structure) of the affected cities in the long run. More recently, it took a little over one year for the industrial production of Kobe, one of the major cities destroyed by the Great Hanshin Awaji Earthquake in 1995, to bounce back up to the pre-earthquake level. Even outside of Japan, the long-run economic effects of natural disasters tend to be very small in developed countries (although we are less confident about the effects of similar shocks in developing countries where economic shocks can have serious adverse effects on political stability).
Although standard economic theory and a set of relevant historical experiences offer an optimistic picture for the future performance of the Japanese economy, there are some X-factors that are specific to this particular incident. One potentially important X-factor is on the supply side. The ongoing Fukushima nuclear accidents can have highly unpredictable effects on the politics of energy policy in Japan (and perhaps elsewhere) in the long run. The weakening public support for nuclear energy, which satisfies a quarter of Japan’s energy consumption, might force Japan to rely more on alternative energy sources which can be just as socially expensive as nuclear energy, if not more.
The other X-factor is on the demand side. The earthquake happened to hit the deflationary economy where the fiscal health of the government is already weak and the nominal interest rates are virtually zero. Monetary stimulus that usually work through interest rate reduction and exchange rate depreciation are likely to be less potent, and thus fiscal stimulus might be particularly important. The limited fiscal space, however, might make the government more cautious about applying much-needed fiscal stimulus to the economy. A few days ago, there was a (fairy radical) idea that the government ought to finance extra earthquake recovery-related spending via selling “earthquake emergency bonds” to the Bank of Japan. This could have stimulated inflationary expectation (and thus lowers nominal interest rates and the value of yen). However, the Japanese government rejected it out of its concern about fiscal discipline for the time being.
Imai is an Associate Professor of Economics and Director/Chair of the Mansfield Freeman Center for East Asian Studies
Leave a Reply